A small but growing number of dealers are shaving up to 0.75 point off floorplan interest rates by negotiating loans tied to the London Interbank Offered Rate, or LIBOR, auto lenders say.
Unlike the prime rate on which most dealer loans are based, LIBOR fluctuates daily. Thus, variable-rate loans can become cheaper when LIBOR drops and prime does not. LIBOR tends to fall more quickly and rise more slowly than the prime rate.
Banks have offered LIBOR-based rates to commercial accounts since the early 1980s. But most dealers use loans based on the prime, which is used by most captive finance companies.
In the past few years, some big national and regional banks have used LIBOR-based rates to court dealers' floorplan business.
'We had to go to Chicago to get LIBOR. My own bank wouldn't do it,' says Jon Lancaster, owner of Jon Lancaster Inc., a dealership group based in Madison, Wis. 'Prime is artificially high. It is used more on consumer loans than on business loans.'
Banks adjust the spread so that the initial rate on a loan is about the same whether it is based on LIBOR or prime. The advantage to LIBOR comes when LIBOR drops and prime lags in its drop or when prime rises more quickly than LIBOR.
The prime rate generally changes when the federal funds rate goes up or down. The federal funds rate is the rate charged by one bank to another.
'Banks are under no obligation to change the prime rate' when the federal funds rate changes, says Tom Webb, chief economist for the National Automobile Dealers Association. 'The prime rate is usually stickier on the way down than it is on the way up.'
Dealers using LIBOR say that even if rates rise, LIBOR does not fluctuate as drastically as prime and most likely would not climb as quickly.
LIBOR's daily changes reflect the market more accurately than the prime rate. LIBOR also is more stable than prime, which changes less often but more dramatically.
LIBOR, currently about 2.75 percentage points under prime, is the rate that the most creditworthy international banks dealing in Eurodollars charge each other for large loans. This month, after the Federal Reserve Board announced a quarter-point cut in the target federal funds rate, prime was 7.75 percent and LIBOR was 5 percent.
Dealers who have negotiated LIBOR-based rates say they are paying LIBOR plus a spread of 1.5 to 3 points. A 2-point spread is typical.
About 6 percent of dealer floorplan accounts are tied to LIBOR, according to NADA. But more dealers are asking lenders for LIBOR-based loans as dealership groups expand and become more sophisticated in financial matters, NADA's Webb says.
Although most of the dealers with LIBOR-based loans are larger dealership groups, LIBOR is not just for the big boys. A smaller operation with good credit could negotiate a LIBOR-based rate, because banks are hungry for floorplan business.
'I don't think a lot of smaller dealers know about' LIBOR-based rates, says Larry Cloninger, co-owner of Cloninger Ford-Toyota in Salisbury, N.C., and Florence Toyota in Florence, S.C.
Cloninger, who has annual revenues of $100 million, obtained LIBOR-based floorplan and mortgage rates on about $12 million in debt after learning about LIBOR from a bigger dealer.
Competition has driven floorplan rates lower. Several years ago, dealers typically paid prime plus 1 point interest on floorplan. But healthy auto sales in recent years have prompted more banks to vie for the lucrative floorplan business. Now, many dealers pay prime rate plus a half-point interest; some even pay below prime.
Lancaster, a multifranchise dealer, tracked LIBOR and prime over a three-year period. He concluded: 'I found I was going to be 75 basis points (0.75 of a percentage point) better off on LIBOR.'
An advantage of 75 basis points on floorplan loans of $2 million would save $15,000 in a year.