The Fed has been busy: 9 rate cuts this year

Falling auto sales and the hoopla surrounding 0 percent auto loans have taken attention away from the fact that so far this year the Federal Reserve has cut short-term interest rates a stunning nine times and 4 percentage points.

“All things being equal, this (declining interest rates) is a great situation for lenders — but all things are not equal,” said John Casesa, auto industry analyst at Merrill Lynch & Co.

Through September, U.S. sales of light vehicles were off 5.7 percent to 12.8 million. Nevertheless, this year still could be the third-best for sales, behind 1986, which had 16 million, and last year, which had a record 17.4 million.

Analysts estimate that, in calmer times, every quarter-point cut in interest rates adds about 100,000 annual auto sales. The rule of thumb also says it takes six months for auto sales to feel the effect of Fed rate cuts. That implies that this year’s Fed actions added about 1.1 million units to this year’s auto sales and will add another 500,000 next year. Or, to put it another way, rate cuts may have prevented auto sales from falling that much.

Captives gain share

In today’s market, factory incentives such as 0 percent loans have a much more direct effect on auto sales and on the rates people actually pay for a loan.

“The Fed’s interest rate cuts do not have much impact on someone’s decision to go buy a car,” said Art Spinella, vice president of CNW Marketing/Research of Bandon, Ore.

“You can already get an interest rate lower than what the Fed is offering by going to the captives. That’s how the captives have gained so much ground in a matter of weeks.”

Spinella estimated that before automakers started offering 0 percent deals last month, about 45 percent of all finance contracts written at a dealership went to captive finance companies. “After the captives started offering 0 percent deals,” he said, “almost 75 percent of contracts written went to them. Consumers are basically saying, ‘I‘ve got to be an idiot not to do this.’ ”

No-interest loans at Ford Motor Co. and DaimlerChrysler were scheduled to expire Oct. 31, but on Oct. 17 General Motors extended its 0 percent offers through Nov. 18.

Ford CFO Martin Inglis said in an Oct. 17 conference call that he does not want to follow suit. Thanks in part to incentives, Ford’s marketing costs in the quarter just ended were 16 percent of North American automotive revenues, compared with 11.1 percent in the year-ago quarter. “These levels of marketing costs I do not think are sustainable,” Inglis said.

In the same conference call, Ford announced a third-quarter loss of $692 million, compared with a year-ago profit of $888 million.

The cost of continuing zero-interest offers through the end of the fourth quarter would be enormous, said analyst William Pochiluk, president of Auto-

motiveCompass LLC of West Chester, Pa.

He estimated that another two months of 0 percent loans would add sales of 175,000 to 225,000 units this year. If such a program were to continue for a full year, increasing sales at the same rate, the price tag would be “north of $20 billion” he said.

The cost of 0 percent loans has been defrayed by lower interest rates, which make it cheaper for automakers to borrow money.

Ford reported on Oct. 17 that the cost of funds for Ford Motor Credit Co. was 5.9 percent in the third quarter, down from 6.2 percent in the second quarter. Casesa at Merrill Lynch estimated that at a cost of funds of 5.9 percent, it would cost $2,200 to lend $20,000 at zero interest for 48 months, or $2,700 for 60 months. At a cost of funds of 6.2 percent, the same offers would have cost more: $2,337 for 48 months or $2,850 for 60 months, Casesa said.

Low-interest loans also help auto lenders by offering customers an alternative to leasing. Because of huge losses on the resale value of off-lease cars and light trucks, auto lenders want to reduce their dependence on leasing.

The bad news

Despite the Fed’s actions, the interest-rate news isn’t all good for the automakers.

On Oct. 15, for instance, Standard & Poor’s Ratings Group in New York downgraded its credit ratings for Ford Motor Co. and General Motors and indicated it was reviewing ratings for DaimlerChrysler.

Lower credit ratings translate directly into higher borrowing costs as investors demand a higher rate for corporate debt, such as bonds. Anything less than the highest rating also takes securities issued by a company off the shopping list for many institutional investors.

A higher cost of funds could be especially bad news for the automakers, just as consumers are eager for low-interest financing.

According to Spinella, 47 percent of consumers in a CNW survey last year said a low annual percentage rate was important to them. In the first nine months of 2001, that figure had increased to 57.9 percent.

Said Spinella: “Of all the pricing-related issues — low monthly payments, sticker prices, low prices compared to competitors — it’s the low APR that grew the fastest in importance among consumers.”

You can reach Jim Henry at

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