H & R Block Inc (HRB) 2006 Q2 法說會逐字稿

Good afternoon.

My name is Katina and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the H&R Block second 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. [OPERATOR INSTRUCTIONS]

Mr. Ernst, you may begin your conference.

Thank you.

Good afternoon and thanks for joining us to discuss our fiscal second quarter 2006 results.

With me are Bill Trubeck, our Chief Financial Officer, Tim Gokey is the President of our H&R Block Tax Services businesses, Bob Dubrish, President of Mortgage businesses and I would also like to introduce Scott Dudley, our new Assistant Vice President of Investor Relations who will read our forward-looking statements.

Scott?

Thank you, Mark.

Before we begin our formal remarks I need to remind you that various comments we make include 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.

The factors that could cause actual results to differ include the uncertainty that the Company will achieve its revenue earnings and earnings per share expectations for the fiscal year 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 interest rates, changes in economics, political, regulator or competitive environments and the effects of such changes, the inability of H&R Block's subsidiaries to successfully expand their businesses, litigation involving H&R Block and its subsidiaries, the uncertainty of the Company's ability to purchase shares of its common stock pursuant to its Board of Directors repurchase authorization and other risks described from time to time in H&R Block's press releases and Form 10-K, Form 10-Q, Form 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 and periodic SEC filings and you are encouraged to review those filings.

You should note that in conjunction with today's call we 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.

With that, I'll turn the call back over to Mark.

Thanks, Scott.

Before beginning, let me take a moment to again thank our thousands of associates throughout our organization for the results that we collectively delivered this quarter and the work that's underway in preparation for the upcoming tax season.

You should all know that we appreciate your dedication and commitment to our collective success.

I want to extend a particular welcome to the thousands of new associates who joined us during the quarter from the former American Express Tax and Business Services organization.

We're excited about the opportunity that we have to build on what is becoming the leading accounting firm serving the middle market.

I'd also like to welcome our recently appointed controller, Jeff Nabor.

Before joining us Jeff served at Senior Vice President and Chief Financial Officer for specialty retailer Sharper Image.

He also has held financial leadership positions at Staples and at Limited Brands.

Finally, we wish to say farewell to one of our business colleagues and friends, Jeff Yabuki, who will be leaving us shortly to accept a great opportunity to become the President and Chief Executive Officer at Fiserv.

Since joining H&R Block in 1999, Jeff has been a highly valued member of our management team.

Perhaps Jeff's most important contribution has been to help build a strong organization across the H&R Block brand of businesses which positions us well for a smooth transition and a successful tax season.

We wish Jeff the very best.

You should note that we'll be hosting our annual investment community conference at the Millennium Broadway Hotel in New York City on January 10th beginning at 7:30 Eastern time.

For those unable to attend, we invite you to participate in our Webcast of the meeting which will be accessible through the Investor Relations section of our Web site.

Looking at some of the highlights for the second quarter, we're pleased with the tax season planning and outlook as well as the good progress we're making in our Investment Services and business services segment.

Our mortgage business continued to show a solid increase in originations and lower costs, although market conditions remain highly competitive.

We recorded second quarter revenue growth of 9% in our tax business and 6% in our mortgage operations.

Investment Services and Business Services each achieved top line growth of about 30%.

Consolidated revenue increased more than 14%, or $78 million.

However, the consolidated net loss increased by $22 million for a total loss of $72 million, or $0.22 per share compared to a net loss of $50 million, or $0.15 a share in last year's quarter.

I'll review each of our businesses in more detail starting with Tax Services.

Tax Services results were in line with our expectations and office expansion is proceeding on our plan to open 1000 additional points of presence for the upcoming tax season.

Our overall tax season preparations across all channels are on track.

The pretax loss for this segment was $143 million, in line with our expectations.

The increased loss of $9 million was primarily due to the incremental costs associated with our continued retail office expansion.

The increased loss also reflected the inclusion of some tax and business service operations which incurred higher off-season losses due to the full-year effect of expansion last year.

After these investments in our growth, we actually achieved a slight reduction in losses.

Included in these results are our international tax operations which include strong performance in our Australian operations which are currently in the middle of tax season.

We're now in the midst of implementing our established plans for the upcoming tax season.

As we've described previously, our expansion is two-fold, adding new locations to our network and increasing capacity in our existing locations.

These service expansion efforts will enhance our ability to meet the demand that exists for H&R Block's services.

As most of you 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 update you on some of our fiscal year 2006 initiatives.

In September, we said we expected to be at the upper end of our range to open between 500 and 700 company-owned and franchise regular offices this year.

At this point, we believe we will meet or exceed the top of that range.

It's important to recognize that not all locations are equal in terms of client service potential and returns on capital.

We estimate we will open approximately 300 new shared locations in Sears, Wal-Mart, and other retail stores across our company-owned and franchise networks.

This element of our expansion strategy increases the number of clients we can serve through increased distribution and provides additional branding opportunity.

While shared locations help to increase our level of accessibility and convenience, we [were biased] toward regular office locations to better enhance the long-term value of our distribution system.

We continue to make excellent progress ahead of the upcoming tax season in our digital business.

I believe most of you are aware that the IRS and members of the digital tax industry have recently committed to a four-year agreement to renew the Free-File Alliance.

Under the new program, the IRS and the consortium have agreed to set a $50,000 taxpayer adjusted gross income cap to qualify for free service, and consortium members will be permitted to offer other services including state tax filings and refund settlement products.

I also want to mention an important development with regard to the funding of our Refund Anticipation Loan program.

We recently extended our relationship with HSBC with whom we have had an agreement for many years to provide tax refund settlement products.

We entered into a new five-year agreement that will begin in 2007 and continue through 2011.

We're in the midst of reviewing our settlement product, programs, and strategies in the context of this new agreement.

This agreement provides us with important flexibility for the future in addition to enhanced economic benefits.

We would expect to share the impact in more depth in June of 2006 when we provide guidance for fiscal 2007 performance.

We're very pleased to maintain our long-standing relationship with HSBC and will continue to deliver to clients the best product available in the market today.

Investment Services again delivered improved results this quarter with a strong increase in revenues and much improved profitability over the prior year.

The better performance for the quarter was primarily a result of higher production levels, favorable net interest revenue from market rate increases and a continued focus on cost management.

Results over the last several quarters are encouraging and indicative of the kind of progress we are committed to drive and expect from this operation.

Revenues for the second quarter were up 30% versus the prior year and were up 3% sequentially.

Pre-tax loss for the second quarter was $8 million, an improvement of $13 million versus the same period last year and essentially flat compared to the sequential quarter.

As we noted last quarter, these results and those in future quarters include $9 million of intangible amortization.

