H&R Block Inc., the biggest U.S. tax preparer, had its finance unit downgraded by Moody’s Investors Service as a legal dispute with HSBC Holdings threatens the company’s ability to offer customers refund loans next year. The stock declined in New York trading.

Block Financial LLC’s long-term debt was cut to Baa2, Moody’s second-lowest of 10 investment-grade scores, and could be lowered further, the ratings firm said today in a statement. The previous rating was Baa1.

“Block’s financial performance in fiscal 2011 could materially decline” if the Kansas City, Missouri-based parent fails to provide refund anticipation loans, Moody’s said.

The U.S. Internal Revenue Service has said it will no longer help banks including HSBC and Republic Bancorp Inc. underwrite tax refund loans that lawmakers and consumer groups say carry unfairly high interest rates. H&R Block sued HSBC in federal court in St. Louis on Oct. 15, claiming the London-based bank violated its contract to provide the loans through 2013.

H&R Block tumbled 33 cents, or 3 percent, to $10.52 at 3:21 p.m. in New York Stock Exchange composite trading. The shares had fallen 52 percent on the year through yesterday, the worst performance in the Standard & Poor’s 500 Index.

Block Financial’s $600 million of 7.875 percent notes due in January 2013 dropped 3.25 cents to 98 cents on the dollar as of 2:59 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The securities fell to the lowest since March 2009, the data show. Kate O’Neill Rauber, a spokeswoman for H&R Block, didn’t’ return a message seeking comment.

‘Harsh Operating Environment’

S&P said today that it may cut H&R Block’s credit rating.

Block’s “inability to offer RALs, its most prominent settlement product, would in our view hurt revenue and earnings for the 2011 tax season and possibly beyond,” S&P said in a statement. “In recent years, a harsh operating environment and management missteps have buffeted Block’s tax business. This has caused declining client traffic, lost market share, weakening earnings, and senior management turnover.”

Block prepared 20.1 million U.S. tax returns in fiscal 2010 and more than 3 million customers, or 17 percent, also purchased refund anticipation loans, S&P said.