Business Context and Reporting Period
This Form 8-K, filed on September 27, 2007, by H&R Block, Inc. (the "Company"), reports material definitive agreements and terminations related to financing facilities for Option One Mortgage Corporation ("OOMC"), a wholly-owned indirect subsidiary. The filing details amendments to warehouse financing facilities used to fund non-prime mortgage loan originations and the establishment of a new servicing advance facility.
Key Financial Metrics and Facility Details
The filing outlines specific funding amounts and terms for OOMC's financing arrangements as of late September and early October 2007:
- Citigroup On-Balance Sheet Warehouse Facility: Reduced from $1.5 billion to $150 million, extended through October 30, 2007.
- Greenwich Warehouse Facility: Reduced from $2 billion committed (plus $1 billion uncommitted) to $750 million committed, extended through April 25, 2008.
- Servicing Advance Facility: New facility established with $400 million in funding through October 1, 2008.
- Terminated Facilities: Two facilities totaling $2 billion ($1 billion each from JP Morgan and Citigroup Off-Balance Sheet) were terminated.
- Guarantees: OOMC provides a guarantee up to approximately 10% of the aggregate principal balance of loans held by trusts. Maximum potential undiscounted future payments are $15 million for the Citigroup facility and $75 million for the Greenwich facility.
Material Changes Versus Prior Period
The Company significantly contracted its non-prime mortgage origination funding capacity. Key changes include:
- Reduction in Capacity: The Citigroup on-balance sheet facility was reduced by $1.35 billion, and the Greenwich facility was reduced by $2.25 billion in total available funding.
- Terminations: The JP Morgan Warehouse Facility ($1 billion) and the Citigroup Off-Balance Sheet Warehouse Facility ($1 billion) were terminated entirely.
- Reasoning: Terminations were driven by the pending expiration of "minimum net income" covenant waivers and reduced mortgage origination volume due to the sub-prime mortgage environment.
Outlook, Risks, and Contingencies
Management commentary and risk factors highlighted in the filing include:
- Covenant Triggers: Remaining facilities are subject to strict performance triggers, including tangible net worth ratios, capital adequacy tests, non-warehouse leverage ratios, and minimum net income tests.
- Cross-Default Provisions: A default under one financing arrangement (e.g., Greenwich) could trigger a default under others (e.g., Servicing Advance Facility).
- Acceleration Clauses: The Citigroup facility includes acceleration of payment obligations if the sale of OOMC to a subsidiary of Cerberus Capital Management is not completed by October 30, 2007.
- Change in Control: The new Servicing Advance Facility terminates if OOMC undergoes a change in control, defined as a party acquiring 20% or more equity or the Company owning less than 50% equity.
- Market Conditions: The decision to sell whole loans or securitize them depends on market conditions, which are currently constrained in the sub-prime sector.
Investor Verification Checklist
- Verify the status of the pending sale of OOMC to Cerberus Capital Management, as failure to close by October 30, 2007, triggers acceleration of the Citigroup facility.
- Confirm OOMC's compliance with the "minimum net income" covenants that led to the termination of the $2 billion in facilities.
- Assess the impact of the reduced warehouse capacity ($150M + $750M remaining) on OOMC's ability to originate non-prime loans.
- Review the cross-default clauses to understand the risk of cascading defaults across the remaining financing facilities.
- Monitor the $90 million total potential liability from OOMC's guarantees on the remaining warehouse facilities.