Our number of advisors has increased slightly to 995 from 985 in the first quarter.

We continue to enforce minimum production standards for our advisors which is offsetting some of the gains in the number of advisors.

We had a solid recruiting quarter that brought the number of experienced advisors added to 141 for the fiscal year-to-date.

Through the remainder of this year, we will continue to strategically focus on recruiting and developing high quality advisors.

In issue to financial performance, this business must deliver strategic relevance for us as a company overall.

We continue to make solid progress in converting our tax client leads into new accounts.

As of October 31st, nearly 8,000 funded new accounts have been opened with assets of $363 million.

For the fiscal year-to-date period, we had $5.6 million in revenue from these accounts, representing a 57% improvement versus the prior year.

As we approach the launch of the tax season '06, we're focused on expanding our tax client reach through a growing partnership with our tax professionals.

To date, we have nearly 5,000 tax professionals enrolled in our Preferred Partner program, and we expect that neck to be over 7,000 by the time tax season begins.

The program strengthens our tax professional's understanding of how to identify and refer tax clients to our financial advisors.

While we believe Investment Services performance suggests it's turning a corner, we will continue to closely manage and monitor the business.

We now expect that we will improve performance in Investment Services for the year by 30 to $35 million.

We continue to work closely with the OTF on our bank charter application.

We remain confident that we have the people, systems, and controls in place to begin operations upon being granted a charter.

We believe the bank will benefit a high percentage of our clients who did not have access to basic banking services and savings services and will help differentiate our tax service business and provide predictable earnings.

Mortgage Services continued to show good growth with loan production totaling nearly $13 billion.

Overall focus on cost effectiveness, including the integration of our pre-qualification technology, has enabled us to achieve our goal for reducing our cost of origination.

However, market dynamics continue to be challenging, and these conditions had a significant negative effect on results for this quarter.

Mortgage revenue for the quarter increased 6% to $302 million, while pretax earnings decreased 44% to $61 million.

Although we originated record levels of loans during the quarter, we're disappointed with the margin realized in this production and have taken actions to improve margins over the remainder of the year and to enhance our competitive position beyond this fiscal year.

Second quarter loan production totaled a record 12.6 billion, about double the volume compared to the previous year's quarter and an increase of 16% from the sequential quarter.

The average loan balance for the quarter increased to $188,000 compared to $165,000 in our first quarter.

Increased productivity of our account executives and support staff, emphasis on originating larger balance loans, and progress towards integrating our pre-qualification technology drove these results.

While volumes were strong, pricing was a problem.

As we noted last quarter, we took the lead in the industry on raising prices, announcing a 40 basis point increase in our coupon effective September 1st.

However, those actions, which we thought would begin to restore margins, were completely negated by the rate at which funding costs went up during September.

During that month, the two-year swap rate increased 39 basis points, in effect neutralizing our rate increase.

We were not able to raise our coupons fast enough to compensate for the rising two-year swap rates, the additional credit enhancement requirements by the rating agencies and moderating demand by whole loan buyers.

As you know, there's a 30 to 45-day lag from the time we increase rates to when we see those rates in funded loans.

The credit quality of loans that we're originating remains strong.

Our average FICO score for non-prime originations averaged 629 for the second quarter, up from 623 last quarter.

Our loan-to-value was essentially flat at about 81%.

Average loan balances and credit quality are influenced by interest-only fundings that generally require higher credit qualify, have higher leverage and larger loan balances.

In the second quarter, interest-only loan funding, which had average FICO scores of 654, average LTV of 82% and average loan balances of about $329,000, represented 28% of our overall loan production versus 25% in the first quarter.

Recently, the percentage of IOs has declined, and we expect that level to be closer to 25% or less of our loan production going forward.

Our second quarter net gain on sale gross margin decreased 115 basis points compared to the first quarter as our funded WAC did not keep up with the increased market required funding costs, increased credit enhancements and a whole loan market demand.

As loans in the pipeline before our rate increases were funded throughout most of the quarter, the weighted average coupon on new originations during the second quarter decreased slightly to 7.48% from 7.52% in the first quarter.

This reflects both the competitive environment and a slight shift toward higher balance interest-only loans which generally have a lower rate.

We recorded $61 million of hedge gains during this quarter due to the rise in market interest rates.

Approximately 17 million of this hedge gain represents loans that had not funded by quarter end, suggesting that these earnings were pulled forward as a result of our hedging practice.

This quarter's reported results had an offset of $14 million in hedge gains that were recognized in the first quarter related to loans that were funded in the second quarter.

During the quarter we executed 78% of our non-prime loans to the whole loan market while the remaining 22% were secured types.

The decision between whole loan sales and securitizations is highly dependent on how to best optimize value wit a strong bias obviously to cash.

The value of retained mortgage servicing rights on loans originated and sold during the quarter was 76 basis points as compared to 45 basis points in the first quarter.

The increased value of servicing rights is a result of higher average loan balances, higher interest earnings and lower costs of servicing.

Our overall cost of origination of 179 basis points was 15 basis points lower than the first quarter and 68 basis points better compared to the last year's equivalent quarter.

This continued improvement resulted primarily from increased funding volumes, prudent spending and greater leverage of newly hired account executives and support staff.

Our pre-qualification technology 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 rolled out now and we expect it to be in the network over the next six months.

We expect an increase in productivity when it's fully implemented.

In last year's second quarter call, we stated our objective to reduce our cost origination by 50 to 75 basis points, and we have achieved this goal.

We believe that for the next six months our cost of origination will stay at about where it is now, around 175 basis points, reflecting further cost reductions to counter slightly lower volumes.

In the six to 12 months after that, we are targeting a further 50 basis point reduction in cost of origination.

Through our automated underwriting and other productivity measures, we can achieve this to further improve our competitive position as our industry goes through a turbulent time.

Our debt origination margin, that is gross gain on sale less cost of origination and acquisition, was a loss of 10 basis points as compared to income of 92 basis points in the first quarter.

As mentioned earlier, this was a result of our insufficient pricing in the midst of the rapidly changing market conditions that I've discussed.

At quarter end, Option One servicing portfolio was $82 billion, an increase of $29 billion over last year and $12 billion over the previous quarter.

Servicing revenue for the quarter was $100 million, up 60% from the second quarter a year ago and represented one-third of total mortgage revenue in the current quarter.

As our average servicing portfolio continues to rise and mortgage rates increase, we believe servicing revenue and profitability should continue to be strong.

This is an important stable earnings stream that reflects the business that we've been building for a number of years.

Overall loan performance trends remain positive.

Twelve-month seasoned and beyond delinquency rates have been holding in the 11 to 12% range resulting from higher credit quality and continued strong servicing practices.

