H & R Block Inc (HRB) 2006 Q1 法說會逐字稿

Good afternoon. My name is Michael and I will be your conference facilitator today. At this time I would like to welcome everyone to the H&R Block first quarter earnings release conference call.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. If you would like to ask a question during this time simply press star then the number one on your telephone keypad. If you would like to withdraw your question press star then the number two on your telephone keypad.

Thank you. Mr. Ernst, you may begin your conference.

Great. Thank you and good afternoon and thanks for joining us to discuss our fiscal 2006 first quarter results.

With me are Jeff Yabuki, our Chief Operating Officer, Bill Trubeck, CFO, and Bob Dubrish who's President of our Mortgage businesses.

Before I begin my formal remarks I need to remind you that various comments we make including certain estimates, projections and other forward-looking statements, the words will, plan, estimate, approximate, project, intend, remain, expect, believe, and variations thereof and similar expressions are intended to identify forward-looking statements.

These statements speak only as of the date on which they are made and are not guarantees of future performance. Actual results may differ materially from those expressed, implied, or forecast in the forward-looking statements.

Some factors that could cause actual results to differ include the uncertainty that the Company will achieve its revenue earnings per share expectations for fiscal 2006 or any quarter thereof and that actual financial results for fiscal year 2006 or any quarter thereof will fall within the guidance provided by the Company, changes in economic, political, regulatory or competitive environments and the effects of such changes, the inability of H&R Block subsidiaries to successfully expand their businesses, litigation involving H&R Block and its subsidiaries, and other risks described from time to time in H&R Block's press releases and Forms 10-K, Forms 10-Q, Forms 8-K and other filings with the Securities and Exchange Commission.

H&R Block undertakes no obligation to publicly release any revisions to forward-looking statements to reflect events or expectations after the date of these remarks. H&R Block provides a detailed discussion of risk factors in periodic SEC filings and you're encouraged to review these filings.

You should also note that in conjunction with today's call we've posted supplemental information to the Investor Relations section of our Web site at hrblock.com. In addition, a copy of our prepared remarks will be posted to our Web site shortly after the conclusion of this call.

Before discussing our results let me review a few housekeeping items.

To begin with, we will be hosting our annual shareholders meeting in Kansas City on September 7th at 9:00 a.m. Central time. For those of you unable to attend we invite you to participate in our webcast of that meeting. You will be accessible through the Investor section of our Web site.

This quarter's supplemental slides will include restated financial statements by business segment for fiscal years 2005 and 2004. We'll provide first quarter fiscal 2006 financial statements by business segment in our first quarter 10-Q which will be filed with the SEC next week.

You might also recall that we said that beginning in fiscal '06 we would not present our supplemental U.S. Tax Services and International Tax Services information separately.

And finally before beginning, let me take a moment to thank the people from throughout our organization for the results that we collectively delivered this quarter. Your hard work is what leads to the kind of growth and response to market opportunities that we'll talk about today and I thank all of you.

Before we review the results of the quarter let me update you on a key item that occurred since our June 2005 year-end call.

In August we announced that we had entered into an agreement to acquire American Express' Tax and Business Services for approximately $220 million.

The acquired company will operate as part of our Business Services segment and operating under the RSM McGladrey brand. The combined firm will become the nation's fifth largest accounting and business services firm with more than $1billion in revenue and the largest national firm uniquely focused on serving the middle market.

As we announced previously, our early indication is that this acquisition will be accretive by a split-adjusted $0.02 per share in fiscal '06 and '07 after expected integration costs.

Our first quarter performance both financially and operationally was consistent with our full-year targets. We made good progress in our tax season preparation, recorded a 60% increase in mortgage loan originations versus the prior year, and realized strong revenue and bottom line improvements in both Investment Services and Business Services.

These results are consistent with our full-year earnings estimate of a split-adjusted $2.12 to $2.32 per share.

We recorded double-digit revenue growth for the first quarter in each of our lines of business. Consolidated revenues increased 26% or $128 million and earnings improved 23%.

The consolidated net loss improved by $8 million for a total loss of $28 million, or $0.09 per share compared to a net loss of $37 million, or $0.11 per share in the year-ago quarter. Tech services results were in line with our expectations.

We're now absorbing full-year expenses related to the fiscal '05 real estate expansion as well as the initial cost associated with the fiscal '06 expansion plan. This and other off-season spending during the first quarter was consistent with our planned levels.

Mortgage Services continued to show very strong growth with record loan production totaling nearly $11 billion. Integration of our pre-qualification technology and expansion in our distribution capabilities over the past year contributed to the segments solid overall results for the quarter.

Business Services delivered solid organic top line growth with its eighth consecutive quarter of double-digit revenue growth. Last month's announced acquisition of American Express' Tax and Business Services division further extends our reach and provides additional capabilities that better position the business to deliver strong earnings and cash flows this year.

Investment Services delivered meaningfully improved results this quarter with solid increases in revenues and bottom line results. We're pleased with the results over the past two quarters and believe those results demonstrate that the organization's leaders are making the progress we must see from this line of business.

Lastly, we continue to work with the regulatory agencies on our pending federal savings bank application.

As we mentioned previously we expect to receive a decision from the Office of Thrift Supervision regarding our application for a federal bank charter by the end of the fiscal year. Last week we received approval from the FDIC for deposit insurance coverage, a key step in the regulatory approval process.

With that let me now turn the call to Jeff who's going to talk in detail about our Tax and Investment Services divisions.

Thanks, Mark.

Our Tax Services segment increased revenues 13% over last year. The primary revenue drivers were from increased average charge per client served, additional revenues from express IRAs and Peace of Mind warranties, and Canadian tax preparation fees from the prior tax season that were collected after the 2005 fiscal year-end.

The pre-tax loss for the segment was in line with our expectations increasing 28% over the prior year. Program expenses related to our real estate expansion efforts were the largest driver of the expected year-over-year variance.

As we continue to build our real estate network we will incur off-season expenses from the cohort of offices opened in the prior year along with expenses to open this year's new offices. We expect our real estate program expenses to increase similarly in our second quarter as we continue to ramp up the program.

We also had increased expenses related to our Peace of Mind program along with additional legal expenses which impacted first quarter's results.

We are now deep into our preparation for the upcoming tax season. We have two primary areas of focus this year to build on the client growth momentum we demonstrated last year.

First, we're continuing to expand our capacity to serve the demand that exists for our tax products and services. This expansion is two-fold, adding new locations to our network and also increasing capacity in our existing locations.

These service expansion efforts together will increase our ability to meet the client demand that exists for H&R Block services today. Also, we remain focused on improving our overall level of service differentiation through advocacy and actionable advice.

