Late Thursday — the SEC time-stamp clocks it at 5:01 pm — H&R Block (HRB) filed its preliminary proxy that disclosed that former CEO Mark Ernst, who was ousted in November, saw his compensation jump 70% despite the company’s many problems. And it reminded us that we’ve been meaning to write something about the 10K that H&R Block filed earlier in the week.

Indeed, H&R Block must have felt like it dodged a bullet when it sold the assets of subsidiary Option One Mortgage Corp., a subprime mortgage originator, to Wilbur Ross’s private equity group last May. About $1.3 billion in sale proceeds were used to pay down $1.1 billion in debt, and S&P put Block’s finance subsidiary, currently rated BBB-, on credit watch with positive indications. But as the filing notes, the company’s subprime exposure, while significantly reduced, hasn’t gone away. There’s a $1 billion mortgage portfolio held by subsidiary HRB Bank and some very-hard-to-quantify contingent obligations to repurchase or indemnify mortgages that were previously sold.

In a densely worded section that begins at the bottom of pg. 16, the filing notes that Option One’s repurchase or indemnification obligations have no stated expiration date. The reps and warranties are different for each deal and while they generally cover titles and liens, the filing also spells out five other fairly broad areas.

In other words, if the loan applicant lied on his mortgage application, and the person who processed that application looked the other way, and the loan goes bad when the adjustable rate is reset, then some security holder may come back and demand that Option One much buy back the mortgage or indemnify him for any losses. As you can imagine, discerning whether or not a repurchase obligation may be invoked is a very fact-intensive process, generating lots of billable hours for lawyers.

What remains? Option one has $300 million available to satisfy future claims. In addition, parent H&R Block, indemnified $2.3 billion of the mortgages Option One sold in 2007. To what extent is the parent further exposed? The question was asked by Oppenheimer’s Scott Schneeberger in the Tuesday morning conference call. In response, Jim Ash, H&R Block’s general counsel said “I think it’s difficult for us to project or to speculate about future activities regarding Option One or any of our subsidiaries. Option One is a stand alone subsidiary, it operates with its own staff of employees and its own balance sheet. Beyond that we really can’t speculate.”

One thing is a safe bet. H&R Block’s lawyers are up to date on the latest legal theories regarding substantive consolidation in corporate bankruptcy. They would like that contingent exposure to be contained.

This entry was posted Tuesday, July 8th, 2008 at 9:53 am written by David Fiderer and is filed under Buried treasure, Legal woes with the following tags: 10-Ks, pre-holiday filings, subprime. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.