As both our whole loan sales and securitizations are non-recourse transactions, it's 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 second 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 second quarter which was recorded in other comprehensive income net of deferred taxes.

This write-up, coupled with a $2 million write-up in trading residuals, was offset by $10 million in write-downs.

During the quarter we completed a sale of previously securitized residual interests which netted $30 million in cash proceeds and resulted in a recorded gain of $29 million.

The net gain recorded on the income statement this quarter was $21 million.

Write-downs and write-ups on trading residuals are recorded in gain on sale of mortgage assets on the income statement.

As you know, we don't provide quarterly guidance.

However, given our disappointing original margin in the second quarter and the current conditions of the non-prime market, I want to share some perspectives on things that are happening in the market, how we're responding to them and how we see that affecting us over the balance of this fiscal year.

Until recently, the increase in market funding rates has not been matched with increases in rates for consumers throughout the industry.

Although we began to aggressively raise rates midway through the quarter, we have just begun to outpace increases in our benchmark index, the two-year swap.

You'll be able to see this on the supplemental slide, Page 7 which we entitled, "Rate Change Summary" that we provided for today's call.

We began to see the effect of our actions late in our second quarter.

Our funded WAC for the months of August, September, and October was 7.32%, 7.41% and 7.76% respectively.

For the first half of November, our funded WAC is approximately 7.98%.

You'll be able to see this on our supplemental Slide 8 entitled, "Option One Non-prime Funded WAC".

Including the price increases this month, our total increase in WAC since September 1st has been 107 basis points versus 76 basis points for two-year swaps.

With the rate increases we have made and based on the current interest rate environment, we enter the third quarter with an anticipated funded WAC that will bring margins to a level that more closely reflects a risk adjusted return that we expect from this business.

We believe the service advantage that we enjoy will permit us more rate flexibility than many of our competitors.

In addition to our technology initiatives, we've implemented other cost containment measures that we believe will have a positive effect on our cost of origination to counter slightly lower volumes.

The next two quarters, we believe we can achieve funding volumes consistent with first quarter levels of 10 to $11 billion per quarter, with origination margins of 40 to 50 basis points in the third quarter and 90 to 100 basis points in the fourth quarter.

These should prove to be reasonable expectations as we realize the full effect of rate increases and cost saving measures that we're implementing.

As we stated before, we believe that for the next six months our cost of origination will remain close to where it is now, around 175 basis points, but that we can achieve a 50 basis point reduction from there over the next six to 12 months after that.

Business Services had a very good off-season quarter with solid double-digit organic top line growth.

Meanwhile, the integration of our newly acquired American Express Tax and Business Services division is going well, and we're pleased with the increased market presence this provides for us.

Importantly, we have expanded our presence in several major markets including Chicago, Cleveland, New York, Boston and Baltimore.

Second quarter revenues increased 29%.

Organic growth, excluding the first month of the American Express acquisition, was 13%.

The pretax loss improved 56% to $2 million compared to a loss of nearly $5 million last year, and that includes $3 million that was attributable to the TBS acquisition in this quarter.

We saw strong 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.

Like our tax business, Business Services core operations are seasonal, resulting in earnings gains of fiscal third and fourth quarters.

However, RSM McGladrey continues to benefit from client flow from the Big Four firms as they shift their focus to serve larger clients and meet their significant resource needs related to Sarbanes-Oxley 404.

Our ability to serve the needs of mid-size firms is already benefiting from our recent acquisition of American Express Tax and Business Services.

Integration is well underway and going smoothly, and we look forward to further leveraging our additional scope and market presence.

Our belief remains that this acquisition will be accreted by approximately $0.02 per share in fiscal years 2006 and 2007 after expected integration costs.

Going forward, we'll be more focused on building our brand and improving the awareness of RSM McGladrey as one of the nation's leading accounting and business services organizations.

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

As compared to July 31, 2005 of notable changes to the balance sheet include a decrease in cash and cash equivalents net of short-term debt from 633 million to a negative 106 million.

This was due largely to normal off-season working capital requirements, share repurchases, and the American Express acquisition.

On a year-to-date basis cash net of all debt is only $81 million less than the first half of fiscal 2005.

I would also note that commercial paper of 498 million was outstanding at quarter end versus a zero balance at April 30th due of course to the seasonality of our cash requirements.

Available for sale mortgage residual interests were 144 million, while trade residuals of 95 million were outstanding at quarter end which were recorded on marketable securities trading on our balance sheet.

This reflects a timing issue as we have not yet executed the NIM from our last securitization.

For capital efficiency purposes, it is our intention to continue to manage the residual balances down.

One of our goals has always been to maintain a prudent balance sheet with sufficient capital retained to appropriately support our business mix and with excess capital returned to shareholders.

Retained capital is expected to be higher primarily due to the addition of the bank this fiscal year.

As for the remaining capital location, we acquired 4.6 million treasury shares during the quarter at a total cost of 128 million, or an average cost of $27.98 per share on a split adjusted basis.

A total of 1 million shares were issued for option exercises, employee stock purchase plan purchases and restricted shares.

The total available capital remaining to be allocated for the year will be dependent largely upon earnings and the level of stock option exercises.

As of October 31st, there were 325 million shares outstanding.

The Company continues to strengthen its liquidity position.

In August, Block Financial Corporation closed on a $2 billion five-year committed line of credit from a consortium of 31 banks.

These lines can be used for general corporate purposes as well as backed up for the commercial paper program.

We also increased committed warehouse capacity for non-prime loans from 10 billion at the end of the first quarter, to 13.5 billion at the end of the second quarter.

An additional uncommitted facility of $1 billion is also available, bringing total liquidity for Option One to 14.5 billion.

We're still expecting to implement an on balance sheet commercial paper facility for Option One by the end of the fiscal year.

For those of you building your models, we expect our full-year tax rate to be approximately 39%.

This increase over our prior expectation of 38% reflects changes in our state tax reserves.

Lastly, just a quick note that we plan to file our fiscal second quarter 10-Q on December 9th.

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

Thanks, Bill.

In Tax Services, we expect that incremental clients and revenues from network expansion during this fiscal year will be more than offset by expansion costs.

We are assuming segment revenue growth to be in the high single digits for the fiscal year and that margins will be generally in line with the prior year.

In Mortgage, while the remainder of our fiscal year will be challenging, we believe the service advantage that we enjoy will permit us more flexibility around rates than what many of our competitors may have.

We're in a unique position to withstand difficult market conditions given our strong balance sheet, access to liquidity and our other strong annuity-like cash generating businesses.

In addition to our technology initiatives, we've implemented other cost containment measures that we believe will have a positive effect on our cost of origination.

