Ford 2007 Annual Report Download - page 46

Management’s Discussion and Analysis of Financial Condition and Results of Operations
44 Ford Motor Company | 2007 Annual Report
depreciation expense would result in a change in the depreciation rates of the vehicles subject to operating leases, and are
recorded prospectively on a straight-line basis.
For retail leases, 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 Ford Credit or
return it to Ford Credit. Ford Credit's North America operating lease activity was as follows for each of the last three years
(in thousands, except percentages):
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For rental repurchase vehicles, practically all 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 volumes for our leased vehicles, industry-
wide used vehicle prices, our marketing plans and vehicle quality data.
Assumptions Used. For retail leases, 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 volume. The number of vehicles that will be returned to us at lease end.
See Note 5 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 December 31, 2007, if future auction values for
Ford Credit's existing portfolio of operating leases on Ford, Lincoln and Mercury brand vehicles in the U.S. were to
decrease by one percent from its present estimates, the effect would be to increase the depreciation on these vehicles by
about $60 million. Similarly, if return volumes for Ford Credit's existing portfolio of operating leases on Ford, Lincoln and
Mercury brand vehicles in the U.S. were to increase by one percentage point from its present estimates, the effect would
be to increase the depreciation on these vehicles by about $10 million. These increases in depreciation would be charged
to depreciation expense during the 2008 through 2011 period so that the net investment in operating leases at the end of
the lease term for these vehicles is equal to the revised expected residual value. Adjustments to the amount of
accumulated depreciation on operating leases will be reflected on our balance sheet as Net investment in operating leases
and on the income statement in Depreciation, in each case under the Financial Services sector.
Allowance for Credit Losses
The allowance for credit losses is Ford Credit's estimate of the probable credit losses inherent in finance receivables
and operating leases at the date of the balance sheet. Consistent with its normal practices and policies, Ford Credit
assesses the adequacy of its allowance for credit losses quarterly and regularly evaluates the assumptions and models
used in establishing the allowance. Because credit losses can vary substantially over time, estimating credit losses
requires a number of assumptions about matters that are uncertain.
Nature of Estimates Required. Ford Credit estimates the probable credit losses inherent in finance receivables and
operating leases based on several factors.
Retail Installment and Lease Portfolio. The retail installment and lease portfolio is evaluated using a combination of
models and management judgment, and is based on factors such as historical trends in credit losses and recoveries
(including key metrics such as delinquencies, repossessions, and bankruptcies), the composition of our present portfolio
(including vehicle brand, term, risk evaluation, and new/used vehicles), trends in historical and projected used vehicle
values, and economic conditions. Estimates from models may not fully reflect losses inherent in the present portfolio, and
an element of the allowance for credit losses is established for the imprecision inherent in loan loss models. Reasons for
imprecision include changes in economic trends and conditions, portfolio composition and other relevant factors.