Ford 2014 Annual Report Download - page 90

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
We must also assess the likelihood that we will be able to recover our deferred tax assets against future sources of
taxable income. GAAP requires a reduction of the carrying amount of deferred tax assets by recording a valuation
allowance if, based on all available evidence, it is more likely than not (defined as a likelihood of more than 50%) that all
or a portion of such assets will not be realized.
We presently believe that a valuation allowance of $1.6 billion is required, primarily for deferred tax assets related to
our South America operations. We believe that we ultimately will recover the remaining $13.1 billion of deferred tax
assets. We have assessed recoverability of these assets, and concluded that no valuation allowance is required.
For additional information regarding income taxes, see Note 21 of the Notes to the Financial Statements.
Allowance for Credit Losses
The allowance for credit losses represents Ford Credit’s estimate of the probable credit loss inherent in finance
receivables and operating leases as of the balance sheet date. The adequacy of Ford Credit’s allowance for credit losses
is assessed quarterly and the assumptions and models used in establishing the allowance are evaluated regularly.
Because credit losses can vary substantially over time, estimating credit losses requires a number of assumptions about
matters that are uncertain. See Note 7 of the Notes to the Financial Statements for more information regarding allowance
for credit losses.
Nature of Estimates Required. Ford Credit estimates the probable credit losses inherent in finance receivables and
operating leases based on several factors.
Consumer Portfolio. Ford Credit estimates the allowance for credit losses on consumer receivables and on operating
leases using a combination of measurement models and management judgment. The models consider factors such as
historical trends in credit losses and recoveries (including key metrics such as delinquencies, repossessions, and
bankruptcies), the composition of Ford Credit’s present portfolio (including vehicle brand, term, risk evaluation, and new/
used vehicles), trends in historical used vehicle values, and economic conditions. Estimates from these models rely on
historical information and may not fully reflect losses inherent in the present portfolio. Therefore, Ford Credit may adjust
the estimate to reflect management judgment regarding observable changes in recent economic trends and conditions,
portfolio composition, and other relevant factors.
Assumptions Used. Ford Credit’s allowance for credit losses is based on assumptions regarding:
• Frequency. The number of finance receivables and operating lease contracts that are expected to default over
the loss emergence period, measured as repossessions; and
• Loss severity. The expected difference between the amount a customer owes when the finance contract is
charged off and the amount received, net of expenses, from selling the repossessed vehicle, including any
recoveries from the customer.
Collective Allowance for Credit Losses. The collective allowance is evaluated primarily using a collective loss-to
receivables (“LTR”) model that, based on historical experience, indicates credit losses have been incurred in the portfolio
even though the particular accounts that are uncollectible cannot be specifically identified. The LTR model is based on
the most recent years of history. Each LTR is calculated by dividing credit losses by average end-of-period finance
receivables or average end-of-period operating leases, excluding unearned interest supplements and allowance for credit
losses. An average LTR is calculated for each product and multiplied by the end-of-period balances for that given
product.
Ford Credit’s largest markets also use a loss projection model to estimate losses inherent in the portfolio. The loss
projection model applies recent monthly performance metrics, stratified by contract type (retail or lease), contract term
(e.g., 60-month), and risk rating to Ford Credit’s active portfolio to estimate the losses that have been incurred.
The loss emergence period (“LEP”) is a key assumption within Ford Credit’s models and represents the average
amount of time between when a loss event first occurs to when it is charged off. This time period starts when the
consumer begins to experience financial difficulty. It is evidenced, typically through delinquency, before eventually
resulting in a charge-off. The LEP is a multiplier in the calculation of the collective consumer allowance for credit losses.
For accounts greater than 120 days past due, the uncollectible portion is charged off, such that the remaining
recorded investment is equal to the estimated fair value of the collateral less costs to sell.
84