For the next two quarters we believe funding volumes consistent with first quarter levels of 10 to $11 billion per quarter, with original margins of 40 to 50 basis points in the third quarter, and 90 to 100 basis points in the fourth quarter, are achievable as we realize the full effect of increases in our rates and cost saving measures that we're implementing.

We continue to expect strong loan original growth of 20% for full-year fiscal year 2006.

Lowering our cost of origination from our reported second quarter 179 basis points by a targeted 50 basis points over the next 12 to 18 months is a key priority.

We believe we can achieve this by targeting increasing operating productivity and integrating pre-qualification and underwriting technologies.

In Business Services, our focus or this fiscal year is to further grow the business organically and to successfully leverage the increased scope from the acquisition of American Express Tax and Business Services.

We will continue to support our national business development strategy, and we expect the demand for risk management services and financial process outsourcing to continue.

We also believe the demand in competition for qualified professional staff will continue.

We expect this segment's pretax income for fiscal year 2006 to increase nearly 75% to over $50 million.

The improving performance trend that we've seen over the last several quarters from Investment Services gives us confidence that the business is taking the right actions to achieve sustainable profitability.

Although we still expect reported GAAP loss for fiscal 2006 as previously mentioned, we anticipate that loss will be approximately 30 to $35 million less than the loss recorded in 2005 and will include $37 million of intangible amortization.

For the Company as a whole, we continue to expect fiscal 2006 revenue growth within our long-term guidance range of 10 to 15%.

However, due to the shortfall in expected earnings from our mortgage operations, we're reducing our fiscal 2006 full-year earnings guidance to a range of $1.90 to $2.15 per share.

You will notice that this range is wider than we usually target but reflects the continuing uncertainty within the mortgage market overall.

With that, Operator, I think we're now ready to stop and open the line for questions.

[OPERATOR INSTRUCTIONS] We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Michael Hodes with Goldman Sachs.

Good afternoon, guys.

I have a few questions on mortgage and I have to confess up-front I'm not exactly sure where to begin.

In terms of the re-NIM gain of roughly $0.05 in the quarter, does your guidance contemplate further re-NIM sales?

And why is this an opportune time to be selling residuals?

That's my first question.

My second question has to do with the WAC.

I'm a little bit confused.

I mean sequentially it went down 4 basis points on sequential quarter basis, but I'm not following exactly why that doesn't reflect some of the pricing gains that you guys made in the market.

And I'm also, I'd love another explanation of why the servicing, the MSR gain on sale went up so significantly.

I'll just pause right there.

So let me, and I'll have both Bill and Bob join to the extent I don't get this quite right.

Let me start with your first question about the NIM sales.

First of all, we are not in our guidance expecting further sales of residuals through those types, and there's no anticipated additional gain from that.

Obviously write-ups and write-downs occur, write-ups occur through OCI and write-downs occur through income.

So our forward look assumes all that as having no effect for the balance of the year.

I would tell you right now one of the things that we do believe we will have the opportunity to do is to realize better gains in the coming, certainly in our third quarter by doing more securitization rather than whole loans as that part of the market is softer than we think is justified.

So by reducing our residual balances through this re-NIM, it positions us in a position with our capital levels to put more residuals on the balance sheet if we so choose and to capture that value.

That's why I think we believe now was the appropriate time to be doing that.

Your question about the WAC, obviously there is a lag between when we introduced price increases into the market and when those worked their way through the pipeline.

There's about a 45 to 60-day lag between when price increases go in and when they show up in the funded WAC.

And so that's why the WAC that you saw coming through this quarter really reflects where pricing was at back in the first quarter in the June, July timeframe and into August.

So that would be why you see that.

The other thing that happened or was happening this quarter was that, as we have done more higher balance IO kind of production in some of the states where that is very attractive, those loans typically have higher FICOs, they have higher balances but they often have lower overall WACs.

That's why you saw the overall WAC come down.

Finally, I'll take a shot at the MSR.

The MSR levels are really driven by a variety of things.

They're driven by our cost of servicing which has been coming down as we have been very aggressively working to enhance the productivity of our service operation.

It also reflects market interest rates where we earn more on the balances that are inherent in that business and therefore an MSR in a higher rate environment, a servicing right is worth more in a higher rate environment.

And finally, because the loan balances are larger, that gives us a more valuable MSR.

So the primary driver for the increase in MSR value this quarter was this big increase that we saw in our overall average loan size.

This is the last question on this average loan size.

I'm just struggling a little bit mathematically.

It went up $23,000 sequentially, yet the percentage of higher loan size IOs only went up a few percent.

It's really the mix.

What you saw is more of a, while the average increase in the IOs didn't go up that much, IOs were a bigger part of the mix this quarter than they have been at previous quarters.

Thank you.

Your next question comes from Kelly Flynn with UBS.

Thanks.

Couple of questions.

First on the bank charter.

I know you mentioned it, but the Office of Thrift Supervision has you guys now slated for February approval at the earliest.

Could you just comment on the significance of that data point and any info on your level of confidence in your ability to get the charter in the face of what seems to be a lot of skepticism out there?

And then the second one relates to the HSBC relationship with the RALs.

You mentioned this, Mark, but could you just revisit that?

Were you saying that you saying that you are hoping that you might be able to realize some incremental benefits from the contract change?

I'll leave it at that.

Thanks.

Great.

Thanks.

On the thrift charter application, we continue to work closely with the OTS.

And in that sense I'd tell you that as new data has come out and as more things have progressed, they've continued to ask very appropriate questions about parts of our operation.

We think that we've been actively working with the OTS to respond to those things, and I think they're just doing a very appropriate diligent review process.

So from our perspective, we remain hopeful that we will have the opportunity to enter into this business, and I'm not sure it would behoove us to go much deeper than that.

They will obviously make the judgment in the time that they believe is appropriate.

On the HSBC contract, we clearly see a greater flexibility in the way that contract is now structured.

We were, as some of you know, have been partners with HSBC and predecessors to HSBC in this business for the last nine years now in the tenth year of a ten-year contract.

I think during the course of that time, we have both learned a lot about the kinds of things we would like to be able to do in the market and how we can best leverage this product set to enhance our ability to compete in the market in the tax business.

We have had as a result of that the opportunity to negotiate what we believe will be important new flexibility in the way we price and structure that set of products or those products in the market.

How exactly we will do that we have not yet decided.

As a consequence, that's why we're kind of putting off until next June any thinking or any kind of description of what we think the net effect is.

But clearly the contract gives us economics that are at least as good as what we have today.

And how we choose to use the flexibility that's inherent in this contract will determine how much incremental economic impact we will get out of the contract.

Do you have anything you want to add to that?

