Mortgage Loans | H&R Block Surges As Chief Says Firm Can Handle Mortgage Refunds

September 5, 2010 – 7:50 am

H&R Block Inc. , the tax preparerwhose stock slid 18 percent last month, told investors to ignorespeculation that it faces a surge in costs tied to its defunctmortgage business. The shares rose the most in more than a year.

Concern about potential losses tied to buybacks of homeloans “is not based on fact,” and reserves to protect thecompany against claims “are adequate,” Chief Executive Officer Alan Bennett said yesterday during a conference call aboutfiscal first-quarter earnings. The call included repeatedqueries about claims, which have totaled more than $680 million.

“There’s nothing that we’re seeing anywhere that wouldlead to the kind of phone calls we just listened to other thanspeculators that, in my mind, have probably sold our stock shortand then stirred this up,” Bennett said in an interview afterthe call. Mortgage buyback claims “are getting better,” hesaid.

H&R Block, the biggest U.S. tax preparer, originatedmortgages through January 2008, and some were sold to becomepart of mortgage-backed securities. Buyers have the right todemand refunds if the loans are later found to have been basedon false or missing information, and losses for the biggest U.S.home lenders may total $179 billion, according to Compass PointResearch and Trading LLC.

H&R Block has repurchase reserves of $188 million forpotential losses on faulty mortgages, interim Chief FinancialOfficer Jeffrey Brown said during the conference call.

‘Adequate’ Reserves

The company’s mortgage buyback liability “remains withinour reserved expectations, and we continue to view relatedreserves as adequate,” Brown said.

“As of right now, they’re not seeing the claims,” David Burtzlaff , a Dallas-based analyst with Stephens Inc., said todayin a telephone interview. “I’m still concerned that they maysee more claims in the future. If they don’t, the stock probablywill move higher. It’s been pushed down because of this fear.”

Shares of H&R Block rose 73 cents, or 5.8 percent, to$13.30 at 4 p.m. in New York Stock Exchange composite trading,the biggest one-day gain since June 2009. They have declined 41percent this year, the second-worst performance in the Standard& Poor’s 500 Index.

‘Word on the Street’

“Word on the street” was that the Kansas City, Missouri-based H&R Block was among the recipients of 64 subpoenas issuedby the Federal Housing Finance Agency in July that soughtinformation on mortgage buybacks, Michael Millman , founder ofMillman Research Associates, said yesterday on the conferencecall. Bennett said he “can’t comment as to speculation.”Millman had a “buy” rating on the stock.

The FHFA oversees Fannie Mae and Freddie Mac, which buy andsell mortgages from originators. They’ve been sustained by U.S.aid since being placed under federal conservatorship inSeptember 2008, and are under pressure from Congress to recouplosses from soured mortgages.

Credit-default swaps to protect against losses on H&R Blockbonds for five years surged 274.2 basis points to 322.3 basispoints this year through yesterday, according to CMA DataVisionprices.

That means it costs $274,200 more annually on a contractprotecting $10 million of debt. Credit-default swaps act likeinsurance contracts, paying the owner in the event of a default.

Short Interest Rose

Short interest in H&R Block has increased to 3.1 percent ofoutstanding shares as of yesterday, from 1.4 percent on July 15,according to Data Explorers , a London-based research firm thattracks short sales. Short sellers profit from the decline inshare prices by selling borrowed stock and later replacing itwith cheaper shares.

H&R Block’s portfolio of originated mortgage loans hasdeclined 34 percent, to $33 billion, from the principal balancewhen the company stopped servicing mortgages, Brown said.

Of the $33 billion, $15 billion of the portfolio wasoriginated before 2006, with the rest in 2006 and 2007. “Webelieve the likelihood of repurchase claims decline as loansbecome more seasoned,” he said.

About one-third of the portfolio is securitized, and thecompany had $500 million of direct loan sales to government-sponsored entities such as Fannie Mae and Freddie Mac , Brownsaid.

Since April 2008, the company has received cumulativerepurchase claims on an unpaid principal balance of $686 millionof loans, he said. The company has reviewed $557 million of thatbalance and has realized losses of $55 million since then.

As of July 31, claims are under review on $136 million ofan unpaid principal balance of loans, Brown said.

Second Term

H&R Block reported a loss from continuing operations of$127.6 million, or 40 cents a share, for the three months endingJuly 10, compared with $130.6 million, or 39 cents, in the sameperiod last year. The average estimate of eight analystssurveyed by Bloomberg was a loss of 41 cents a share. The netloss narrowed to $130.7 million from $133.6 million.

Bennett, the 59-year-old director and former CEO, returnedin July after Russ Smyth resigned. The company stopped providingdetailed earnings guidance earlier this year after missing itsfiscal 2010 forecast as online competitors such as Intuit Inc. ’sTurboTax gained share.

“The reason we didn’t give specific guidance for this yearis we have to prove that whatever guidance we give iscredible,” Bennett said in the interview.

Competing better online is “a strategic imperative for2011,” he said. The company has lost more than 2 million retailtax clients in the last two years to rivals including MountainView, California-based Intuit, which said Aug. 19 that unitsales of its Web-based TurboTax software climbed 19 percent forfiscal 2010.

To contact the reporter on this story: Craig Trudell in New York at ctrudell1@bloomberg.net .