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8 key questions about 0% loans

Much ado about nothing

In two months, the U.S. auto market has veered from the disaster of Sept. 11 into a surprisingly robust fourth quarter. The critical reason? The rapid infusion of 0 percent financing.

But even as the pall lifts from the market, consumers and retailers are wondering what happened. What role did 0 percent financing play? Is it actually helping? How can the industry afford it? Is it merely a short-term sales aid that will deflate the market in the months to come?

The following questions address some of those issues.

1. How much have manufacturers suffered by lending at a 0.0 interest rate?

Not as much as you might think. Though 0 percent loans cost automakers money, they are smaller losses than manufacturers have absorbed in the past. Two years ago, manufacturers made a splash offering consumers 0.9 percent deals. At that time, the capital market was charging automakers 7 percent for money. Thanks to the Federal Reserve's lending rate cuts this year, money is available at between 4.5 percent and 5 percent. The difference between that and 0 percent is less than five points. Two years ago, the difference was six points.

2. Who pays for it?

That's a complex issue. When it comes to accounting for the program cost, the issue is more complex. At General Motors, the finance arm is handling the program, but the cost is being absorbed at the corporate level, according to a General Motors Acceptance Corp. spokeswoman. Because the program covers vehicles that were already on dealers' lots, it is paid for as any other incentive would be, from the budgets of the automaker's vehicle sales, service and marketing operations.

One accounting consultant to the Big 3 suggests the programs can be justified at the corporate finance level as cost avoidance. A manufacturer such as Ford Motor Co. can estimate the cost of running its factories at reduced capacity, which appeared imminent after Sept. 11. If the scenario of idled car plants represented, say, $1 billion in fixed costs, then spending several million to keep the plants running - even at reduced profitability - would save the manufacturers money.

But as it worked out, the program didn't merely keep plants from being idled but triggered sales of vehicles in other programs.

3. How is 0 percent financing helping?

Mostly by exciting consumers. In actual numbers, not that many consumers are taking advantage of the 0 interest incentive - especially not to the degree that sales boomed in October and November. According to CNW Marketing/Research of Bandon, Ore., which tracks the industry's financial transactions, only 65 percent of new vehicles are financed at all and only one-third of those consumers qualify for 0 percent programs. Just half of those who qualify have been taking advantage of 0 interest, according to CNW President Art Spinella. That means only about 11 percent of the market is using the tool that was introduced to stimulate the business.

What 0 interest is doing is bringing in floor traffic. After suffering a major drop in floor traffic in the 10 days after the terrorist attacks, the industry is reporting that as of mid-November, traffic was nearly even with the first 10 days of September. Scott Merlis, industry analyst with Dresdner Kleinwort Wasserstein in New York, believes the adoption of 0 percent is single-handedly responsible.

"Let's not forget that the blow to the market was so great after Sept. 11 that many of us really believed that no incentives would work to correct the situation," Merlis said. "All at the same time, the market was dealing with the shock of the attack, the talk of going to war, bioterrorism, a plunge in the stock market, the loss in consumer confidence and even the fact that you might be laid off or not get your year-end bonus. And 0 percent got people coming into the dealerships."

4. Isn't 0 interest exacerbating the industry's incentives problem?

Yes, but not by that much. According to CNW, the U.S. industry's per-vehicle incentive level reached $2,874 in October, a $458 increase from one year ago. But of that $458 increase, the widespread use of 0 percent interest contributed only $114 per vehicle.

At the same time, incentive levels appear to be dropping. The first half of November saw average per-vehicle incentives of $2,647, a decline of $227 from the previous month, CNW estimates.

5. Why do so many customers not accept 0 percent financing?

For starters, manufacturers mostly have limited the program to 36-month loans. Many consumers still find the resulting monthly payments too high. Instead, they are opting to finance for 48 months or longer, accepting finance rates that are only moderately higher anyway and thereby qualifying for the optional factory and dealer cash rebates. Those rebates usually are not available with 0 percent financing.

6. Is 0 percent cutting into retailer margins?

For the most part, the opposite is true. Because the 0 percent programs are factory financed, retailers have less of their own money on the table. Spinella estimates dealer margins were better in October than a year ago. The amount of money dealers gave up to close deals declined by 7 percent to 8 percent in October, CNW reports.

7. Is 0 percent interest enabling some manufacturers to grab market share from those not offering it?

There is no evidence of that. Although GM made stunning gains in October, offering 0 percent interest on all products ahead of the industry, the entire market benefited. There were no big losers in October. The biggest volume decliners of that month were Pontiac and Oldsmobile, which had the benefit of 0 percent interest.

Just as noteworthy, the excitement over 0 percent interest appears to have spilled over onto brands that are not using it. At American Honda Motor Co., which did not offer 0 percent interest, heavy floor traffic helped sales of the CR-V sport-utility jump nearly 50 percent in October. Although Toyota Motor Sales U.S.A. did offer 0 percent interest on some models and outpaced rival Honda, Honda's Accord has continued outselling Toyota's Camry.

8. Now that the industry has given consumers a taste for 0 percent interest, how can automakers stop it?

They probably won't stop cold turkey. But the robust market already is prompting automakers to scale back. GM has excluded the Cadillac and Corvette from its 0 percent program and will exclude the Saturn Vue. Merlis believes 0 percent interest will continue through next year, but in an increasingly truncated form.

Said Merlis: "Zero interest makes for a powerful ad. But we'll see the automakers gradually cut back on which models are eligible in the coming weeks. Not all regions of the country are doing equally well. You can envision 0 percent as a tool you would continue to use in, say, the Northeast market but not the Southwest, on certain cars but not others."

You can reach Lindsay Chappell at lchappell@crain.com

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