Increasing convenience and accessibility through our expansion efforts, combined with a more differentiated service experience, will expand our market share, build loyalty and drive revenues. We've learned a lot from the past tax season and have a number of programs that are geared at driving long-term shareholder value.

As those of you who have followed our Company know, we choose not to provide the details of our strategic and marketing plans at this point during the year for competitive reasons. However, I will provide some additional color on our fiscal year '06 expansion efforts.

We are slightly ahead of schedule in identifying this year's new retail locations. We are in the early stages of our multi-year objective of increasing our overall level of accessibility and convenience for consumers.

We told you in June that our plan is to open between 500 and 700 company-owned and franchised regular offices this year. Based on our real estate program results to date we now expect to be toward the upper end of that range.

We are also continuing to expect a 15% reduction in the level of capital required to open this year's class of new retail offices versus comparable locations in fiscal '05. In addition, we are planning to open up to 400 new shared locations in retailers such as Sears and Wal-Mart across our company-owned and franchised network.

This element of our expansion strategy not only increases the number of clients we can serve, it also provides additional branding opportunities while limiting our competitors' ability to enter new locations. We believe this is an important way to grow our overall distribution and client service capacity.

Our objective is to build a distribution system that has the optimal balance between regular offices and shared locations. That said, the amount of capacity that is created by a location varies annually depending upon the number of tax professionals in that location. Said differently, not all location are capacity equal.

We do not expect each new location to deliver a similar number of returns. Instead, we are building a mix of location types that will optimize incremental client growth over the long-term. We look to optimize performance in each location.

We will give you more insights into what we expect our distribution system to deliver in January.

You might recall that we had a fairly successful marketing campaign targeting early season filers last tax season. Our fiscal year 2006 marketing programs will continue to reach these important early season filers with additional focus on mid and late-season filers.

Lastly, along with controlling the client base, I'm sorry, along with growing the client base, we are also focused on better managing our controllable expenses and increasing efficiency which we expect will lead to increased profitability in fiscal '06.

As announced previously we have added new leadership to our digital tax business through the acquisition of TaxNet, Inc., a Web-based tax preparation business located in San Diego, California. Tom Allenson, who is our Senior Vice President and General Manager, and David Murray, Vice President Digital Tax Marketing and Innovation, joined us in July.

Both Tom and Dave were previously with TurboTax prior to founding TaxNet. Tom and Dave will compliment our existing team bringing a proven track record in delivering both digital client growth and product innovation.

While we again won't disclose our plans for competitive reasons, we intend to aggressively build our business and market share over the next several years. I am confident that we have the team in place to help us reach our potential.

We continue to believe our unique ability to offer tax preparation in the channel that clients choose will lead to increased loyalty and enterprise retention.

Our International Tax operations which include Canada, Australia, and the United Kingdom generated revenues of $8 million, a 41% increase over last year, and a pre-tax loss of $7 million that improved nearly 10% over last year. First quarter results were driven primarily by increased tax preparation fees collected in Canada after the 2005 fiscal year-end.

You might recall that because April 30th fell on a Saturday this year, Canada extended its filing deadline. This extension resulted in approximately 47,500 tax returns that clients picked up and paid for on May 1st and 2nd.

In Australia we are expecting a strong start, we experiencing a strong start to the tax season. While it is early in the season, indications are that we are on track to meet our growth objectives for our Australian operations.

Our Investment Services business had excellent results in the first quarter with improvements in revenue, expense management and profitability. We had material improvement in the majority of our key business metrics versus both the prior year and sequential quarter.

Revenues for the first quarter were up 27% versus the prior year and down 3% sequentially. Production revenues increased 17% compared to the previous year and decreased 4% from the prior quarter.

Changes to our pricing strategies, along with a rising interest rate environment, contributed to a 52% increase in net interest margin as compared to last year's first quarter and 9% sequentially.

The pre-tax loss for the first quarter was $8 million an improvement of $13 million versus the same period last year, and $7 million better than the sequential quarter. These results and each quarter going forward include 9 million of intangible amortization versus the 7 million of quarterly intangible amortization that was reported last year as a result of a shortened amortization period after the restatement.

The life of customer intangibles was shortened from ten years to eight years resulting in higher amortization expense in each period. The operating improvements were achieved by prudent expense management, more focused sales management and better execution of our pricing strategies.

Our number of advisors decreased slightly from 1010 to 985 at quarter's end. This expected decrease was due primarily to the impact of the implementation of minimum production standards for our advisors.

The resulting attrition outweighed our positive recruiting results for the quarter. Based on our new standards we now expect that we could be net down in financial advisors for the year but that productivity and profitability will increase as a result of that change.

We also had very good recruiting results during the first quarter. High quality financial advisors are seeing the unique value proposition we offer which is leading to a heightened degree of success in this area. We expect these recruiting results to continue throughout the year.

Our strategic focus continues into the second quarter with tax client leads received in the fiscal '05 tax season. As of July 31 over 4,000 new accounts have been opened.

For the first quarter we had $3 million in revenues from these accounts representing a 107% improvement versus the prior year. We are pleased with the Investment Services performance for the quarter and the strong start to the year.

We are managing and monitoring performance to ensure that we continue to show substantial improvement in this business. We continue to believe that we will improve the Investment Services loss in fiscal '06 by $25 million to $35 million.

As Mark mentioned, we're expecting the OTS to make a decision on our bank charter application later this year. A bank would benefit a high percentage of our clients who do not have access to basic banking and savings services.

We believe banking services to be instrumental in extending our ability to differentiate our services by helping tax clients invest in depository assets and to utilize basic banking services which will provide an earnings stream for our shareholders over time. As we have stated previously, we also intend to move client depository assets, which today are held with third parties, into the bank and we'll move those assets upon the favorable determination of our proposed federal savings bank charter.

Let me now turn the call back to Mark for a review of our Mortgage and Business Services operation.

Thank you, Jeff.

Mortgage revenues this quarter increased 33% to $360 million while pre-tax earnings improved 23% to $134 million. Behind that performance was a 60% increase in originations during the quarter offset by the tighter margins that are being experienced across the non-prime mortgage market, Option One included.

First quarter loan production totaled a record $11 billion an increase of 60%, and an increase of 17% from the sequential quarter. Increased productivity of our account executives and support staff, new product introductions, along with progress toward integrating our pre-qualification technology drove these results.

The credit quality of loans that we're originating remains strong. Our average FICO scores for non-prime originations averaged 623 for first quarter compared to 618 last quarter.

Our loan to value have increased to 81.1% from 79.6%. These increases are influenced by interest only fundings that generally require higher credit quality and have higher leverage and larger loan balances.

In the first quarter IO loan fundings with average FICO scores of 647 and average loan balances of about $285,000 represented 25% of our overall loan production versus 21% last quarter.

