Ford 2009 Annual Report Download - page 74

Quantitative and Qualitative Disclosures About Market Risk
72 Ford Motor Company | 2009 Annual Report
Interest Rate Risk. Ford Credit's primary market risk exposure is interest rate risk, and the particular market to which it
is most exposed is U.S. dollar LIBOR. Interest rate risk exposure results principally from “re-pricing risk” or differences in
the re-pricing characteristics of assets and liabilities. An instrument’s re-pricing period is a term used to describe how an
interest rate-sensitive instrument responds to changes in interest rates. It refers to the time it takes an instrument’s
interest rate to reflect a change in market interest rates. For fixed-rate instruments, the re-pricing period is equal to the
maturity of the instrument’s principal, because the principal is considered to re-price only when re-invested in a new
instrument. For a floating-rate instrument, the re-pricing period is the period of time before the interest rate adjusts to the
market rate. For instance, a floating-rate loan whose interest rate is reset to a market index annually on December 31
would have a re-pricing period of one year on January 1, regardless of the instrument’s maturity.
Re-pricing risk arises when assets and the related debt have different re-pricing periods, and consequently, respond
differently to changes in interest rates. As an example, consider a hypothetical portfolio of fixed-rate assets that is funded
with floating-rate debt. If interest rates increase, the interest paid on debt increases while the interest received on assets
remains fixed. In this case, the hypothetical portfolio’s cash flows are exposed to changes in interest rates because its
assets and debt have a re-pricing mismatch.
Ford Credit's receivables consist primarily of fixed-rate retail installment sale and lease contracts and floating-rate
wholesale receivables. Fixed-rate retail installment sale and lease contracts are originated principally with maturities
ranging between two and six years and generally require customers to make equal monthly payments over the life of the
contract. Wholesale receivables are originated to finance new and used vehicles held in dealers’ inventory and generally
require dealers to pay a floating rate.
Funding sources consist primarily of securitizations and short- and long-term unsecured debt. In the case of
unsecured term debt, and in an effort to have funds available throughout business cycles, Ford Credit may borrow at
terms longer than the terms of their assets, in most instances with up to ten year maturities. These debt instruments are
principally fixed-rate and require fixed and equal interest payments over the life of the instrument and a single principal
payment at maturity.
Ford Credit is exposed to interest rate risk to the extent that a difference exists between the re-pricing profile of its
assets and its debt. Specifically, without derivatives, in the aggregate Ford Credit's assets would re-price more quickly
than its debt.
Ford Credit's interest rate risk management objective is to maximize its economic value while limiting the impact of
changes in interest rates. Ford Credit achieves this objective by setting an established risk tolerance and staying within
the tolerance through the following risk management process.
Ford Credit determines the sensitivity of its economic value to hypothetical changes in interest rates. Ford Credit then
enters into interest rate swaps, when available, to economically convert portions of its floating-rate debt to fixed or fixed-
rate debt to floating to ensure that the sensitivity of its economic value falls within an established tolerance. As part of its
process, Ford Credit also monitors the sensitivity of its pre-tax cash flow using simulation techniques. To measure this
sensitivity, Ford Credit calculates the change in expected cash flows to changes in interest rates over a twelve-month
horizon. This calculation determines the sensitivity of changes in cash flows associated with the re-pricing characteristics
of its interest-rate-sensitive assets, liabilities, and derivative financial instruments under various hypothetical interest rate
scenarios including both parallel and non-parallel shifts in the yield curve. This sensitivity calculation does not take into
account any future actions Ford Credit may take to reduce the risk profile that arises from a change in interest rates.
These quantifications of interest rate risk are reported to the Treasurer regularly (either monthly or quarterly depending on
the market).
The process described above is used to measure and manage the interest rate risk of Ford Credit's operations in the
United States, Canada, and the United Kingdom, which together represented approximately 80% of its total on-balance
sheet finance receivables at December 31, 2009. For its other international affiliates, Ford Credit uses a technique,
commonly referred to as "gap analysis," to measure re-pricing mismatch. This process uses re-pricing schedules that
group assets, debt, and swaps into discrete time-bands based on their re-pricing characteristics. Ford Credit then enters
into interest rate swaps, when available, which effectively change the re-pricing profile of its debt, to ensure that any re-
pricing mismatch (between assets and liabilities) existing in a particular time-band falls within an established tolerance.