Ford 2004 Annual Report Download - page 48

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Nature of Estimates Required. We estimate the credit losses related to impaired finance receivables and operating leases by
evaluating several factors including historical credit loss trends, the credit quality of our present portfolio, trends in historical
and projected used vehicle values and general economic measures.
Assumptions and Approach Used. We make projections of two key assumptions:
• Frequency – the number of finance receivables and operating lease contracts that we expect to default over a period of time,
measured as repossessions; and
• Loss severity – the expected difference between the amount a customer owes us when we charge-off the finance contract and
the amount we receive, net of expenses, from selling the repossessed vehicle, including any recoveries from the customer.
We use these assumptions to assist us in setting our allowance for credit losses. See Note 13 of the Notes to the Financial
Statements for more information regarding our allowance for credit losses.
Sensitivity Analysis. We believe the present level of our allowance for credit losses adequately reflects credit losses related to
impaired finance receivables and operating leases. However, changes in the assumptions used to derive frequency and severity
would affect the allowance for credit losses. Over the past twenty years, repossession rates for our Ford, Lincoln and Mercury
brand U.S. retail and lease portfolio have varied between 2% and 4%.
The effect of the indicated increase/decrease in the assumptions is shown below for Ford, Lincoln and Mercury brand vehicles
in the U.S. (in millions):
Changes in our assumptions affect Provision for credit losses on our income statement and the Allowance for credit and
insurance losses on our balance sheet.
Accumulated Depreciation on Vehicles Subject to Operating Leases – Financial Services Sector
Accumulated depreciation on vehicles subject to operating leases reduces the value of the leased vehicles in our operating lease
portfolio from their original acquisition value to their expected residual value at the end of the lease term.
We monitor residual values each month, and we review the adequacy of our accumulated depreciation on a quarterly basis.
If we believe that the expected residual values for our vehicles have changed, we revise depreciation to ensure that our
net investment in the operating leases (equal to our acquisition value of the vehicles minus accumulated depreciation) will
be adjusted to reflect our revised estimate of the expected residual value at the end of the lease term. Such adjustments to
depreciation expense would result in a change in the depreciation rates of the vehicles subject to operating leases and are
recorded on a straight-line basis.
Each lease customer has the option to buy the leased vehicle at the end of the lease or to return the vehicle to the dealer. If the
customer returns the vehicle to the dealer, the dealer may buy the vehicle from us or return it to us. Over the last three years,
about 60% to 70% of Ford Credit’s North America operating lease vehicles have been returned to us.
Nature of Estimates Required. Each operating lease in our portfolio represents a vehicle we own that has been leased to a
customer. At the time we purchase a lease, we establish an expected residual value for the vehicle. We estimate the expected
residual value by evaluating historical auction values, historical return rates for our leased vehicles, industry-wide used vehicle
prices, our marketing plans and vehicle quality data.
Assumptions and Approach Used. Our accumulated depreciation on vehicles subject to operating leases is based on our
assumptions of:
• Auction value – the market value of the vehicles when we sell them at the end of the lease; and
• Return rates – the percentage of vehicles that will be returned to us at lease end.
See Note 11 of the Notes to the Financial Statements for more information regarding accumulated depreciation on vehicles
subject to operating leases.
Sensitivity Analysis. For returned vehicles, we face a risk that the amount we obtain from the vehicle sold at auction will be less
than our estimate of the expected residual value for the vehicle. At year-end 2004, if future auction values for Ford, Lincoln
Increase/(Decrease)
December 31, 2004
Percentage Allowance for 2004
Assumption Point Change Credit Losses Expense
Repossession rates +/- 0.1 pt. $50/$(50) $50/$(50)
Loss severity +/- 1.0 15/(15) 15/(15)