I think the only thing I would add is, as we've renewed the partnership, we believe we have renewed agreement between the two of us to work together on new product development that will better meet our client needs, and we have strengthened intellectual property rights as a result of that contract.

Right.

Thank you.

Thanks, Kelly.

Your next question comes from Kartik Mehta with Midwest Research.

Good evening.

A couple questions, Mark.

First on this mortgage business, you said you'd hoped to get to about 90 to 100 basis points of net margin in the fourth quarter.

I'm wondering if you'd tell what kind of WAC you'd have to reach to be able to get to your net margin assumptions assuming the two-year swap rate doesn't move around too much from here?

I'm going to maybe look to Bob.

I know we have that.

Off the top of my head, I don't recall.

I'm going to say 8.25, something like that, Bob?

So 8.25 by the fourth quarter.

We're sort of targeting sales from pricing standpoint of 225.

About 25 basis points more than where you are now?

Yes.

I think that sounds right.

And Mark, from a big picture standpoint, what type of returns do you think a business has to give you for you to say this makes sense and this is why I want to commit capital?

You mean the mortgage business generally?

Yes.

Well you know, we really actually look at the mortgage business breaking it down into the various different components.

So we look at returns on the servicing part of the business, we look at returns on the origination side of the business as well as the returns that we expect to realize on sort of the residual assets and that as a dedicated use of capital, and break it down and think about each of those components separately.

The servicing business is becoming very attractive.

The returns on capital in that business are not as good yet as we think they need to get to, but they're clearly trending in the right direction.

We like the kind of stability of earnings that is inherent in that.

We're now at the point where that business probably generates, the servicing business probably generates $100 million a year of very stable, kind of reliable earnings.

So we like that aspect although there's a little bit more capital attached to that business yet, so I think we're looking for improvement beyond where we're at today, and we're primarily addressing that through looking at how we can lower our cost to serve.

The residuals, we have always had a very disciplined view of that and use very conservative, or what we think are appropriately conservative discount rates, on expected cash flows to value those residuals so that we're looking at anywhere from 18 to 25% discount rates and therefore returns on those assets in order to hold them.

That's okay.

We'd like it to be higher, but we think it's okay, and that's why it's only okay.

That's why we choose to kind of reduce our exposure to that asset category when we have the opportunity.

The origination business which is sort of the biggest swing factor, frankly, we think gives incredibly great returns on capital and returns on equity.

It's very volatile because the barrier to entry has not been great in that part of the business.

But having said that, the returns on equity in that business are really great.

So I think for those reasons the business continues to look attractive as long as we can manage it in a very appropriately prudent way.

And one last question on the RSM McGladrey business.

You've said in the past that it's a business and the biggest challenge you have is that nobody bears the brand name and you could do a better job with a brand name.

Does it make sense at this point in time to go out and buy a brand name rather than trying to build a brand name for this business?

Well the RSM McGladrey brand is known by about 27% of the business decision makers out there.

We know the sort of brand awareness of that mark pretty well.

And we have been exploring what it will take to increase the level of awareness of that business.

What you're suggesting would sort of have us losing the value of 27% brand awareness that we have already built up in some of those key markets.

Never say never, but we continue to explore ways to make that business better known.

And just one last question, Mark.

I know we've asked this question in the past but, I just wanted to get your thoughts once again.

As you look at the structure of H&R Block and all of its business segments, in your mind do they still all make sense all together the way you have the Company built or does it make sense maybe to think about another structure at this point in time?

Well, I'm not sure I would say at this point in time anything is really different than what it's been in the past.

We have always talked about and we continue to do is we have, we are operating our businesses under three separate brand names, each independently kind of operating and building their own strategy.

That clearly I guess gives us flexibility if at some point we felt that those three businesses together didn't make sense.

But in many ways I would tell you I think that the stability of the tax business and the enhancements that we're trying to build into the value proposition in that business through extensions, through things like the bank, and if we had that opportunity, and through things like financial advisors that enhances our position in that market in time so we think that all makes sense.

The RSM McGladrey business and businesses have very attractive economic characteristics though operating in a different market space, but we think that that over time creates great value for shareholders.

And we also believe, I believe that the stability of cash flow and earnings that are inherent in those two lines of business gives us the ability at least to accept volatility from the mortgage business in a way that can be value enhancing for shareholders over time.

But it does require us to be patient through various volatile points of the cycle which I think we're in the midst of one of those right now.

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

I guess the follow-up a little bit on the question that was just asked before.

If you look, and obviously the financial advisor business has done better, but as margins are not necessarily improving at this quarter-to-quarter base, where do you think they have to get I guess on a revenue contribution level to be profitable?

And even if it maintains on this sort of a non-profitable level, do you think the contribution it makes may be crossing over to benefit the tax business, you know, kind of offset any weakness or maybe offset losses from a return perspective?

Yes, Mark.

Generally speaking I would tell you no.

I think they could, but I don't think we would tolerate that as a standard from which to accept kind of performance out of that business as a stand-alone sort of choice.

So we have clear sort of profitability expectations out of the financial advisors business that must be met if we're going to pursue the strategic opportunity that's inherent in that.

My sense is that on a pre-amortization basis, that business should be expected to generate something in the order of operating margins of 20%.

We've done a lot to control and manage down the cost structure of that business so to get there, we know we have to raise the revenues in that business and sort of hold the line on our cost structure.

So on a stand-alone basis, that business we would expect has to get to kind of 20% operating margins to give us some degree of satisfaction before the kind of strategic impact it can have on the tax business.

I would also say that that's our level of expectation before any advantage that may come from assets that would be able to be spread in a banking platform if and when we were in that position.

Gotcha.

And I guess to transition back a little towards the mortgage business here, you're mentioning obviously getting some of the benefit of the WAC increases as we go forward.

Maybe I'm just slightly confused, but if you're obviously not seeing a benefit for sort of 30, 40 plus days from the point at which you increase the rates, are you always sort of chasing after the two-year swaps as it rises up or are you going to get as you look out, is the reason the expectation is that you'll get the 100 basis points as you get out to Q4 is sort of a stabilization at that point and is there still a risk here that you could see yourself in a pretty tough environment?

And then I guess on the back side of that, as you keep raising rates, and obviously this quarter wouldn't show this, but as you keep raising rates, do you think you see maybe some significant slowdown on the volume side as well?

Yes.

I think that in particular that chart that we included in the slides on Page 7 of the slide deck sort of shows you this.

When we increased our WAC, or when we increased our rates back in September by 40 basis points, we thought we were doing that to affect an increase in margins or an improvement in margins.

And what you can see is that by the end of September, that entire increase in rates had been offset by an increase in the funding cost or the two-year swap as a proxy for funding costs.

