H&R Block tumbles on fears regarding mortgages

AP News
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Posted: May 09, 2011 8:54 PM
H&R Block tumbles on fears regarding mortgages

Shares of H&R Block Inc. lost nearly 8 percent Monday on renewed fears that the company will be dragged back into the subprime mortgage mess.

News that a group of mortgage bond investors may try to force H&R Block's former mortgage unit to buy back potentially billions of dollars in defaulted home loans sent shares sliding.

The mortgages written by Block's former Option One unit, which stopped issuing new loans in December 2007, have been a recurring issue for investors in recent years, but one that had been discounted lately.

Morgan Stanley analyst Vance Edelson said that many _ but not all _ Block investors had grown complacent about the mortgage issue over the past year. Yet the topic has been raised on every recent conference call. "This has remained part of the investor debate, because many investors have realized that H&R Block is not entirely out of the woods on this issue."

At the end of its fiscal third quarter in March, then-CEO Alan Bennett said the unit created to deal with the remaining mortgage issues, Sand Canyon Corp., had $131 million in reserve to cover potential claims, and that claims were coming in "within reserved expectations."

The exact amount of loans in question is not yet known.

Dallas attorney Talcott Franklin told The Associated Press he is still bringing together the group of investors in mortgage bonds backed by bad Option One loans. Once it is assembled, the group will press H&R Block to repurchase the soured agreements. "At this stage you don't really know what you have, until you actually get confirmation of those holdings," he said.

Some analysts have estimated the bonds purchased by banks and other non-government entities could add up to as much as $100 billion.

An H&R Block spokesman said the company has not received any requests, and cannot comment on actions by outside parties. During a conference call late last month, Bennett said the company would provide "a full update" on mortgage activity when it reports fiscal full-year results on June 23.

Morgan Stanley's Edelson said the company has a number of factors on its side. To force the buyback, bond investors would have to prove there was wrongdoing in the mortgage lending on some level, not simply that a homeowner defaulted on an Option One loan, he said.

"This could be a messy situation that takes years to litigate, because going through all the paperwork is a painstaking process," Edelson said.

Earlier this year, the analyst pointed out to clients that Option One had avoided home equity loans and second liens, which are a typical generator of buybacks. Plus, Block did little business with government sponsored enterprises Fannie Mae and Freddie Mac, which have been the source of most buybacks in the industry.

Franklin said the investors would only need to show a "material and adverse effect." For example, Sand Canyon could be pressed to buy back loans where it could be shown that borrowers committed fraud by providing incorrect information that misrepresented their income. During the housing bubble, such loans were known as "liar's loans" because individuals did not have to provide documentation for their income. "What do you think the odds are that some of the borrowers were, in fact, liars?" the attorney asked.

"A lot of this liability is back-end driven," he added. "If the loan doesn't have a loss associated with it, then there's no repurchase."

Franklin said he hopes the matter can be settled through negotiation, not litigation.

Concerns about the sputtering housing market may have provided fuel to the stock sell-off. With home prices remaining suppressed, and some suggesting the bottom of the market has not yet been reached, investors may be worried that a new round of foreclosures is on the way.

H&R Block shares fell $1.31, or 7.6 percent, to close at $15.93. The stock has traded between $10.13 and $18.08 in the past 52 weeks, with the low point hit in October, the last time the mortgage issue came to the top of traders' agenda.