H&R Block Still Haunted By Subprime Mortgages

(MoneyWatch)  Despite shedding its money-losing mortgage operations to focus on its tax business, H&R Block is still haunted by collapsing real-estate prices. As of the second-quarter ended October 30, the largest provider of U.S. tax preparation services held approximately $812 million in residential loans purchased from former mortgage loan affiliates, Option One and H&R Block Mortgage, net $63.7 million in allowance for loan losses, according to its recent 10-Q regulatory filing:

• We recorded a provision for loan losses on our mortgage loans held for investment of $23.1 million during the current quarter, compared to $9.8 million in the prior year. Our loan loss provision increased primarily as a result of abrupt and steep declines in residential home prices, particularly in certain states where we have a higher concentration of loans. Our allowance for loan losses as a percent of mortgage loans was 7.27%, or $63.7 million, at October 31, 2008, compared to 4.49%, or $45.4 million, at April 30, 2008. This allowance represents our best estimate of credit losses inherent in the loan portfolio as of the balance sheet dates.
• Loans 60 days past due are considered impaired. Impaired loans at October 31, 2008 and April 30, 2008 totaled $150.8 million and $128.9 million, respectively.

At October 31, management anticipated a fiscal 2009 year-end default rate of about 15 percent. Actual charge-off rates would be higher, but in some cases the company has granted concessions to some borrowers experiencing financial difficulties, modifications known as troubled debt restructurings (TDR). At October 31, TDR loans totaled $110.9 million, up from $37.2 million at April 30, 2008.

Of the loans purchased from former affiliates, Florida and California represent 19 percent and 17 percent of the total portfolio, with respective delinquency rates of 12.2% and 19.1 percent. In addition, mortgage loans currently held as investments represent 15 percent of total assets. Consequently, if residential property values continue to deteriorate and mortgage default rates trend higher, H&R Block would be required to record additional loan loss provisions -- adversely impacting forward earnings results. As Michael Corleone (Al Pacino) said in The Godfather: Part III: "Just when I thought I was out-- they pull me back in."

This post first appeared in the BNET Insight blog 10-Q Detective.