Certainly when we went into that we were looking at a forward curve that would have implied kind of flattening out forward expectations.

To the extent market rates, market funding cost is measured by I think something like a two-year swap, to the extent those are rising, we find ourselves chasing rates.

And as we're chasing rates, it is clearly more difficult to improve margins.

So when we look out for the balance of the fiscal year, we again look at what the forward curve is telling us about what is expected to happen with rates.

And while we would, in our expectations see rates go up a little bit from here, which is what the forward curve implies, if they went up a lot, that would be difficult.

If they went down, that would be good.

Now, the one thing you should keep in mind is that we do hedge so that to the extent we have a rate that's offered in the market today, that offer rate is hedged.

The challenge is, how do you as secondary market rates go up and funding costs in effect goes up, can you put through price increases to consumers to fully reflect that or, in our case, reflect that and more to be able to regain margins?

That's what we're trying to do.

That's what we think we have begun to do.

That's why we think we're going to see recovery now in the third and into the fourth quarters.

But again, that relies on sort of a view that says market funding costs are going to be stable or reasonably stable going forward.

The point about volume, and I'll maybe let Bob kind of comment on this as well, you know, there certainly, as we went into the rate increases that we started in September, whether or not that was going to dramatically affect volume was a key question in our minds.

I think now, with a quarter's experience, we are reasonably satisfied that a couple things are happening.

Competitors have followed to a large degree, so we're not seeing ourselves squeezed by competitors who are in effect trying to buy position in the market with dramatically lower rates, and we have not seen the kind of falloff, we've seen some falloff as we indicated, but from the height of where fundings were happening back in August, maybe even a little bit in July, beginning of September, we've stabilized and we think this 10 to 11 billion a quarter is a pretty reasonable level.

Bob, things you'd add to that?

I think that's right.

We're seeing commissions today that probably would get us to those numbers.

Again, I think that the bigger thing you said was that the competition seems to be raising their rates a lot faster than they had in the past so we're seeing a lot less differences.

We're not out of the market as much as we were.

Okay.

And if I can ask one more question really quickly on the tax side and maybe it's too early and I know you guys will like to get to a lot of this in January.

You're building 1000 new locations.

You're sort of mentioning kind of incremental benefit as far as clients served here.

How do you look at the build-out there?

Is it much more of trying to alleviate some convenience and capacity issues or is it also the same side driving organic growth and how do you sort of look at the cost benefit of expanding new stores as far as sort of on a customer acquisition level?

Thanks.

Sure.

And again, Tim can comment on that.

For the most part, we do think that by adding additional points of presence in whatever form that is, it gives us, that greater convenience of assets makes organic growth an easier thing to accomplish and so it is clearly designed to allow us organic growth strategies.

But, Tim, anything you would add to that?

I think it's something that is clearly good for clients in terms of increased convenience both from a location standpoint and from a capacity standpoint.

We believe it does do a lot to blunt the competitors and the lack of building offices is one of the things that allows competitive inroads and it creates great professional opportunities for tax professionals.

As we model out our [inaudible] of offices, we see very good financial returns for shareholders as well.

The thing I would emphasize is we use a very strict sort of return on capital discipline around these decisions.

We continue to see very good returns on capital from this incremental expansion.

And the other thing to keep in mind is that, when you open up an office, it takes about five years to fully mature.

So we think that the laddering that occurs as you add additional offices means that we are not just improving our results for this year from an organic growth perspective but we're setting ourselves up for better improvement into the future four, five, six years.

Thanks.

Your next question comes from Andrew [Bord] with Fenimore Asset Management.

Hi.

Thanks for taking my questions.

I guess I'm trying to understand the mortgage business a little better like a lot of folks today.

I guess I have two questions really.

The servicing business, it's obviously very helpful.

I'm curious as to what impact, how sensitive is the profits there to any change in delinquencies?

If the economy got worse, job losses got worse, how sensitive is that income stream?

There's a little bit of sensitivity only in that to the extent loans are performing a little bit poorer the cost of service goes up because of the way we would intervene on behalf of trying to improve the performance of the loans, so there's probably some sensitivity but it's principally on the cost side.

We obviously don't own the loan, and the servicing right itself doesn't necessarily get hurt from that kind of a situation.

So there's a little bit of sensitivity but this is probably a more stable part of the overall earnings stream.

I think that's right.

Plus if you look at the credit quality as measured by FICO it continues to get better.

So we would expect performance to probably improve rather than go the other way.

Okay.

Let me ask you one other question then.

The residual gains, I guess I'm having a little trouble modeling what should I expect quarter-to-quarter.

Not the re-NIMs but the regular residual gains.

I wondered if you could give us any kind of thoughts there on what we should think of?

You know, this is a hard thing for us to, you know, it creates a little bit of volatility in quarter-to-quarter results.

And the reason for that is we value our residuals every quarter at what we believe are the appropriate kind of values.

But when they change, we see that residual values go up and go down, you know, different pools or different residuals will have increases or decreases as the case may be.

The accounting treatment is that when we have increases in value, it goes through OCI and gets amortized into earnings, or accreted into earnings over the remaining life of the residual.

When we have decreases in value, those come right out of the earnings in the current quarter.

So that's why you see kind of lumpiness in the reported results that come from residuals quarter-to-quarter.

Obviously we think that we have valued our residuals just right at the end of every quarter and it's only things that change during the course of that quarter either in sort of loan performance expectations or interest rates or prepayment speeds on different pools that give rise to changes, and that's really a quarter-to-quarter review.

So I don't know that I can give you much, you know, a better answer other than it's a little bit lumpy.

Okay.

Well thank you very much.

Thanks.

Your next question comes from Scott Schneeberger with Lehman Brothers.

Good afternoon.

Bill, for you, the share repurchases in the quarter, it was I think in the 4 to 5 million range and the price acquired was up near $28.

So I guess the bulk of those were acquired in July, because I think the stock was trading below that in the subsequent quarters.

I'm trying to get a better idea of what type of repurchase you think you're going to do through the end of the year or what authorization is out there and just use of capital going forward.

Well we still have basically the same authorization that we had from the Board which is a 10.5 million shares.

And you're right.

In terms of what appeared to be a relatively high price on the repurchase versus where today's level is, you're right.

The purchases occurred early in the quarter at the point in time where that share price was higher.

And in terms of the allocation, I think we've talked about this in the past.

We have a very good I think model which allocates capital to a variety of things including first to the capital requirements of the business, you need capital associated with any acquisition, and finally to share repurchases as that may be available to us.

Thanks.

Bouncing around a little bit, I guess, Mark, any thoughts on filling the COO position?

Internal?

External?