Despite aggressive pricing, we increased the weighted average coupon on our new originations during the quarter to 7.52% up from 7.21% a year ago and 7.45% from the previous quarter.

Our first quarter net gain on sale gross margin decreased 36 basis points compared to sequential quarter as rate increases did not keep up with the increased market required funding costs. Two-year swaps rose approximately 33 basis points at the end of the quarter compared to our 7 basis point increase in WACs.

We recorded $26 million of hedge gains during the quarter due to the rise in market interest rates. We used interest rate swaps, caps and forward loan sale commitments as our primary hedging tools to reduce risk to loans in our pipeline.

Approximately $14 million of this hedge gain represents loans that had not funded by quarter end, suggesting that these earnings were pulled forward due to our hedging practice.

In the first quarter there was a slight shift from whole loan sales to securitization. We executed 77% of our non-prime loans in the whole loan market with the remaining 23% of the loan securitized.

The decision between whole loan sales and securitizations is highly dependant on how to best optimize value with a strong bias for cash.

Our overall cost origination declined 13% to 194 basis points, or a 28 basis point decrease from the prior year's first quarter. This continued improvement resulted primarily from prudent spending and greater leverage of newly-hired account executives and support staff.

Pre-qualification rollout is also impacting productivity. This technology expedites the review of products, rate, and loan information between brokers and account executives.

Over time we believe an increasing number of brokers will access the technology to review and choose our services.

Another opportunity to significantly improve origination costs will be realized when we introduce automated underwriting technology. This technology is being piloted and will be in the network later in fiscal '06.

We continue to work to a net cost of origination that would bring us closer to 175 basis points.

At quarter end Option One servicing portfolio was $71 billion, an increase of $21 billion over last year, and $3 billion over the previous quarter. Servicing revenue for the quarter was $90 million.

Loan performance trends remain positive.

12-month seasoned and beyond delinquency rates since the high in January 2002 at 14.8% have been holding now in the 11 to 12% range resulting from higher credit quality and continued strong service practices. At the end of July 2005, 31-day delinquency rates were 10.3%.

As both our whole loan sales and securitizations are non-recourse transactions, it is important to note that our risk as it relates to loan performance is primarily limited to the tax affected value of residual assets and mortgage servicing rights on our balance sheet. As the value of these residual assets is based on future performance, we continually monitor the reasonableness of our evaluation assumptions relative to actual loan performance and performance in the market.

Overall first quarter residual assets trended as expected as the effect of lower than previously modeled credit losses was mostly offset by higher interest rates. We realized a net write-up of $13 million in the first quarter which was recorded in other comprehensive income net of deferred taxes.

Those write-ups were offset by $12 million in write-downs which were reported as a reduction in gain on sale of mortgage assets on the income statement.

As you know we don't provide quarterly guidance. However, given the significant volatility that is currently occurring in the subprime market, I will share some perspectives on things that are happening in the market, how we are responding to those things, and how we see them affecting us over the balance of this fiscal year.

Margins have gotten extremely tight as you've seen from us and from all of our competitors. The increase in market funding rates has not been matched with increases in rates for consumers.

We believe that the service advantage that we enjoy permits us more flexibility around rates than what many of our competitors may have. As of today we are applying a 40 basis point increase in rates across our products.

We expect that this along with future rate increases will bring WACs and by extension margins, to a level that more closely reflects a risk adjusted return that we expect from this business. The effect of this action will begin to be felt later in our second quarter and through the balance of the fiscal year as rates on new production begin to reflect this and subsequent rate changes that we feel are appropriate.

While the upcoming quarter will be challenging we believe that the balance of the year view of margins in the 90 to 115 basis point range is achievable and appropriate from a risk return perspective. Full-year margins likely will be at the low end or below the 90 to 115 basis point range given the coming weakness that we expect in our second quarter.

We continue to expect loan origination growth will exceed 20% over the previous year. In fact, we are currently seeing conditions that suggest much stronger origination growth than we've previously expected.

This growth would have the effect of offsetting some of the margin shortfall and our guidance incorporates that view. However, the net effect of all this is that you should expect that the next quarter for us, and probably many people in the industry, will be weaker than our current quarter from a net income perspective.

We are taking the actions that are necessary to return to a more appropriate level of profitability, but this likely won't be felt until our third quarter and beyond.

Turning to Business Services.

First quarter revenues increased 16%. The pretax loss improved 33% to $7 million compared to a $10 million loss last year.

We saw double-digit year-over-year growth in both our core Tax and Accounting business as well as our non-traditional services such as payroll processing and financial process outsourcing.

So like our tax business, Business Services is a seasonal business that makes the bulk of its earnings in our third and quarter fourth quarters. However, there is clear evidence that the strength that we experienced last year has continued into this fiscal year.

As the big four accounting firms have shifted to serve larger clients and their consuming Sarbanes Oxley 404 needs we have benefited by securing a fair amount of work from mid-size companies. However, the market demand for our services is not being driven by a one-time business opportunity.

Our focus on building business development and branding for this business sets us up for continued strong growth.

It's with this in mind that we're excited with the recently announced plans to acquire American Express' Tax and Business Services division. The combination will bring together two of the industry's leading firms, expand our reach as a global service provider, and deepen our talent base.

Perhaps most importantly, it will clearly establish RSM McGladrey as the leading alternative to the big four accounting firms at a time when such an alternative is in clear demand. We believe that we are uniquely positioned to drive value for our target clients, value as an employer of choice in the industry, and value for our shareholders.

We expect the transaction to close in the second quarter and to be immediately accretive by approximately $0.02 per split-adjusted share in fiscal years 2006 and 2007 after any expected integration costs. Our integration plans include furthering our brand building efforts and improving the awareness that this is the nation's leading accounting and business services organization.

Let me now ask Bill to discuss some of our key financial statement highlights.

Thanks, Mark.

As compared to April 30, 2005, some notable changes to the balance sheet include a decrease in cash and cash equivalents from 1.1 billion to $639 million, primarily due to off-season working capital requirements, treasury share repurchases and dividends. When compared with the like period for FY '05 however, the cash and net debt positions are actually stronger.

No commercial paper was outstanding at quarter end compared with $105 million outstanding one year ago. This largely reflects fewer shares repurchased and the timing of tax payments compared with the first quarter of FY '05.

Available for sale mortgage residual interest decreased 13 million during the quarter to 193 million, while a residual's trading balance of 58 million was outstanding at quarter end and reported in marketable securities trading. This was the result of a securitization transaction executed in the first quarter where the corresponding NIM transaction had not yet been completed.

We continue to focus on cash and minimizing the balance sheet risk and as such we expect to complete the NIM transaction during the second quarter.

