6-1 Finance Companies Chapter 6

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6-1 Finance Companies Chapter 6

  1. 2. Historical Perspective <ul><li>Finance companies originated during the depression. </li></ul><ul><ul><li>Installment credit </li></ul></ul><ul><ul><li>General Electric Capital Corporation. </li></ul></ul><ul><ul><li>Competition from banks increased during 1950s. </li></ul></ul><ul><li>Expansion of product lines </li></ul><ul><ul><li>GMACCM is one of the largest commercial mortgage lenders in U.S. </li></ul></ul>
  2. 3. Finance Companies <ul><li>Activities similar to banks, but no depository function. </li></ul><ul><li>May specialize in installment loans (e.g. automobile loans) or may be diversified, providing consumer loans and financing to corporations, especially through factoring. </li></ul><ul><li>Commercial paper is key source of funds. </li></ul><ul><li>Captive Finance Companies: e.g. GMAC </li></ul><ul><li>Highly concentrated </li></ul><ul><ul><li>Largest 20 firms: 65 percent of assets </li></ul></ul>
  3. 4. Major Types of Finance Companies <ul><li>Sales finance institutions </li></ul><ul><ul><li>Ford Motor Credit and Sears Roebuck Acceptance Corp. </li></ul></ul><ul><li>Personal credit institutions </li></ul><ul><ul><li>HSBC Finance and AIG American General. </li></ul></ul><ul><li>Business credit institutions </li></ul><ul><ul><li>CIT Group and FleetBoston Financial. </li></ul></ul><ul><ul><li>Equipment leasing and factoring </li></ul></ul><ul><ul><ul><li>Key Bank locally </li></ul></ul></ul>
  4. 5. 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/
  5. 8. Largest Finance Companies
  6. 9. Balance Sheet and Trends <ul><li>Business and consumer loans are the major assets </li></ul><ul><ul><li>52.8% of total assets, 2006. </li></ul></ul><ul><ul><li>Reduced from 95.1% in 1977. </li></ul></ul><ul><li>Increases in real estate loans and other assets. </li></ul><ul><li>Growth in leasing </li></ul><ul><li>Finance companies face credit risk, interest rate risk and liquidity risk. </li></ul>
  7. 10. Balance Sheet and Trends <ul><li>Consumer loans </li></ul><ul><ul><li>Primarily motor vehicle loans and leases. </li></ul></ul><ul><ul><li>Anomalous low auto finance company rates are anomalous following 9/11 attacks. </li></ul></ul><ul><ul><ul><li>Attempts to boost new vehicle sales via 0.0% loans lasted into 2005. </li></ul></ul></ul><ul><ul><ul><li>By 2003, rates 3.5% lower than banks on new vehicle rates </li></ul></ul></ul>
  8. 11. Consumer loans (continued) <ul><li>Generally riskier customers than banks serve. </li></ul><ul><ul><li>Subprime mortgage lenders </li></ul></ul><ul><ul><li>Jayhawk Acceptance Corp. </li></ul></ul><ul><ul><ul><li>From auto loans to tummy tucks and nose jobs </li></ul></ul></ul><ul><li>Increase in “loan shark” firms with rates as high as 30% or more. </li></ul><ul><li>Payday loans </li></ul><ul><ul><li>390 percent APR (Implication for EAR is staggering!) </li></ul></ul>
  9. 12. Balance Sheet and Trends <ul><li>Mortgages </li></ul><ul><ul><li>Recent addition to finance company assets </li></ul></ul><ul><ul><li>Smaller regulatory burden than banks </li></ul></ul><ul><ul><li>May be direct mortgages, or as securitized mortgage assets. </li></ul></ul><ul><ul><li>Growth in home equity loans since passage of Tax Reform Act of 1986. </li></ul></ul><ul><ul><ul><li>Tax deductibility issue. </li></ul></ul></ul><ul><ul><ul><li>Conversion of credit card debt </li></ul></ul></ul><ul><ul><ul><li>2006 average home equity loan $82,872 </li></ul></ul></ul><ul><ul><ul><li>Defaults in subprime and relatively strong credit mortgages in 2007 </li></ul></ul></ul>
