Fitch Downgrades H&R Block's IDR to 'BBB'; Rating Watch Negative

NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded the following ratings for H&R Block Inc. (H&R Block) and Block Financial Corp:

H&R Block:

--Issuer Default Rating (IDR) to 'BBB' from 'BBB+';

Block Financial Corp:

--IDR to 'BBB' from 'BBB+';

--Senior unsecured debt to 'BBB' from 'BBB+';

--Short term IDR to 'F3' from 'F2';

--Commercial paper rating to 'F3' from 'F2'.

In addition, the ratings remain on Rating Watch Negative.

The ratings downgrade and Rating Watch Negative status reflect the following considerations:

--Uncertainty surrounding the ultimate timing and net proceeds of the company's intended divestiture of its mortgage servicing business;

--Increased leverage resulting from the losses in H&R Block's mortgage origination business with Fitch estimated total debt to EBITDA of approximately 3.3 times (x) as of Oct 2007 versus 2.6x at the end of fiscal 2007 (April 30). Fitch estimates adjusted leverage (total adjusted debt to total operating EBITDAR) to be 4.6x as of Oct 2007;

--Reduced liquidity due to the nearly fully drawn credit facilities and a $500 million bridge loan which matures in December 2007, partially mitigated by Fitch's belief that the company will receive an extension for the bridge facility and is expected to generate strong free cash flow of approximately $2.0 billion during the April 2008 quarter;

--A new chairman and interim executive team with the potential for forthcoming changes in strategy including additional asset divestitures as well as capital allocation strategy;

--Potential liabilities resulting from H&R Block's significant participation in the sub-prime mortgage business including the potential for future lawsuits.

In addition, Fitch believes H&R Block has reduced financial flexibility as a result of various net worth constraints including an OTS requirement that the company maintain an adjusted tangible capital to adjusted assets ratio of 3% which, as of July 31, 2007, Fitch estimated to be negative 3%. In addition, H&R Block's credit facilities require that the company maintain at least $450 million of adjusted net worth at the quarter end for January 2008, and $650 million thereafter. H&R Block's adjusted net worth was $1.1 billion at July 31, 2007 but Fitch believes this figure has declined considerably due to expected write downs and net operating loss in the recently ended October quarter.

However, Fitch expects H&R Block will generate approximately $2 billion of free cash flow for the quarter ending April 30, 2008, reflecting the high seasonality of the tax season, which could serve to aid any potential liquidity or balance sheet issues.

Resolution of the Rating Watch Negative status could occur under a number of various scenarios including:

--A resolution of H&R Block's intent to sell its mortgage servicing business;

--Finalization of the company's management team and clarification of the longer-term operational and financial strategies;

--Refinancing of the $500 million bridge facility due December 2007;

--Traditionally strong free cash flow generation in the April 2008 quarter and the use of a majority of free cash flow to reduce short-term borrowings; and

--Resolution of H&R Block's non-compliance with the OTS adjusted net worth ratio requirement.

Fitch believes H&R Block's liquidity is currently limited and includes $200 million of availability under the company's $2 billion credit facilities due August 2010 plus remaining cash balance which as of July 31, 2007 was $438 million. However, Fitch believes cash has declined due to the typical negative free cash flow generated during the October quarter. Fitch expects liquidity to continue to decline until free cash flow turns positive, typically in mid-January 2008 when the 2008 tax season should begin.

Fitch estimates total debt as of Oct 31, 2007 was $2.7 billion and included $1.8 billion drawn against H&R Block's unsecured credit facilities, $500 million outstanding under the bridge facility and $400 million of 5.125% senior unsecured notes due Oct 2014. In addition, H&R Block's bank subsidiary has $100 million drawn from the Federal Home Loan Bank due April 2009.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.