A recent Securities and Exchange Commission fine against Ford Motor Credit Corp. has put a spotlight on something captive finance companies have increasingly been using as a source of cheap short-term funding: demand notes.
The steady decline in their credit ratings since 2001 has forced General Motors Acceptance Corp. and Ford Credit to reduce their reliance on short-term funding sources like unsecured commercial paper. But the issuance of demand notes by the General Motors Corp. and Ford Motor Co. units has surged in that same period.
The unsecured, floating-rate notes are offered to individual investors, who can invest as little as $1,000 and can then write checks against the accounts as they would with a money market fund.
The SEC's scrutiny of demand notes began a year ago and came to light last month, when the agency fined Ford Credit $764,282 for inadequate disclosures related to the "Ford Money Market Account."
Because the Federal Deposit Insurance Corp. does not insure demand notes, their rates are considerably higher than those on money market accounts - but comparable to what the units pay for 90-day commercial paper.
Ford Credit and GMAC have offered demand notes since the 1980s, but from the end of 2000 through the end of last year, each of the two units doubled its demand notes outstanding, to $9.15 billion for GMAC and $7.7 billion for Ford Credit. Over the same period each lender's outstanding unsecured commercial paper fell 80%, to $8.4 billion for GMAC and $8.9 billion for Ford Credit.
The SEC announced the fine June 14, less than six weeks after Standard & Poor's Corp. downgraded Ford Credit's debt to junk status. The regulator said some of the marketing materials did not make it clear that the notes were corporate debt, not traditional money market accounts. (It did not accuse Ford of fraud.)
"We thought that our bringing the case would direct the spotlight on the issues of risk and return involved in corporate money market investments more broadly," said Peter Bresnan, an associate director of enforcement at the SEC.
A company typically markets the notes to its employees and retirees, their family members, and others with ties to the company. GMAC and Ford Motor Credit both say that these people want to further invest in their companies, and that the debt gives them a way to do so.
In the prospectuses, Ford Motor Credit and GMAC guarantee that the interest rate will beat the weekly average tracked in Informa Financial Information Inc.'s Money Fund Report. Both lenders readily admit that the products are not money market accounts.
Last week's rates for the notes - close to 4% for both GMAC and Ford Motor Credit - were well above the average money market fund rate of 2.45%. Last week the 90-day unsecured commercial paper rate for GMAC was 3.9%, while Ford Credit's paper paid 3.81%. But commercial paper has a specified maturity and is actively traded and issued in much larger amounts than demand notes; all those factors influence its pricing.
Ford Motor Credit's pricing policy for the demand notes "reflects market perceptions of the company's creditworthiness," Brenda Hines, a spokeswoman for the unit, wrote in an e-mail. "Bond ratings are one component of that evaluation."
Joanne Krell, a spokeswoman for GMAC, said that it prices the accounts "by looking at similar type investments."
By mentioning money market rates in the prospectus, GMAC is "just choosing one measure, since we look at a variety," she said. "There is nothing particularly compelling about the comparison."
Charles Jones, a finance professor at Columbia Business School, said that funding costs aside, money invested in demand notes is probably "stickier" than money invested in commercial paper.
In the event of a downgrade, "some of the retail investors might not get out, so the company would be able to keep that financing in place, whereas the commercial paper market might shut down completely," Mr. Jones said.
