Finance Company - The Federal Reserve defines finance companies as any firm whose primary assets are loans to individuals and businesses.
Finance Companies vs. Banks and Thrifts
Some finance company loans are similar to commercial bank loans (i.e. commercial and auto loans), but others are aimed at relatively specialized areas such as high risk (low credit quality) loans to business and consumers.
Unlike banks and thrifts, finance companies do not and cannot accept deposits. Instead, they rely on short and long-term debt for funding.
The first major finance company was originated during the Depression when GE created GE Capital Corp (GECC) to finance appliance sales to cash strapped customers unable to obtain installment credit (a loan that is paid back to the lender with periodic payments consisting of varying amounts of interest and principal).
By the late 1950s, banks had become more willing to make installment loans, so finance companies began looking outside their parent companies for business (GECC now offers leases on rail cars, planes, leveraged buyout financing, mortgage servicing and other loans to its customers.)
The industry is very concentrated (the 20 largest firms control 80% of the assets). In addition, many of the largest finance companies such as GMAC tend to be wholly owned or captive finance companies - a finance company wholly owned by a parent company (usually, they serve to provide financing for the purchase of the parent company’s products).
Between 1975-1999, the industry experienced over 1200% growth, making it one of the fastest growing industries in the financial services sector.
Sales Finance Institutions - specializes in making loans to customers of a specific retailer to manufacturer (e.g. Ford Motor Credit, Sears Roebuck Acceptance Corp.).
Personal Credit Institutions - specializes in making installment and other loans to consumers (e.g. Capital One, Household Finance Corp., MBNA, etc.).
Business Credit Institutions - provide financing to corporations, especially through equipment leasing and factoring - the process of purchasing A/R from corporations (often at a discount), usually with no recourse to the seller should the receivables go bad.
Finance Companies - Loans (Receivables) Outstanding Source : Federal Reserve Bulletin - Survey of Finance Companies, 1996
Finance companies are often willing to issue mortgages to riskier borrowers than commercial banks.
Mortgages include all loans secured by liens on any type of real estate either by direct lending or as a result of securitizing mortgage assets - purchasing mortgages and using them as assets backing secondary market securities.
Mortgages can be first mortgages or second mortgages (home equity loans). Secondary mortgages are increasingly attractive due to lower bad debt expense and lower administrative costs.
Consumer loans include motor vehicle loans and leases and other consumer loans (i.e. credit cards, furniture financing, appliance financing, cash loans, etc.).
Finance companies generally charge higher rates of interest on consumer loans due to riskier customer they lend to. High risk customers are often referred to as “sub-prime” .
Loan sharks - sub-prime lenders that charge unfairly exorbitant rates to desperate borrowers. The “sharks” may also use lower rates but charge high fees. The fees may be “disguised”. Other tricks include lower rates but excess collateral.
Wholesale loans - loan/lease agreements between parties other than the company’s consumers (i.e. GMAC provides financing for GM dealers for inventory floor plans, until the car is sold, the dealer only pays for the cost of the financing and not the cost of the car).
Equipment Loans/Leases - the finance company may own or lease the equipment directly to its industrial customer or provide financial backing for a working capital loan or a loan to purchase or remodel the customer’s facilities.
The lack of deposits exempts finance companies from the extensive oversight of the federal and state regulation experienced by banks and thrifts. Because of the lack of regulatory oversight, finance companies are able to offer bank like services, but avoid the expense of regulatory compliance.
Like depository institutions, finance companies may be subject to state imposed usury ceilings on the max loan rates charged to customers.
Because of their heavy reliance on money and capital markets, finance companies need to signal their safety and solvency to investors. As a consequence, finance companies often maintain higher credit ratings than banks and carry higher capital to assets ratios.
Finance companies operate more like non-financial, non regulated companies than the other types of FI’s.
Mutual fund- intermediary that pools the financial resources of investors and invests those resources in (diversified) portfolios of assets.
Open end mutual fund - a fund that sells new shares to investors and redeems outstanding shares on demand at fair market value (the majority of funds).
Closed-end mutual fund - a fund with a fixed number of shares outstanding. The shares are exchange traded and may sell at a discount or premium to fair market value. Real estate investment trusts (REITs) are a common form of closed end investment company
Short-term funds - comprise both taxable and tax-exempt money market mutual funds. Money market do not have FDIC insurance (consequently, they typically have higher yields). Some money market mutual funds are covered by private insurance &/or implicit or explicit guarantees from management companies.
Prospectus - regulators require that mutual fund managers specify the investment objectives of their funds in the prospectus.
Mutual Fund Types Source : Investment Company Institute
Mutual Fund Types Source : Investment Company Institute
Capital gains - when a mutual fund sells assets at higher prices
Capital appreciation in the underlying values of existing assets adds to the value of mutual fund shares (NAV)
Net Asset Value (NAV) - the market value of the assets in the mutual fund portfolio divided by the number of shares outstanding. Each day, mutual fund assets are marked-to-market or adjusted to reflect current market prices. In open-end funds, the NAV is the price that investors obtain when they sell shares back to the fund or the price they pay to buy new shares in the fund on that day.
Two types of fees incurred by mutual fund investors: 1) sales loads 2) fund operating expenses
Load vs. No-load funds
Load funds - funds that charge a 1X sales or commission charge to compensate a registered representative of a broker (front - end loads). Back-end loads (differed sales charges) are sometimes charged when shares are sold.
No-load funds - funds that market shares directly to investors and do not use sales agents working for commissions
Operating expenses - annual fees are charged (as a % of assets) to cover all fund level expenses (management, administration, shareholder services, etc.). 12b-1 fees - (generally in no-load funds) are fees charged to meet fund level marketing and distribution costs (limited to 25 bps).