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Rating Action:

Moody's downgrades Block Financial to Baa2; outlook negative

20 Oct 2010

Approximately $1 billion of rated debt securities affected

New York, October 20, 2010 -- Moody's Investors Service ("Moody's") downgraded the long-term rating of Block Financial LLC (Block Financial) to Baa2 from Baa1, and affirmed its Prime-2 short-term rating. Block Financial, a wholly-owned subsidiary of H&R Block, Inc. (Block), is the issuer of all of Block's corporate public debt. This rating action concludes the review for possible downgrade initiated on August 13, 2010. The rating outlook is negative.

The following ratings were downgraded:

Senior unsecured notes to Baa2 from Baa1

Medium term note program to (P)Baa2 from (P)Baa1

Senior unsecured shelf registration to (P) Baa2 from (P)Baa1

The following rating was affirmed:

Prime-2 commercial paper

For additional information please refer to the Credit Opinion of Block Financial on Moodys.com.

RATINGS RATIONALE

"The downgrade of Block Financial's long-term ratings to Baa2 reflects declining tax return volumes over the last two years, the risk of further market share losses in the bricks and mortar segment to digital products over the medium term, regulatory and business risks related to financial settlement products and financial strength metrics that are more appropriate for the Baa2 rating category," says Moody's Senior Lenny Ajzenman. "The ratings are supported by the company's leading market position and brand in the bricks and mortar tax business, solid operating margins and an expanded digital presence and potential synergies resulting from the recently announced acquisition of the developer of TaxACT digital products," adds Mr. Ajzenman.

The negative outlook reflects concern that Block's financial performance in fiscal 2011 could materially decline due to the elimination of the "debt indicator" by the IRS, negative tax return volumes by Block over the last two years and the recent litigation by Block against HSBC related to their contract for the provision of financial settlement products. Block alleged that HSBC has refused to perform under a 2005 contract that requires HSBC to provide refund anticipation loans (RALs) and refund anticipation checks (RACs) to Block clients. Income from financial settlement products constitute a material portion of Block's profitability and are an important driver of customer traffic to its offices. A disruption in Block's ability to offer instant RALs or RACs in the 2011 tax season could lead to a material decline in profitability. Moody's will monitor developments in the pending litigation between Block and HSBC as well as Block's strategies to minimize any adverse impacts to its business. The negative outlook also considers the risk that a significant step-up in valid claim repurchase volumes or a change in estimate of expected loss rates could lead to a material increase in Block's repurchase reserve related to its legacy mortgage business.

The affirmation of the Prime-2 short term rating reflects the company's adequate liquidity profile, characterized by a sufficient committed bank facility relative to peak short term borrowing needs and stable, though highly seasonal, cash flow generation.

The ratings could be downgraded if (i) the litigation with HSBC leads to an adverse outcome for Block and it appears that Block's ability to offer financial settlement products will be substantially diminished (ii) tax return volumes, revenues or profitability decline significantly in fiscal 2011; (iii) the company implements more aggressive financial policies or experiences further instability at the management or board level; or (iv) valid claim trends indicate a substantially greater than expected repurchase liability related to its legacy mortgage business.

Given the negative outlook and weak tax return volume trends of the last two years, an upgrade is unlikely in the near term. However, the outlook could be changed to stable if during the 2011 tax season the company demonstrates (i) steady tax return volumes in its retail network; (ii) an effective offering of instant RALs, RACs and other financial products to its customer base; (iii) steady revenues and profitability; and (iv) solid growth in the digital business. Over the medium term, upward rating pressure could develop if (i) the company achieves sustained revenue and profitability growth over the next two to three tax seasons with improving performance in the retail network, financial settlement and digital products; (ii) debt to EBITDA and free cash flow to debt are expected to be sustained at about 2 times and over 15%, respectively; (iii) the company demonstrates management and board level stability and a commitment to conservative financial policies; and (iv) exposure to contingent liabilities declines.

Block, through its subsidiaries, provides tax, banking, business and consulting services. The majority of the firm's profitability is generated by the preparation of tax returns through the company's bricks and mortar retail network and through financial settlement products to primarily lower income customers. Revenues for the fiscal year ended April 30, 2010 were approximately $3.9 billion.

The principal methodologies used in rating Block Financial LLC were Global Business & Consumer Service Industry published in October 2010. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found on Moody's website.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings, public information, confidential and proprietary Moody's Investors Service's information, confidential and proprietary Moody's Analytics' information.

Moody's Investors Service considers the quality of information available on the issuer or obligation satisfactory for the purposes of maintaining a credit rating.

MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODY'S is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

New York
Lenny J. Ajzenman
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
John Diaz
MD - Corporate Finance
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's Investors Service
250 Greenwich Street
New York, NY 10007
U.S.A.

Moody's downgrades Block Financial to Baa2; outlook negative
No Related Data.
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