Subsequent to quarter end the Company entered into a new $1 billion committed line of credit to replace the expiring $1 billion 364-day line of credit. This facility is for five years maturing in August 2010.

In addition, the Company extended and repriced a second $1 billion facility to mature on the same date. The $2 billion of unsecured lines are used to support issuance of commercial paper and for general corporate purposes.

These facilities were done at a reduction in pricing of 2.5 basis points on average for the undrawn component and 20 basis points for fully drawn.

Also, the Company entered into an additional $1 billion warehouse agreement for mortgage loans bringing the total capacity for Option One to $10 billion. We expect total at capacity to increase to 14 to $15 billion by fiscal year-end which may include the previously discussed single seller commercial paper program.

During the first quarter we acquired 5 million treasury shares at a total cost of $132 million or an average cost of $28.42 per share on a split-adjusted basis. A total of 3 million shares were issued for option exercises, employee stock purchase plan purchases, and restricted shares.

As of July 31st there were 329 million shares outstanding. My expectation is that we will allocate approximately the same amount of capital towards share repurchase as we did in FY '05 and after taking into effect the American Express TBS acquisition.

I'll turn now to our recent statements which included a write-up of goodwill of $132 million dating back to fiscal year 2000 form the acquisition of Olde. The final restatement included and additional impairment of $85 million in fiscal year 2003.

Previously in fiscal year 2003 the Company had reported an impairment of $24 million related to Investment Services.

I'd also like to update you on our SOX review.

As mentioned in our recent 10-K filing we identified two issues which when combined rose to a level of material weakness in our internal controls over financial reporting. While we made significant process improvements prior to filing our 10-K we determined that our income tax accounting and corporate tax resources were insufficient at our year-end resulting in a weakness in internal controls.

We are continuing with the major changes within our corporate tax, a function that had begun including resources to remediate the identified weaknesses. Additional information regarding these efforts is presented in Item 9A of our Form 10-K.

And finally, I would like to note that Moody's Investor Service recently affirmed the Company's ratings at A3P2 with a stable outlook.

With that, I'll turn it back over to Mark for the performance outlook.

Thanks, Bill.

You know for the Company as a whole we continue to expect fiscal 2006 revenue growth within our long-term guidance range of 10 to 15% and earnings within our previously communicated range of $2.12 to $2.32 after the stock split. Volatility within our earnings range will primarily be a function of developments within the mortgage business in the coming months and we will keep you informed as that develops, but overall you should also know that our capital allocation practice remains essentially unchanged from our traditional philosophy.

To conclude, in the short-term we anticipate a strong fiscal year 2006 from the mix of businesses that we have. Over the longer term we will build these businesses and create differentiated services for our clients while prudently using our capital to create shareholder value.

And I think with that, Operator, we'd be happy to open the lines for questions. Operator?

Yes, sir.

I think we're ready for questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Michael Hodes with Goldman Sachs.

Good afternoon, guys. Just a couple questions on mortgage. First, I guess just more of a technical question. The securitizations that did you in the quarter, I guess they were multiple securitizations, and one of them you're able to do a NIM transaction and [inaudible] you weren't? I was just a little surprised with the timing difference. I just want to get a better understanding what's going on there.

Yeah, actually, it's sort of highly technical and it wasn't because there was an issue of any sort. What happened was that we used a slightly different structure during the quarter and we included a swap in the securitization.

We wanted to make sure that, which was a new thing for us, we wanted to make sure that, which was a new thing for us, we wanted to make sure that the accounting treatment on the NIM would be correct and so we carried the NIM transaction over quarter end so that we could pin down the accounting treatment without running the risk of making a mistake. That's the only difference. We expect that we will complete that NIM sale now during the second quarter.

Gotcha. And then Mark, just from your comment it sounds like the trends through the end of August were pretty harsh in mortgage. One, I was just hoping you could give us kind of a feel kind of one month into the quarter since that's pretty much known, and then two, how you're thinking about how did you come to the 40 basis point kind of general lift in WAC and why do you think that that will hold and why do you think that won't hurt volume?

Well, let me start sort of describing some of what we were seeing out the in the market. And I'm going to have Bob Dubrish also join and share perspective.

The caution that we have and probably the action that we're taking is really driven by a couple things. We've all known that the competitive environment has been very intense and that nobody's really been willing to kind of move rates very aggressively up to this point.

We have seen just in the last several weeks, and I'd say for that reason we're maybe kind of on the leading edge of describing this, we have seen just in the last couple of weeks some evidence, although not final, but I think some evidence that certain of the rating agencies may be taking a tougher view on how to view the collateral and therefore what the value is that comes out of securitization pools. Our observation, which is preliminary, and it's early, would suggest that if that is in fact the case, that we are all going to need to raise rates in order to maintain the level of margins that we've been even having out of the business.

Our decision to raise rates by 40 basis points we think is a sort of prudent first step to bring the rates that consumers are receiving on loans closer in line with the funding costs that is represented essentially by the two-year swaps but, you know, and that obviously has been relatively volatile since the time we made that decision. We've seen two-year swaps come down a lot in the last 72 hours, so it's a very fluid environment that we're kind of operating with, but we believe that from a sort of risk return perspective, that it's more appropriate that the margins that we are realizing on the business should be higher.

Now, I think your key, a key question in that is if we move rates can that be sustained and also can you also sustain the volume? We believe the answer is yes. We have worked very hard to develop a unique position in the market, as unique as somebody in this market can around the quality of service that we deliver to our broker community and clients and, you know, we have not necessarily been sort of leveraging that position in the market as aggressively I think as we think we could. So that's why we think this is the right thing to do.

Let me ask Bob to kind of add to that.

On the first point, certainly the rating agency, you know, we've seen those changes. Additionally, it just seems like it sort of feels like anecdotally talking to the investment bankers and things that, for long time we were getting pretty aggressive bids and aggressive bidding between the investment banks. That sort of has really sort of gone away in the last few times we've been to the market.

So on top of the rating agencies we think that there's really, the deals are pretty levered. We don't see any structure changes that's going to create more value other than us raising rates.

As it relates to why we think we can raise the rates we've actually been talking pretty close, working closely with our sales advisory council and they're the ones that came to the suggestion that we raise 40 basis points rather than try to do it with it add-ons and things like that. And their view is that, as Mark indicated, if we can give them the service they feel pretty confident they can sell the rate and maintain the relationship so I think we feel pretty good about it not being a top-level decision, it was really a decision that the sales people helped make for us.

Gotcha. And just the, if you could give us a feel through the end of August, it sounds like from your comments that this quarter's going to be particularly tough just given the dynamics kind of in motion as you started the quarter. Am I right, you're saying substantially below 90 basis points? I know you I don't want to give specific guidance on the quarter.