  10. 13. Business Loans <ul><li>Business loans comprise largest portion of finance company loans. </li></ul><ul><li>Advantages over commercial banks: </li></ul><ul><ul><li>Fewer regulatory impediments to types of products and services. </li></ul></ul><ul><ul><li>Not depository institutions hence less regulatory scrutiny and lower overheads. </li></ul></ul><ul><ul><li>Often have substantial expertise and greater willingness to accept riskier clients. </li></ul></ul>
  11. 14. Business Loans <ul><li>Major subcategories: </li></ul><ul><ul><li>Retail and wholesale motor vehicle loans and leases </li></ul></ul><ul><ul><li>Equipment loans </li></ul></ul><ul><ul><ul><li>tax issues and other associated advantages when finance company leases the equipment directly to the customer </li></ul></ul></ul><ul><ul><li>Other business loans and securitized business assets </li></ul></ul>
  12. 15. Liabilities <ul><li>Major liabilities: commercial paper and other debt (longer-term notes and bonds). </li></ul><ul><li>Finance firms are largest issuers of commercial paper (frequently through direct sale programs). </li></ul><ul><ul><li>Commercial paper maturities up to 270 days. </li></ul></ul><ul><li>Consequently, management of liquidity risk differs from commercial banks relying on deposits </li></ul>
  13. 16. Industry Performance <ul><li>Strong loan demand and solid profits for the largest firms in the early 2000s </li></ul><ul><ul><li>Effects of low interest rates </li></ul></ul><ul><li>Not surprisingly, the most successful became takeover targets </li></ul><ul><ul><li>Citigroup/Associates First Capital, </li></ul></ul><ul><ul><li>Household International/HSBC Holdings </li></ul></ul><ul><li>Mid 2000s problems arose </li></ul><ul><ul><li>2005, 2006: falling home prices and rising interest rates </li></ul></ul><ul><ul><li>Pullback from subprime loans </li></ul></ul>
  14. 17. Regulation of Finance Companies <ul><li>Federal Reserve definition of Finance Company </li></ul><ul><ul><li>Firm, other than depository institution, whose primary assets are loans to individuals and businesses. </li></ul></ul><ul><li>Subject to state-imposed usury ceilings. </li></ul><ul><li>Much lower regulatory burden than depository institutions. </li></ul><ul><ul><li>Not subject to Community Reinvestment Act. </li></ul></ul><ul><ul><li>Lack the banks’ regulatory safety-net </li></ul></ul>
  15. 18. Regulation <ul><li>With less regulatory scrutiny, finance companies must signal safety and soundness to capital markets in order to obtain funds. </li></ul><ul><li>Lower leverage than banks (11.4% capital-assets versus 10.36% for commercial banks in 2006). </li></ul><ul><li>Captive finance companies may employ default protection guarantees from parent company or other protection such as letters of credit. </li></ul>
  16. 19. Global Issues <ul><li>In foreign countries, Finance companies are generally subsidiaries of commercial banks or industrials </li></ul><ul><li>In Japan, ownership of finance companies by banks created opportunities when banks hit by increase in nonperforming loans </li></ul><ul><ul><li>GE Capital/Japan Leasing Corporation </li></ul></ul>
  17. 20. Pertinent Websites <ul><li>American General www.aigag.com </li></ul><ul><li>Federal Reserve www.federalreserve.gov </li></ul><ul><li>Citigroup www.citigroup.com </li></ul><ul><li>Consumer Bankers Association www.cbanet.org </li></ul><ul><li>Ford Motor Credit www.fordcredit.com </li></ul><ul><li>General Electric Capital Corp. www.gecapital.com </li></ul><ul><li>General Motors Acceptance Corp. www.gmacfs.com </li></ul><ul><li>HSBC Finance www.hfc.com </li></ul><ul><li>Household International www.household.com </li></ul>
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