H&R Block Tries To Renegotiate

KANSAS CITY, Mo. (AP)– H&R Block Inc. on Thursday cast new doubt on the pending sale of its troubled mortgage lending arm, saying it's trying to renegotiate sales terms as credit markets continue to deteriorate.

“The mortgage origination market is in the midst of the most severe dislocation it has seen in years, maybe the most severe since the 1930s,” Mark Ernst, chairman and chief executive, told analysts during a conference call to announce its first-quarter results.

The Kansas City-based company said if negotiations are successful, it would stop selling new loans through Option One Mortgage Corp., have several closing requirements waived and try to get the buyer, a subsidiary of Cerberus Capital Management, to close before the current deadline of Dec. 31.

H&R Block will exit the mortgage business regardless of negotiations with Cerberus, Ernst said, but added “when and how exactly that would happen is fairly fluid at the moment.”

For the three months ending July 31, the nation's largest tax preparer reported losing $302.6 million, or 93 cents per share, compared with a loss of $131.4 million, or 41 cents per share, during the same quarter a year ago.

Not including Option One and other discontinued operations, the company said it lost $109.8 million, or 34 cents per share, an improvement from a year ago when it lost $117.8 million, or 36 cents per share, on continuing operations.

Analysts surveyed by Thomson Financial, who typically exclude one-time charges, expected a loss of 36 cents per share.

Revenue during the quarter grew 11 percent, from $342.8 million to $381.2 million, but missed Wall Street's expectation of $448.4 million by a wide margin.

The company is busiest during the annual income tax season and typically loses money during the first and second quarters.

Typical losses were exacerbated by Option One, which was caught up in the collapse of the subprime mortgage market. The company said Option One and two small non-mortgage businesses that are being dismantled lost $192.8 million.

H&R Block has already slashed its Option One work force by more than half. About 400 workers now originate loans. The company announced Thursday it has stopped approving any new loans that don't comply with Fannie Mae and Freddie Mac requirements, limiting loan originations to $200 million a month, beginning in September. Last year, the company originated $27.1 billion in loans.

H&R Block announced earlier this year that the Cerberus subsidiary would buy Option One for $300 million less than the net value of the subprime mortgage unit's assets, a number that has yet to be determined as the mortgage market for people with spotty credit deteriorates.

On Thursday, the company said some of the conditions of the sale will need to be waived or changed, such as requirements that it have $2 billion in loans funded within 60 days of closing and the ability to warehouse at least $8 billion in loans.

“Essentially, the deal is off,” wrote Goldman Sachs analyst James Fotheringham in a research note.

The company said if negotiations are successful, it would immediately divest or shut down Option One's loan origination business and wants Cerberus to buy Option One's loan servicing platform.

The company narrowed its profit guidance for the full year, saying it expects earnings from continuing operations to range between $1.30 and $1.45 per share, compared with the earlier estimate of $1.25 to $1.45 per share.

Analysts expect annual per share earnings of $1.33.

Fotheringham said he was increasing his guidance for the full year by 4 percent to $1.35 per share, saying he was pleasantly surprised by the strength during the quarter of the company's consumer financial division, which includes the H&R Block bank.

But Fotheringham warned that “with expectations waning” for the Option One sale, a poor tax season or continued difficulties in attracting private equity interest could erode expectations.

H&R Block's results come a week before its annual meeting and a showdown with dissident shareholder Breeden Capital Management, which is campaigning for three of the company's 11 board seats.

Breeden, run by former Securities and Exchange Commission chairman Richard Breeden, claims the company's effort to diversify into mortgage lending, banking and other non-tax areas has stymied growth and hurt shareholders.

H&R Block has urged stockholders to reject Breeden, saying he hasn't offered new ideas and his proposal to sell off the company's year-old bank would eliminate what it says is a competitive advantage in attracting early season tax clients.

H&R Block isn't getting much support from Wall Street, where its shares have sank more than 16 percent since July 1.

Last week, the company said it was forced to tap working capital credit lines for more than $1 billion to fund operations because instability in the credit markets made it difficult to sell short-term corporate bonds, typically known as commercial paper.

The company said it has $2 billion available in committed, revolving capital lines, which it believes is more than enough.