I don't think there's any question that it's going to be below 90 basis points. You know, the flip side, I would tell you the two trends that are out there, you know, thinner margins but higher levels of origination, those two trends continue to show themselves for everything that we're doing and I think what we're seeing through August and what we can see into the pipeline into September would suggest that that is clearly what, you know, and by the time you get through that you're now looking at two-thirds of the upcoming quarter.

So we have a pretty good sense of how the quarter is likely to shape up and I think it's just prudent for people to expect that this is going to be a tighter quarter for us. Thanks a lot.

Your next question comes from Kelly Flynn with UBA.

Hi. This is Andrew Fones for Kelly. First off I wanted to ask a question on the bank charter. I was wondering if you could detail where the float is that you will be investing this speed that you think you can ramp up your deposits and then the spread that you think you could earn on those?

Hi, Andrew, it's Jeff. We don't think we've talked about it in that depth.

We continue to prepare for the charter to come on line. We were pleased with the FDIC's decision to issue deposit insurance, and we are in a position that at such time when we, if we are granted or when we are granted a charter that we will move the assets and I think it will depend on what the environment is at the time, to measure the spread.

The majority of the assets that we're bringing in tend to be lower cost assets and our strategy will allow to us continue to focus on that, which will help to insulate us, or inoculate us a bit against the, maybe the oddity in the yield curve right now.

Okay. And then also I wanted to ask a question on the Investment Services business. You saw a nice improvement there this quarter. What's your expectations as you look at Q2 and perhaps the rest of the year? It appears like you're trending a little ahead of your guidance.

We are clearly pleased with the performance in Investment Services this quarter. We continue to believe that we'll see improvement in profitability in the 25 to $35 million range for the year and I think it's premature to say at this stage that things will be necessarily better on the strength of one quarter. Our goal is to deliver continuing improvement quarter in and quarter out.

I think once we get to the end of the second quarter if we were to continue to see results that look like that in the outlook, looked like they were in the first quarter and the outlook still looked bright I suspect that we would say, you know, we would be at the, at least at the upper end of the 25 to 35 million improvement but for now we're just comfortable that we'll be within the 25 to $35 million range for the year.

Is there anything that makes you feel like the Q1 results might be ahead of the normal level?

No. We're quite pleased. It's much more about, it's much more about, it's only one quarter and I think for now we're grateful for the improvement, the organization is working painstakingly hard and we're just going to take it one quarter at a time.

Okay. Thanks guys.

Thanks.

Your next question comes from Kartik Mehta with FTN Midwest.

Good evening. Sorry about that. Wanted to kind of ask you a question on the bank charter, Mark. You said you've received FDIC approval, OTS approval is next. Which is a biggest hurdle the FDIC approval or the OTS approval in you opinion?

Well, I would say that depending on how they, either one of those agencies views the appropriateness of a charter, it can vary, so in our case it's obvious that it's the OTS, because they haven't yet signed off on this. But, you know, frankly, I think we're very close to helping to address all the challenges that would be behind a charter for an institution like H&R Block.

This is a, we're a non-traditional kind of organization and we have a lot of different activities that go on outside of the banking business, and I think the OTS is doing a very prudent, thorough job of understanding those and understanding what kind of exposure or risk that might create if we were a regulated entity, and that's their job, and that's what they should do, so I think we're in great shape.

So once you receive your charter what would be first thing you'd be able do in terms of taking advantage of the float? Where would you be able to take advantage of?

Well, you know, we have a number of assets that are currently residing. I guess, legally through investment accounts at financial advisors, both the IRA accounts that we have been offering to H & R Block tax customers as well as FDIC insured money fund assets also in financial advisors, we would be able to move a substantial number of those assets into an institution early on.

Of course, how we will spread those liabilities against a different set of assets is a different question. Our expectation, I think, is that we would build an appropriate portfolio of mortgage assets that would meet the requirements for an OTS entity over a period of time to ensure that we have a good mix of assets.

Mark, we're hearing a lot more about home prices and maybe where to point that home prices won't increase at the level they have been. Your thoughts on how that may impact your volume if it has any impact?

Well, certainly, you know, home price appreciation does a lot of different things. It probably has an effect on the risk of certain mortgages because appreciating assets or underlying asset just reduce the risk of the loans that have been made in the past. Obviously we have some exposure to that through our residual assets but not in a real big way.

I think in terms of production levels, my expectation would be that slowing home price appreciation would have an effect industry-wide on slowing down the level of originations that has been going on. Probably even more importantly where interest rates go is going to be a critical question to resolve or to answer that. So the combination of those two things probably will drive much of this.

From our perspective, we think we're in a strong position, not immune from those factors, but a strong position in two ways. We're in the non-prime business which tends to have much more product innovation and be less susceptible to sort of movements in interest rates generally.

We operate our business model in a way that does not necessarily rely on home price appreciation to drive our business, and because we have historically built our business around service differentiation we think there are a number of controllable aspects of the business like our pre-qual technology and the relationships that we've been building and are expanding through our account executives that we control uniquely that will allow us to continue to be successful with the business. Bob, anything you would --

I think that's right.

And then one final question.

Jeff, I think in your prepared remarks you said in fiscal '06 the capital investments needed will be about 15% less to open offices. Is that just because you're opening fewer offices or is there something different you're doing?

It's 15% on a comparable, on a kind of on a single unit basis so it's not related to the number of units specifically it's on a per unit basis. We've done a lot of cost re-engineering to try to lower the capital that's going into these locations. So those are actual improvements on a unit basis.

Thank you very much.

Thanks.

Your next question comes from Mark Sproule with Thomas Weisel Partners.

Thanks. Just to go back to the mortgage business a little again here.

If you look back about a year ago I think you guys were not necessarily overly willing to try to be at the forefront of the pricing decreases and compete for volume and give up some of your margin on that side of the business and then had moved that way as the season went along, and now you're going to go kind of the other way and raise the, you know, your WACs 40 basis points coming out.

Do you think that you, is it all going to be, or do you think, I guess, the service side of your business is going to be able to maintain the volumes and not maybe give up a little bit of share as you go forward and then maybe the other players are really going to move upwards as we go out?

This is Bob Dubrish. It's a good question.

I think the answer is we may lose a little bit of business by raising rates like this but we think that our service levels, well, we've always thought that and actually sort of surveyed our customers, and if we're within 25 basis points typically we would get the deal because of our consistency and dependability and of our underwriting and our process, and so I think that, you know, again, we talked to our sales people about this and, you know, we think that probably the 40 basis points is, I don't know there's any magic in it but the combination of raising 40 basis points, we're also, we typically make about 40 basis points in price exceptions which we're now down to 30.

We've changed our commissions for our sales people which should allow us to make less price exceptions. Our target is about 15 basis points.