Will it be filled?

Just your thoughts on the executive suite there.

Frankly, we think we've got a really strong team here.

Obviously with Jeff Yabuki's leaving we lose a key person who's been here to help develop a lot of the talent that we have, but one of the great legacies of Jeff is that he helped us build a really strong team, so I think we're in really good shape right now.

As a consequence, we're at the Board level discussing what we think is the best course of action for strengthening the team and dealing with Jeff's departure.

I think we would probably be in a position to have a better sense of the answer to that within the next month or so.

The Board's meeting in early December, and we're going to have that as one of the topics of conversation.

Thanks.

Again switching around on subjects, I just want to make sure on tax client growth, did you say anything new on what you're expecting for this year, this quarter, and your views on that currently as is?

We have not explicitly talked about tax client unit growth.

What we have said consistently, and this has not changed at all, in fact we're probably closer to the season, and we still believe this is right.

We're looking for high single-digit revenue growth.

That's obviously made up of a combination of price and client numbers.

We had talked previously about sort of moderating our price increases relative to where we've been in the past so my implication there's a bit of unit growth expectation based into that sort of overall statement.

I think, as we get closer to tax season and look at the things that we've now executed on and how the market is shaping up, I think we're feeling pretty good that that high single-digit revenue growth is still a very reasonable expectation for this coming season.

Thanks.

One final one.

Just a litigation update relating to RALs and also any update on tax shelter litigation at all?

On RALs, we continue to work those cases that are out there.

There's nothing really to say as an update to that today.

On the tax shelter cases, we have, as you may recall, six individual cases.

They're all reasonably small so we don't think that we have a material exposure to that situation much at all.

And there's really not been major developments at all in that whole line.

Thanks.

I'll stop there.

Thanks.

Thanks.

Your next question comes from John Neff with William Blair.

I was wondering if you could give us a little bit of a breakdown of original volume by type I guess specifically purchases versus refi and just give us an update on the trends in that breakdown?

Bob, do you have that?

Yes, I do.

Are you talking about loan program?

Types of loan and is it purchase versus refi versus?

Okay.

Purchase is about, right now, about 33% in October.

Rate in term refi is 5% and 61% cash out which means I think defined is [inaudible] $1500 cash out or more.

Have those proportions changed much in recent quarters?

No.

It's pretty much the same.

Yes.

That sounds very consistent.

That's kind of the way our business almost always performs.

It sounds a little bit higher on the purchase, just slightly higher on the purchase than maybe it's been for some time.

About 80% of those are adjustable and the fixed rate is about 20%.

That has stayed fairly flat in the last quarters as well.

And then could you just give us some commentary on the recent tax reform proposals and also give us a little bit of a sense of what, if any, impact you expect from the employment situation heading into the next tax season?

Thank you.

Sure.

On the tax reform proposal, there's probably two things to talk about.

One is the proposal that came out of the President's Commission on Tax Reform generally.

Our take, and we've sort of said this in previous calls, now that the official or final report is actually out, I think our assessment is that, if in fact that were adopted, it would probably be good for our business.

And it's not because there wouldn't be substantial simplification, in fact, the proposal has meaningful simplification that would be really healthy for, we think, the tax system overall.

However, what it does not do is fundamentally change what we think would be the need for the interest in sort of professional help which is really what drives our business.

And, in fact, some of the simplification and change would give rise to the desire for the kind of financial advice that we've more and more incorporated into our overall value proposition.

The net-net is that the reform proposal looks reasonably good, both, we think, from a policy perspective but also would not have a big impact on our business in a negative way.

There's also proposals of changes that are underway right now that are being discussed in Congress.

Those also, I think, are kind of at the margin as it relates to our business.

The employment situation in general I think looks good for the coming tax filing season.

Our current models would suggest that, and I think this is, our models are consistent with what the IRS has recently said that they're looking for overall tax filings to be up 1.5% roughly, 1.4%.

That's very consistent with where we would model based on our own internal assessment of the market.

Looks like it should be an okay year.

Your next question comes from Jennifer Pinnick with Morgan Stanley.

Good afternoon.

Most of my questions have been answered, but on the RSM McGladrey and AMEX acquisitions, were there any positive surprises that you weren't expecting, and additional synergies that maybe you can tell us about?

And also on the other hand, was there anything that was disappointing or a challenge?

Yes.

You know, in general, I would tell you that the integration that we have done thus far has been a little bit hands off.

One of the things we concluded to do early was to not try to aggressively move for the realize of synergies and reduction or integration of offices where we have overlap simply because, as you go into the busy season for that business now in January, February, March, April, we didn't want to risk underserving clients because people were distracted by integration activities.

The net of that is that I think things are moving along fine.

We have not really seen any kind of a hiccup along the way that I'm aware that's of any major, I guess that's both a positive and a negative.

If there was going to be a negative, we would have probably felt the effect of it by now that we've been into this integration for 45 days under our ownership and for some months now in terms of the process.

So net-net I would say it's kind of played out as we would have hoped it would.

And we will look to do much more of the integration work come May and June next year.

Thank you.

Thanks.

Your next question comes from Michael Millman with Soleil Securities.

Thank you.

I have a couple of mortgage questions, and then I'd like to switch to tax.

On the mortgage, can you tell us what your equity investment is so we can get some idea of what a fair return is?

And also can you tell us generally is the market, what's happening to the size of the market?

In looking at the Chart 7, maybe I'm not looking at what you're seeing, but it looks like that the margins, or at least the growth in the two-year swap and your rate improvements about kept in line and as we look at your latest [inaudible] it doesn't look much different than it looked three months ago.

Let me jump at a couple different pieces of that.

Certainly the thing to keep in mind which is inherent in our Chart 7 is that the loans that were being funded or that were being originated during, that were funded during this current quarter were the loans that were being priced back in July and August and September so that we are now kind of feeling the margin effect of that period where swaps had moved up much faster than our funding rates.

The other thing that we noted back in the end of August when we last were talking on our quarter was that we saw meaningful changes in the way rating agencies approached valuation in the middle to late August timeframe, and that was another part of the change or what precipitated the change that we made in overall rates.

That rating agency in effect has not declined or changed.

Really what we saw back then really has been something that we see now all the way through the market.

In general, I would say that we're seeing what we expected but for the fact that the swap rates have moved up so aggressively.

We were looking at the forward curve back in August and believing that it was projecting somewhat flat rates going forward.

Obviously that has not been the case and we've found ourselves chasing rates all the way up.

That is much of what explains why we have not had the kind of margin recovery so far that we expected.

Now, again our expectation, looking into the third and fourth quarters is that we will not be chasing rates up.

