Ford 2003 Annual Report Download - page 67

2003 ANNUAL REPORT 65
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
terms longer than the term of its assets, with five 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 debt. Specifically, without derivatives, Ford Credit’s assets would re-price more quickly than its debt.
Ford Credit’s interest rate risk management objective is to maximize its financing margin while limiting fluctuations caused by
changes in interest rates. Ford Credit achieves this objective by setting an established risk tolerance range and staying within
this tolerance range through an interest rate risk management program that includes entering into derivatives commonly known
as interest rate swaps.
On a monthly basis, Ford Credit determines the sensitivity of the economic value of its portfolio of interest rate-sensitive assets
and liabilities (its economic value) to hypothetical changes in interest rates. Economic value is a measure of the present value of
all future expected cash flows, discounted by market interest rates, and is equal to the present value of interest rate-sensitive
assets minus the present value of interest rate-sensitive liabilities. Ford Credit then enters into interest rate swaps, effectively
converting portions of its floating-rate debt or assets to fixed or its fixed-rate debt or assets to floating, to ensure that the
sensitivity of its economic value falls within an established target range. Ford Credit also monitors the sensitivity of its earnings
to interest rates using pre-tax net interest income simulation techniques. These simulations calculate the projected pre-tax net
interest income of its portfolio of interest rate-sensitive assets and liabilities under various interest rate scenarios, including both
parallel and non-parallel shifts in the yield curve. These quantifications of interest rate risk are included in monthly reporting
to the Treasurer.
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 85% of its total on-balance sheet finance
receivables at December 31, 2003. For its international affiliates, Ford Credit uses a technique commonly referred to as “gap
analysis,” to measure re-pricing mismatch. This process uses re-pricing schedules, which group assets, debt, and swaps into
time-bands based on their re-pricing period. Under this process, Ford Credit enters into interest rate swaps, effectively changing
the re-pricing profile of its assets and debt, to ensure that any re-pricing mismatch existing in a particular time-band falls within
an established tolerance.
As a result of its interest rate risk management process, including derivatives, Ford Credit’s debt re-prices faster than its assets.
Other things equal, this means that during a period of rising interest rates, the interest rates paid on Ford Credit's debt will
increase more rapidly than the interest rates earned on assets, thereby initially reducing Ford Credit’s pre-tax net interest income.
Correspondingly, during a period of falling interest rates, Ford Credit’s pre-tax net interest income would be expected to initially
increase. To provide a quantitative measure of the sensitivity of its pre-tax net interest income to changes in interest rates,
Ford Credit uses interest rate scenarios that assume a hypothetical, instantaneous increase or decrease in interest rates of one
percentage point across all maturities, as well as a base case that assumes that interest rates remain constant at existing levels.
The differences between these scenarios and the base case over a twelve-month period represent an estimate of the sensitivity
of Ford Credit’s pre-tax net interest income. This sensitivity as of year-end 2003 and 2002 is as follows:
Pre-tax Net Interest Income Pre-tax Net Interest Income
impact given a one percentage impact given a one percentage
point instantaneous increase in point instantaneous decrease in
interest rates (in millions) interest rates (in millions)
December 31, 2003 $ (179) $ 179
December 31, 2002 $ (153) $ 156
While the sensitivity analysis presented is Ford Credit’s best estimate of the impacts of specified assumed interest rate scenarios,
actual results could differ from those projected. The sensitivity analysis presented assumes interest rate changes are instantaneous,
parallel shifts in the yield curve. In reality, interest rate changes are rarely instantaneous or parallel. Had the analysis assumed a
gradual change in interest rates of 100 basis points, it would have resulted in a lower pre-tax net interest income impact. The
model used to conduct this analysis is heavily dependent on assumptions, particularly those regarding the reinvestment of
maturing asset principal, refinancing of maturing debt, and predicted repayment of sale and lease contracts ahead of
contractual maturity.
The fair value of net derivative financial instruments (derivative assets less derivative liabilities) as of December 31, 2003 as
reported in Note 16 of the Notes to Financial Statements was $8.9 billion, approximately $1.3 billion higher than a year ago.
This increase primarily reflects the strengthening of the Euro against the U.S. dollar which increases the value of receive-Euro/
pay-U.S. dollar cross currency swaps and the decrease in U.S. interest rates which increases the value of our pay-floating/
receive-fixed rate swaps. For additional information on our derivatives, please refer to the “Financial Services Sector”
of Note 16 of the Notes to Financial Statements.
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