But that combination really reflects probably what the overall risk of the business is today, and again, we're doing this, we're going to watch it very closely, we'll monitor it very closely, but we feel really pretty confident that our volumes are not going to go down that we can continue to grow our business through the drivers that we've always talked about, the number of sales people, aps per day, et cetera.

Would you say that the risk of the originations is increasing enough that the pricing should increase concurrently and that maybe the market in general, some of the players are sort of mispricing their risk?

I'm not sure we should, we could speak for what other people are doing, but what we do know is that we have a pretty good sense of what we believe the appropriate level of risk is.

One of the things that we have done for a long time and we continue to do is we believe we have to run the business for the long-term. That means that the loan quality that we produce today really needs to, you know, expect to be there for the investors in these loans in the next two, three, four years as they actually perform.

So, you know, I think it's our judgment that with where the home equity market, the real estate market is today, it's just prudent that the level of risk that's inherent in these loans, we all, as investors, ought to be paid more for it.

Gotcha. On the tax side, you're building 5 to 700 new stores. How many of those new locations are going to be in kind of previously unpenetrated H&R Block areas versus how many of them are going to be to sort of increase density on local markets?

It's obviously a mixture. We have a large target of new locations that we had scoped out that takes us over the next five years or so and we are not wed to any specific geography except to say that we have models and we look to make sure that we get the right locations within the models. So I couldn't tell you today if they are going to be a higher propensity in what you refer to as underpenetrated areas versus more competitively dense areas, I can tell you that we have a mixture of both.

And my guess is, if I had to guess, that we would end up in more underpenetrated areas this year as opposed to kind of heavy competitively dense areas.

In general, I think it's probably fair to say that the limitation we have, and therefore where we end up going, at least at this stage of the development of our expansion strategy, has more to do with our ability to execute it effectively in a particular location and the availability of the right kind of location rather than needing to fill in a particular targeted area, because we think there's a lot of opportunity in a lot of different places, and we're really looking at how do you best execute against that.

Gotcha. And then I guess a last though on the bank charter comments that we've already heard about a little bit.

Is there any thought or any kind of initial takes on, I guess, ideas to extend the bank charter beyond its applicability to your investment services maybe into utilizing your large office base and offering sort of a broader financial suite that might take you beyond just tax season in those locations?

There's a lot of different questions in that. The one thing I would tell you, which is part of our charter application which we would like to do on behalf of our, many of our clients, many of whom are unbanked today is that we do think there's an opportunity to extend a savings product across our whole network of offices that works better than the traditional IRA that we've been offering. I think we see that coming, although I think for to us kind of speculate on years from now what might we be doing I think is probably way premature.

Gotcha. Thanks.

Thanks.

Your next question comes from David Horn with Perennial Investor.

Good afternoon. Thank you for taking my question.

On the mortgage side, we applaud the 40 bip increase across your rates, but to what degree are we exposed to basically the competitive whims of largest non-public competitor? I realize servicing, you servicing is tops and gets a lot of business on the margin, but how close do we have to be to them on rate to even be in the ballpark of having service come into play?

Well, you know, it's been our experience in the past that the answer to that is 25, 35 basis points. There's been times where I think we've actually been even further out but, you know, it really, to a certain extent it depends on the broker, the relationship we have with the broker and whether or not we have the kind of depth of relationship that, you know, where the broker is willing to work with us and sees the value of us working with their clients. I think the net-net of all that is we'll see.

The one thing that we do believe is that we've worked really hard on our cost structure. We're continuing to work really hard on our cost structure. We're bringing that cost structure into a place where we think it's as good as anybody out there, even large non-public competitors.

And in that sense we're all working with the same margin and secondary market conditions, and while, you know, we may expect that we ought to be earning bigger margins, larger margins than what some other competitors are willing to work for, at some point we're not even, we think that many competitors are going to have to do something. This has gotten to the stage where even those of us with a rate advantage and a service advantage and a cost advantage believe that rates have to go up.

Clearly 194 bips of cost originate is very low, but how much of that is dependent on originating $11 billion a quarter? I mean if we'd done $10 this quarter, or 9.5, and we had less loans to distribute those fixed costs over, I mean, how much higher would this number have been?

I don't have that number right off the top of my head but that is clearly something that we pay really close attention to, because one of the core issues I think for the industry in general, us included, is the capacity that's out there to originate loans. We are working on how do you make our cost structure not just lower but also more variable.

Bob talked about a few of those when he talked about working on rate exceptions and working on our commission structure and that sort of thing, and we continue to do that because we do recognize that you can't bring costs down, cost origination down exclusively by putting more production through the same engine. You really have to do this in a way that can flex with the overall level of origination. So I don't have the precise answer to your question but we are very attuned to that.

Great. Thank you.

Thanks.

Your next question comes from Michael Millman with Soleil Securities.

Thank you. That's Soleil Securities.

I also wanted to ask about the mortgage business and some of your philosophy behind it. Your earlier 10-K include, in guiding for the mortgage business, included not only 20% with a 90 basis point margin, but also indicated maybe 15 percent growth with a 10 basis point better margin suggesting that you saw, at least at that time, some leverage related to price, and maybe you could talk about that a little bit.

Also, it appears that, at least in California, that in that mid quarter you actually reduced your prices, your mortgage rate substantially, and maybe you can talk about to what extent that had an effect or favorable effect on volume in the first quarter?

And then there's a $40 million gain, maybe gain but it looks like a re-NIM. Was that a re-NIM gain in the first quarter? And if that wasn't a gain, how much was the gain?

And then on the WAC, could you talk about whether your product mix, the IIs and maybe even 103s driving some of your higher WACs?

And then unrelated to that, can you talk about how savings banks do in inverted yield curve environments?

I think I'm going to have all of those so we'll do our best.

I'd appreciate it.

On your first point about at one point there was some suggestion that we were seeing somewhat slower growth but at higher margins in the mortgage business and then we've adjusted it.

You know, this trend that we are seeing we've been seeing for some time. So that was the first indication, and I think what we're talking about today is the next indication that that, in fact is what's happening for our business and I think in many ways for the overall industry.

So, you know, our expectation I think was that more people competitively would be moving rates and accepting a higher margin perhaps at lower volume through the course of this year. So far the evidence would suggest that hasn't been the case, but we think we maybe are kind of at that point. So that's what I'd say on that.

On the, there was no re-NIM gain, so we didn't take a unique gain this quarter at all in the mortgage segment from any NIM sale. Now there was a NIM sale, and I think we treat that, or we identify that as a separate sale because it's separate and apart from securitization, but that's a normal kind of transaction. And I suspect that shows up in the cash flow statement I think in a separate line item versus where the core securitization occurs.

Has it showed up as cash received from securitization?

