Finance CompaniesFinance Companies

Chapter 6

© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.McGraw-Hill/Irwin

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Historical Perspective

Finance companies originated during the depression. Installment credit General Electric Capital Corporation. Competition from banks increased during

1950s. Expansion of product lines

GMACCM is one of the largest commercial mortgage lenders in U.S.

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Finance Companies

Activities similar to banks, but no depository function.

May specialize in installment loans (e.g. automobile loans) or may be diversified, providing consumer loans and financing to corporations, especially through factoring.

Commercial paper is key source of funds. Captive Finance Companies: e.g. GMAC Highly concentrated

Largest 20 firms: 65 percent of assets

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Major Types of Finance Companies Sales finance institutions

Ford Motor Credit and Sears Roebuck Acceptance Corp.

Personal credit institutions HSBC Finance and AIG American General.

Business credit institutions CIT Group and FleetBoston Financial. Equipment leasing and factoring

Key Bank locally

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https://www.hfc.com/learn-about-loans/home/default_customer.html?WT_srch=&DCSext_sot=Self-Directed&WT_seg_1=Prospect

http://www.hsh.com/not-the-associates.html

https://www.beneficial.com/learn-about-loans/home/default_customer.html?WT_srch=&DCSext_sot=Self-Directed&WT_seg_1=Prospect

http://www.kefonline.com/

http://www.docshop.com/education/vision/refractive/lasik/financing/

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Largest Finance Companies

Company Name Total Assets (Millions)

General Electric Capital

Services

$333,780

Citigroup 164,205

GMAC 154,764

Ford Motor Credit Company 153,000

J. P. Morgan Chase 144,835

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Balance Sheet and Trends

Business and consumer loans are the major assets 52.8% of total assets, 2006. Reduced from 95.1% in 1977.

Increases in real estate loans and other assets.

Growth in leasing Finance companies face credit risk, interest

rate risk and liquidity risk.

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Balance Sheet and Trends

Consumer loans Primarily motor vehicle loans and leases. Anomalous low auto finance company rates are

anomalous following 9/11 attacks. Attempts to boost new vehicle sales via 0.0% loans

lasted into 2005. By 2003, rates 3.5% lower than banks on new

vehicle rates

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Consumer loans (continued)

Generally riskier customers than banks serve. Subprime mortgage lenders Jayhawk Acceptance Corp.

From auto loans to tummy tucks and nose jobs

Increase in “loan shark” firms with rates as high as 30% or more.

Payday loans 390 percent APR (Implication for EAR is

staggering!)

-126-12Balance Sheet and Trends

Mortgages Recent addition to finance company assets Smaller regulatory burden than banks May be direct mortgages, or as securitized

mortgage assets. Growth in home equity loans since passage of

Tax Reform Act of 1986. Tax deductibility issue. Conversion of credit card debt 2006 average home equity loan $82,872 Defaults in subprime and relatively strong

credit mortgages in 2007

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Business Loans

Business loans comprise largest portion of finance company loans.

Advantages over commercial banks: Fewer regulatory impediments to types of

products and services. Not depository institutions hence less regulatory

scrutiny and lower overheads. Often have substantial expertise and greater

willingness to accept riskier clients.

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Business Loans

Major subcategories: Retail and wholesale motor vehicle loans and

leases Equipment loans

tax issues and other associated advantages when finance company leases the equipment directly to the customer

Other business loans and securitized business assets

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Liabilities

Major liabilities: commercial paper and other debt (longer-term notes and bonds).

Finance firms are largest issuers of commercial paper (frequently through direct sale programs). Commercial paper maturities up to 270 days.

Consequently, management of liquidity risk differs from commercial banks relying on deposits

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Industry Performance

Strong loan demand and solid profits for the largest firms in the early 2000s Effects of low interest rates

Not surprisingly, the most successful became takeover targets Citigroup/Associates First Capital, Household International/HSBC Holdings

Mid 2000s problems arose 2005, 2006: falling home prices and rising

interest rates Pullback from subprime loans

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Regulation of Finance Companies

Federal Reserve definition of Finance Company Firm, other than depository institution, whose

primary assets are loans to individuals and businesses.

Subject to state-imposed usury ceilings. Much lower regulatory burden than

depository institutions. Not subject to Community Reinvestment Act. Lack the banks’ regulatory safety-net

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Regulation

With less regulatory scrutiny, finance companies must signal safety and soundness to capital markets in order to obtain funds.

Lower leverage than banks (11.4% capital-assets versus 10.36% for commercial banks in 2006).

Captive finance companies may employ default protection guarantees from parent company or other protection such as letters of credit.

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Global Issues

In foreign countries, Finance companies are generally subsidiaries of commercial banks or industrials

In Japan, ownership of finance companies by banks created opportunities when banks hit by increase in nonperforming loans GE Capital/Japan Leasing Corporation

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Pertinent Websites

American General www.aigag.com

Federal Reserve www.federalreserve.gov

Citigroup www.citigroup.com

Consumer Bankers Association www.cbanet.org

Ford Motor Credit www.fordcredit.com

General Electric Capital Corp. www.gecapital.com

General Motors Acceptance Corp. www.gmacfs.com

HSBC Finance www.hfc.com

Household International www.household.com