Ford 2003 Annual Report Download - page 60

58 FORD MOTOR COMPANY
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULT OF OPERATIONS
Assumptions and Approach Used — We use the factors listed above to make projections of two key assumptions:
• Frequency — the percentage of finance receivables and operating leases that we expect to default over a period of time,
measured principally by the repossession rate (the ratio of the number of vehicles repossessed in a time period, typically
a year, divided by the average number of accounts outstanding in the same time period); 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.
Sensitivity Analysis — We believe the present level of our allowance for credit losses adequately reflects probable losses
related to impaired finance receivables and operating leases. However, changes in the assumptions used to derive frequency
and severity would have an impact on the allowance for credit losses. Over the past twenty years, repossession rates for our
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):
Effect on:
Increase/(Decrease)
Percentage December 31, 2003 2003
Assumption Point Change Allowance for Credit Losses Expense
Repossession rates +/- 0.1 pts. $ 50/ $(50) $ 50/ $(50)
Loss severity +/- 1.0 20/ (20) 20/ (20)
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
See Note 9 of the Notes to Financial Statements for more information regarding accumulated depreciation on vehicles subject
to operating leases.
Accumulated depreciation on vehicles subject to operating leases reflects the cumulative amount of depreciation that has been
recorded to date, reducing the value of the leased vehicles in our operating lease portfolio from their original acquisition value to
their estimated residual value (estimated proceeds from the sale of the vehicle at auction at the end of the lease term).
Nature of Estimates Required — Each operating lease in our portfolio represents a vehicle we own that has been leased
to a customer. When we purchase the lease, we establish an estimated residual value for the vehicle. We exercise judgment
in estimating the residual value because future market values of used vehicles are difficult to predict. We depreciate leased
vehicles on a straight-line basis to estimated residual value.
We monitor residual value performance by vehicle line each month and we review the adequacy of our accumulated
depreciation on a quarterly basis. If we believe that the residual values for our vehicles have decreased, we revise depreciation
for the affected vehicles to ensure that our net investment in the operating leases (equal to our acquisition value of the vehicles
minus accumulated depreciation) will be reduced to our revised estimate of residual value at the end of the lease term. Such
adjustments to depreciation expense are recorded over the remaining life of the affected vehicles in our portfolio.
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. The
dealer has the option to purchase the vehicle at the contractual lease-end value or return it to us. For returned vehicles, we face
a risk that the amount we obtain from the vehicle sold at auction will be less than our most recent estimate of the residual value
for the vehicle. Over the last five years, about 60% to 70% of Ford Credit North America's operating lease vehicles have been
returned to us.
Assumptions and Approach Used — Our accumulated depreciation on operating leases is based on the following assumptions:
• Residual value — the market value of the vehicles when we sell them at the end of the lease.
• Return rates — the percentage of vehicles that will be returned to us at lease end.
We estimate residual values and return rates using econometric models. These models use historical auction values, historical
return rates for our leased vehicles, industry-wide used vehicle prices, our marketing plans and vehicle quality data.
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