Yeah, so when we do a NIM it's a separate line item because it's a two-step transaction and I don't think that's any different than what we've always reported. So what you're seeing, I think the key point is, what you're seeing is normal operating activity, it's not sort of a unique asset sale that occurred this quarter.

On the California pricing point, Bob I'm not sure that I --

I think if you're looking at the actual originated coupon, we've had pretty good growth in California. When you look at the drivers of price it's typically LTV, FICO and loan size.

And so what you're seeing in California, and actually the theory being that it costs the same to originate a loan of $100,000 as it does to originate a loan of $200,000. So we actually had looked and on the pricing matrix, if you look at the IL loans, the average balance is about 285,000, so the price is lower at that loan amount, and so 50% of the growth in California, or 50% of the originations in California are on the IL loans right now with that average balance, so that drove probably a little bit lower coupon in California but it wasn't something, it's really driven by loan size, not by anything else.

And on your question about the bank environment in an inverted yield curve world, obviously we understand how that works as well. In general I think, you know, our whole strategy with a banking platform is to use that as an opportunity to leverage access to low-cost deposits so it's really a low-cost deposit strategy principally.

We are not looking to necessarily mismatch duration in a big way as a strategy for getting our returns in that business, and we have, in fact, a series of places where we think we have low-cost deposits that are available to us to put into an institution.

But obviously if the yield curve inverts a lot of things change. Now it could, obviously, we could also decide to slow down the deposit growth and a lot of different things if that were in fact the case, so I think we have a lot of flexibility.

Okay. Great. I appreciate your taking questions.

Thanks, Mike.

Your next question comes from Steven Schroeder with Monroe Securities.

Good afternoon, gentlemen. Thank you for take my question.

My question is in respect to the Tax Services item on your income statement. With respect to the online tax program how do you see this segment augmenting your traditional Tax Services?

We think that there are great opportunities both in the core business that we've always been in, the retail tax preparation business, as well as in the digital, the online and software spaces. More and more do it yourselfers move to the electronic world.

We see it as a great way to build an early lifecycle brand relationship, get them comfortable with working with H&R Block and then serve them over time in whatever channel they choose to be served in, so if they want to be in the retail channel, if they want to be in the small business channel, if they want to be in the digital channel, that's all fine with us so long as they want to have a long-term relationship with H&R Block.

Thank you. Put another way, what percent of total tax revenues would you target for the segment in the current fiscal year?

The revenues from the digital has been reasonably small for us over time, and in the segment itself it's probably going to be less than 5%, something like that 5% maybe. We really do, as Jeff was describing, see this as an opportunity principally for to us capture an early lifecycle stage of life person to the brand.

We're much more interested in scaling that client base. So we're looking to expand the number of clients we serve dramatically over the next few years as a more important metric than likely revenue.

Do you foresee this in any degree going forward to cannibalize from your revenues from your traditional brick and mortar services?

The only thing to keep in mind, which is I think philosophically how we approach this and a lot of other things, it's not about us cannibalizing ourselves, if a consumer is going to decide to use a digital alternative, they're going to choose to use a digital alternative and us offering it only gives them the opportunity to stay in the H&R Block brand rather than us consciously trying to move people to some other channel.

We actually have seen, experienced over the last couple of years where it works just the reverse that we can acquire clients that have never had a relationship with H&R Block and migrate those clients to a deeper office-based relationship, that is, we do more of that than we do the reverse.

I see. Thank you.

Your next question comes from Bob Coleman with Gardner Russo and Gardner.

Can you hear me?

Yes. Hi, Bob.

A couple questions. One dealing with the WAC adjustment of 40 basis points. Could you just walk us through how that will impact your income statement and your balance sheet? And then I have a follow-up question on the Tax Services.

Sure. Well, you know, the, we're putting the increases through beginning today, I guess, in the market. It will take us probably 30 to 45 days before that starts showing up in the funded production so we really won't see this now until October when it starts coming through the pipeline. So from that perspective the impact it will have on the income statement won't show up until we fund.

Now, when we fund a loan, our funding mechanism is such that we value the loan when we originate it so you'll start seeing some effect of that in probably later in October, but that's why we believe the bulk of the effect will start to show up in our third and fourth quarters. The effect it has on the income statement, in fact, it's probably a couple of different, I mean, besides that, it affects the balance sheet in a variety of different ways.

A higher value of loans when they go into our warehouse means that the beneficial interest in trust is going to be larger relatively speaking until we finally sell those loans away, but that's probably the only place that it really affects the balance sheet.

Will you be forced to increase your capital requirements to hold those loans?

No, I wouldn't expect so.

Okay. And just to stay with the mortgage for one second. In this world in which we live where we're experiencing record low delinquencies and default rates, do you think the MSRs are appropriately priced and valued in today's market?

Well, in general, in our, I mean, I don't know about others besides us. I would tell you, you know, we've been actually discussing that internally. We generally think that we are undervaluing our MSRs.

And we do a, we look at the MSR value because I think the accounting rules say you carry them at lower cost or fair value, and we've never had a reduction in value write-down on MSRs because we think we've been very conservative on that, or appropriately conservative, I think is the appropriate thing to say.

So in general I would tell you I think also as we look out and look at what is likely a rising rate environment, it's not inconceivable that you're going to see prepays slow somewhat which also would affect the MSR values and make them more valuable. So for those reasons we actually think that MSRs may have been conservatively, appropriately conservatively valued.

Then on the tax side, Jeff mentioned at least possibly two, maybe three times, that you're all working on points of differentiation with the consumer, the end user tax preparer, and I'm wondering, you know, the industry is filled with copycat processes yet no one has pushed the pricing envelope. And I'm wondering if you would be willing to consider using a stratified pricing tier away from what you're currently using to try to pick up additional market share?

Well, you know, we've looked at a variety of things like that, and we've actually done some testing of it over time. We don't really often talk about all the different testing that we do but we've looked at that notion before.

It's tough to do that under a single brand, and we've, but we've considered it. We have not, I don't think, ever seen anything either in tests or conceptually that we thought was effective that we could roll out across the country, but we have some of that today, in effect.

Our premium offices, which we don't talk a lot about, but they're a separate distribution system in effect inside of our Block branded system, has a different price point attached to the work there. We think there's room to grow that kind of a model and offer a somewhat differentiated service level there.

So I think there's a number of things yet that we continue to work on, expanding the notion of the premium strategy or how that could work for us in the future as I think we've talked about somewhat is an area that we are exploring in much more depth now.

Thank you.

Your next question comes from John Neff with William Blair.

Two quick questions. One, I just was wondering, could you just give us a little more color or explanation on that $14 million hedge gain I think you said you pulled that forward from next quarter.