We think we can get further sort of WAC improvements both through rate increases that we think we will institute or we've instituted more recently as well as the ones that we've put through, coming through in the WACs as we've fund loans going forward.

So I'd say all of that is kind of playing into the timing of the margin improvement that we're talking about.

We do think, by the way, that the size of the market is likely to shrink a bit.

As rates go up, I think it's only reasonable to expect that you're going to see a slowdown in the level of cash out refis that people would have otherwise been doing.

You know, that's kind of a double-edged sword.

On the one hand it will help slow down prepays and it will help our servicing business and probably help the performance of some of the loan pools and maybe the residuals as a result.

The flip side is there's less origination volume overall in the market.

I do think that the overall scale of margins that are in the market today means that it is tougher and tougher for some of the marginal players to weather this storm.

And so, as we look out and say 10 to $11 billion a quarter of originations, that is with the assumption that we're going to see sort of a, somewhat of a reduction in the overall market level of originations in this part of the market.

So you're saying on the margins that basically we should be looking at WACs three months ago compared to today's rates?

No.

We obviously hedged the rates three months ago.

What happened was we put rate increases through starting in September, and we expect that we would put others through assuming that competitors followed that would allow us to improve the margins that we would experience on loans as they then made their way through the pipeline.

What we did not expect should have happened is that, would have happened because we really used the forward curve as the indication of future rates, is that you'd see funding costs, swap rates as a proxy for funding costs going up so aggressively or so dramatically during the course of the last three months.

As a result of that, not only have our rate increases not allowed us to recover margin, we've continued to have to raise rates to stay even with the funding cost in the secondary market.

So your forward guidance is assuming that the two-year swap remains kind of at the 490 level?

Yes.

I think, if I recall, the forward curve implies that by the end of our fiscal year you'd see swaps.

The two-year point be maybe another 10 points higher than where it is today something like that.

So we are assuming some further increase in swap rates as a proxy for funding costs, but not obviously the levels that we've seen in the last three months.

I think right now, somebody just handed me the number, our ending April assumed funding cost or swap cost is 506.

So up about 116, or up about 16 basis points from where we're at today.

And the equity you have in the market, in the business?

I think we've probably assigned something in the order of 650 to $700 million to this business in its various component parts.

So that's about roughly a 5 or 6% equity?

No, no, no.

That's the equity.

That is the equity that we allocate to the business.

Yes.

But in terms of looking at comparisons that that's the equity relative to the originations?

Would we look at the total for that supporting --

Yes.

When I say that number, we really look at the equity that it takes across all the different components of a business.

So that's the 6 to 700 would be across our support of the, the equity supporting the mortgage business in totality.

Now, how that breaks down between the origination business versus the servicing business versus residuals, we could probably take you through that model.

I think we've shared that with people before so there's no reason we couldn't.

I just don't have that at my fingertips.

Okay.

What I was getting to is what margin do you need to get your fair return which I assume is 15 to 20%?

You know, what I believe, it's more than 15 or 20%, I think the risk adjusted kind of return expectations for this business from our perspective is higher than that.

We would generally say that the servicing business can make sense at lower, somewhat lower returns on equity.

The residuals, obviously, have higher return expectations than that, and the origination business is probably kind of the wild card in general because it requires very little equity but has volatility associated with it.

So I don't know that we've ever said here's the precise level of ROE that we expect on this business, but I would tell you that it's easily in excess of 30%.

And would it be fair to say that someone might say at 50 basis points we're getting a good return why do we want to get higher than that?

Well with someone meaning with competitors versus what we would accept as a return?

You know, I suspect the answer is, no, I think that people would generally look at the non-prime business and say, you know, if they, a reasonable return in the prime business is say, 50 basis points, in the non-prime business our expectation is that most rational players would conclude that a reasonable return is probably higher than 50.

How much higher I guess is a debatable point but generally speaking, at this point what we're seeing competitively we think that we're targeting something in the order of 100 basis points as a reasonable margin that we are targeting to achieve over the course of the next twelve months.

Okay.

And moving on to the tax business, I guess what's going to be the impact of that extra Tuesday at the end of the quarter?

And the other question is, typically, the losses in the second quarter compared with first quarter in tax are up 20 to 30% sequentially.

This year they're actually down.

Can you give us some flavor as to the kind of things that you've done on a long-term and maybe on a short-term basis that's held that loss?

Sure.

On the point about the quarter cut off being a Tuesday instead of a Monday, we're going to share in January what we think the effect on the sort of period breaks are, so I don't have that today.

Clearly, being a Tuesday instead of a Monday, the quarter's going to be a little bit stronger in Q3 and at the expense of Q4, but we'll give you our precise view of that when we get together in January.

In terms of the things that we've been doing to sort of control costs across the business, Tim may be the best person to do this because he's really been driving a lot of that work throughout the organization.

Yes, we have been really looking across the organization to see how can we achieve efficiencies that we can reinvest in growth of the business.

We have identified a number of areas where we are able to re-engineer the way we are doing things.

An example of that we've shared on previous calls is the new offices that we are opening, we are opening this year for 15% less per office than we did last year.

We are pursuing a broad effort across the country to take back office operations out of our local districts and centralize those which we think will result in higher quality and lower costs, and a number of other things like that that have resulted in quite a bit of efficiency this year relative to last year.

Why are we seeing more of this seems to show up in the second quarter than the first quarter?

On the assumption that the second quarter typically has higher costs as you're closer to the season, you've anniversaried those new stores?

Yes, you know I think it's just really two things.

One is, these are things that we've begun to do this year so the savings are growing as we move into the year because new things are coming online.

And I think there's also just some second quarter versus third quarter in terms of where some of our costs for recruiting and office openings will fall this year versus last year.

So you're suggesting some of the costs have been pushed back to the third quarter we'd ordinarily see in the second?

You know, I would tell you, Mike, we've done a lot of stuff that kind of moves around.

I generally would tell you I think that we've just seen good cost discipline across the business and while every year there's a little bit of movement between when things will necessarily cut off.

In general I would tell you the other things besides the cost control that's going on this quarter is we saw revenue increases, within the segment also we have the international operations, now Australia is having a strong season, so there's a lot of puts and takes in here.

I think the real point was but for the office openings we would have been about flat with where we were a year ago, net-net within the segment.

And that's with an escalating cost structure that's part of the entire business.

And that's because of the Australia and cost cutting or--

Yes.

Okay.

Great.

Thank you very much.

Ladies and gentlemen we have reached the end of the allotted time for questions and answers.

Great.

So thanks.

I appreciate everybody who hung in here with us and again, thanks for joining us.

Again, give our Investor Relations folks a call if you have additional questions.

Thanks.

This concludes today's conference call.

You may now disconnect.