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The Spokesman-Review Newspaper
Spokane, Washington  Est. May 19, 1883

The wrong engine?


Kelly Eickel of St. Charles, Mo., paints the advertised reduction of $8000 off on an SUV in O'Fallon, Mo., last week. General Motors Corp. and Ford Motor Co. both earned more than $1 billion in the second quarter, but the bulk of the income was from their financial services arms.
 (Associated Press / The Spokesman-Review)
John Porretto Associated Press

DETROIT — Automakers are likely to continue using cut-rate financing promotions to lure customers in the months ahead, even as their borrowing costs are projected to rise. That could cut into overall profits and place more pressure on General Motors Corp., Ford Motor Co. and other manufacturers to do a better job of making money off cars and trucks themselves.

Ford said last week its financing arm accounted for three-quarters of the $1.2 billion in profits it earned in the second quarter, a near tripling of the year-earlier results that easily beat Wall Street forecasts.

Ford’s larger crosstown rival, GM, also reported a $1 billion-plus quarter, and like Ford, it was financial services — not automaking — that drove earnings.

The relative lack of profits from car-building at Ford was disappointing, said Goldman Sachs analyst Gary Lapidus, whose report about the earnings was headlined “Attractive paint job, but underneath a bit of a clunker.”

Executives at GM and Ford, the nation’s two biggest automakers, say they’re hopeful an infusion of new vehicles between now and the end of the year will lift automotive sales and improve that side of the business. But questions remain for many investors and industry observers, particularly as the nation prepares for what’s expected to be a gradual rise in the short-term interest rates controlled by the Federal Reserve.

“Looking ahead, the challenge seems to be gauging how far and how fast income at the finance company will decline, and how much of that deficit the auto company will be able to make up,” Credit Suisse First Boston analyst Chris Ceraso said in a report on Ford.

GM’s shares fell 27 cents to close at $42.66 Monday on the New York Stock Exchange, while Ford shares rose 7 cents to close at $14.74. Both are less than half of their value of April 2000.

In this year’s second quarter, General Motors Acceptance Corp. (GMAC) said it paid an average blended rate of 3.3 percent for various forms of debt it sold to fund operations, down from 3.5 percent a year earlier.

Ford Motor Credit Co. said its comparable rate was 3.7 percent, down from 4.3 percent in the second quarter of 2003.

GM, Ford and industry analysts say it’s unclear how higher borrowing costs would affect profits because GMAC and Ford Credit have diverse operations that also deal in areas such as insurance and home financing.

For example, GMAC’s insurance group reported earnings of $75 million in the April-June period, up from $23 million a year ago, on continued growth in underwriting income.

Analysts say it’s a certainty GM and Ford will continue to offer expensive consumer incentives for the coming months and beyond, including low- and no-interest financing.

Slower-than-anticipated June sales at Ford and GM contributed to already-inflated vehicle inventories, and cash rebates and financing deals are seen as a primary mechanism for clearing out the excess, higher rates or not.

That strategy bodes well for sheer volume, but the effect on the automakers’ bottom lines may not be as rosy. Here’s why: When a company such as Ford Motor Credit finances a new car or truck, it does so at a standard financing rate, which now averages roughly 7 percent, Ford Credit spokesman Dan Jarvis said.

The automotive business then has to dip into its marketing budget to make up the difference between the standard rate and the “incentivized” rate, which could be 5.9 percent, 2.9 percent or 0 percent in some cases. Jarvis said more than half of customers who apply for no-interest financing qualify.

The difference between the borrowing costs and the amount earned from standard financing is how a company like Ford Motor Credit makes money.

In a report, Merrill Lynch analyst John Casesa said “cheap and available credit has become the key competitive tool” for Ford and GM in the United States.

Still, no one is panicking. Ford, in fact, raised it full-year earnings outlook last week. But after sales tanked in June, the pressure is on Detroit automakers to finish the summer with a bang.

George Pipas, Ford’s top sales analyst, acknowledged that high interest rates will require more money from automotive operations to cover the expenses, but he said factors such as an improving labor market should help offset those costs.