And then the second question was just what the remaining share buy back authorization was currently? Thank you.

Thanks, John. Normally the way we account for our mortgage activities, as we fund a loan and it goes into the off balance sheet warehouse facility, that is treated as a, and it is a true sale, and in effect we record the expected profits from that loan as it goes into the warehouse. So normally, and we hedge our origination activity and then we'll close out our hedge positions when loans actually fund.

So in most normal cases the hedge gains or losses are really typically reflective of the activity that we have in any given quarter. One exception to that is that we have over the course of the last year and a half I think begun to hedge our pre-pipeline originations.

The reason we do that is that we have, we know that when we make an offer to the broker community for a loan rate it takes time for us when we want to change rates to have that move through the system, and that we will honor the rates that have been out there. As a consequence we have begun to have a hedge on against our pre, about 30 days before we actually have the application in house.

On those loans that are in the pipeline that have a hedge against them at quarter end, we have to, for the traded marketably traded hedge vehicles, we have to mark those to market. If it's a forward loan sale, whole loan sale, we don't mark that, but if it is a swap, for example, we have to mark that at quarter end.

It's a long explanation but that is what gave rise to a portion of the hedge gains that we recorded this quarter were for loans that will fund now in the second quarter, and we just wanted to call that out and make sure that you realize because we realize that about $14 million of those reported hedge gains are really attributable to loans that won't fund and therefore won't price until the next quarter.

On the buy back authorization, Bill?

It's still in excess of 10 million shares. I can't give the exact number right now but it's over 10 million.

Thank you.

Your next question comes from Chris Gutek with Morgan Stanley.

Thanks, guys. A couple questions.

Starting with the tax business. Since your comments on the fiscal fourth comments call have you done any extra analysis on what happens to the end of the fiscal '05 tax season, any additional lessons you've learned from last season to apply to the upcoming season to help protect your share with both the early season and late season filers?

Chris, we've actually done a lot of analysis on what happened both at the end of the season as well as kind of the softer middle that we saw. Not surprisingly you'll know that we can't really say anything about it right now for competitive reasons.

I suspect in January we'll give some more color to the kinds of things that we've learned, but we do think that there are opportunities for to us improve our performance and we have every expectation that we would improve performance in those two periods.

I'm sure you guys are well aware of the President is expected to come out with a proposal in late September for tax reform and potentially some kind of simplification which would seem to imply the potential for one or more major deductions being eliminated. How concerned are you, if at all, about the preliminary proposal you guys are seeing?

We've had conversations with, I've had conversations with members of that tax reform committee, or study committee, whatever it's called, and I think that as we would have anticipated, the thought of fundamental reform is a much more daunting task than it sounds at first blush and I think that that is much of the conclusion that that group is also going to reach. And we think that there's very, you know, interesting and sort of structural reasons why we sort of find ourselves where we are.

So our expectation is that anything that would come out as a proposal is not likely to have a meaningful impact. In fact, we think that there's probably some things that could be simplified that actually would make the business for us much more successful than what it is today.

One of the key challenges we face is educating all of our people every year to the complexities that are baked into that code. So generally speaking we don't think it's going to be a big deal.

And finally for Jeff. I think you said that for the Investment Services business which seems to be performing a little bit better than we'd expected, yet for the full-year you're still expecting reduction in operating losses of 25 to 35 million, but if you model that out that would imply an increase in quarterly loss run rate versus what you just reported in the fiscal first quarter so it seems like there's a disconnect there.

I think what we were saying, Chris, is we were extraordinarily pleased with our performance in the quarter for the Investment Services group and because it's the first quarter, we just aren't willing to imply that we will have that significant a performance each quarter. We know that the second quarter tends to be a little bit of a softer quarter overall and we're very comfortable with the 25 to $35 million improvement target that we've set for the year.

So I think for now for conservatism we're best served leaving our estimates as is and we will, you can be assured that we will continue to manage that group very closely, day in and day out, month in and month out, and hopefully we'll get to the end of the second quarter and we'll have news that is different than that but for right now we think it's prudent to stay where we are.

Great, thanks.

Thanks.

Your next question comes from Jeff Talbert with Wesley Capital.

Good afternoon. I just wanted to follow-up if I could on one point you raised earlier with respect to Wall Street's less aggressive bidding from loans in the secondary market.

It's our understanding from some of the other public companies that have reported in the same space that they're seeing weaker bids in response in part to the increased percentage of IO loans in the pools. Are you seeing the same thing number one?

And number two, it's our understanding also that there are beginning to be a few concerns over credit in subprime lend generally and whether you feel that that maybe any part of the weakening bids on the secondary market?

As for as the ILs, I mean it's a new product, typically we don't know how it's going to perform yet but I thinks there's been some sort of magic to if your pools are over 20% IOs, then you were getting a little bit larger credit enhancement requirement, so we are seeing that from a rating agency perspective.

I think we're seeing spreads maybe have widened a little bit from a historical, it lasted like probably April or May, they're probably as tight as they were they've [inaudible] out about 5 to 10 basis points but I think what we're seeing when we talk about the Wall Street firms, is that it just seemed like for probably a year and a half that every time we went out for a bid there was somebody who really wanted it better and probably outbid the others by a quarter to three-eighths and that's sort of gone away now.

And in talking to them, getting sort of anecdotal, but I don't think there's anything else left there. And so I think that, what they're, I mean that's [inaudible] we're getting loud and clear is you've got to raise rates. And so that's kind of what, when we talk about the investments bankers, that's kind of what we see. Was there another part of the question?

No, I think you addressed it. Well, the other part of the question really related to credit and the issue really was yes, you've got to deliver more coupon to the buyers but whether part and parcel that was an increased concern as reflected by rating agencies and their desire to see more coupon as well and potential credit cracks relative to the increased percentage of IOs, and although they may not be part of what you're originating, just the option ARMs that are out there generally and Greenspan jaw-boning everybody.

Yeah, you know, the problem there is it's a little bit of a black box right now. Rating agencies don't send out memos saying we're changing our criteria, you sort of have to, you'll know it when you see it and that's kind of where we are right now.

We're trying to get more on top of it. Certainly with all the press about the housing bubble and IL loans and payment option loans, and payment shocks, I think there's some of that in the rating agencies raising there requirements for credit enhancement.

Got it. Thank you very much and good luck second quarter.

Thanks.

That is all the time we have for questions. Gentlemen, this any closing remarks?

Well, no, just I want to thank people who hung in there with us to the end. We continue to believe we're taking those steps that we need to take to be successful over the longer term. And as always if you have other follow-up questions, you're invited to get a hold of us at our Investor Relations group our others and we'll be happy to address your questions. Thank you.

This concludes today's H&R Block first quarter earnings release conference call. You may now disconnect.