Download finance company

Chapter Seventeen
Finance Companies
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Finance Company Functions
• Originated during the Depression when General
Electric Corp. created GE Capital Corp. to finance
appliance sales to cash-strapped customers
• In the late 1950’s, banks became more willing to
make installment loans so finance companies
branched out into leasing and leveraged buyouts
• Willing to lend to riskier borrowers
• Often are directly affiliated with manufacturing
• Limited regulation
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Three Major Types of Finance Companies
• Sales finance institutions
– finance companies specializing in loans to customers of a
particular retailer or manufacturer (e.g., Ford Motor Credit
and Sears Roebuck Acceptance Corp.)
• Person credit institutions
– finance companies specializing in installment and other loans
to consumers (e.g., Household Finance Corp. and American
General Finance)
• Business credit institutions
– finance companies specializing in business loans, leasing, and
factoring (e.g., CIT Group and Heller Financial)
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Balance Sheet
• Assets
– Business and consumer loans (called accounts receivable)
are the major assets
• Liabilities and equity
– FCs cannot accept deposits, so they rely heavily on issuing
short-term commercial paper to finance assets
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Assets of U.S. Finance Companies
(December 31, 2001) ($Bn)
Accounts receivable gross …………… $970.9
Consumer …………………………. 340.2
Business …………………………… 447.0
Real estate …………………………. 183.7
Less reserves for unearned income …… (60.7)
Less reserves for losses ………………. (20.2)
Accounts receivable net ………………. 890.1
All other ………………………………. 500.1
69.9%
24.5
32.2
13.2
(4.4)
(1.5)
64.0
36.0
Total Assets
100.0
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Liabilities of U.S. Finance Companies
(December 31, 2001) ($Bn)
Bank loans …………………………… $ 49.4
Commercial paper ……………………. 157.3
Debt due to parent ……………………. 99.5
Debt not elsewhere classified ………… 564.1
All other liabilities ……………………. 330.8
Capital, surplus, undivided profits ……. 189.1
3.5%
11.3
7.2
40.6
23.8
13.6
Total Liabilities
100.0
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Consumer Loans
• Motor vehicle loans and leases are the major type of
consumer loan (80.4% in 2001)
• Subprime lender - a finance company that lends to highrisk customers
• Loan sharks - subprime lenders that charge unfairly
exorbitant rates to desperate, subprime borrowers
• Other consumer loans (19.6% in 2001)
– personal cash loans
– mobile home loans
– loans for consumer goods
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Mortgages
• Residential and commercial mortgages have become a
major component of finance companies’ assets
• Often issued to riskier borrowers and charge a higher
interest rate for that risk
• Securitized mortgage assets: mortgages packaged and
used as assets backing secondary market securities
• Bad debt expense and administrative costs of home
equity loans are lower and have become a very
attractive product for finance companies
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Business Loans
• Represent the largest portion of the loan portfolio
• Several advantages over commercial banks offered to
small-business customers
– they are not subject to regulations that restrict the type of
products and services
– do not accept deposits so no bank regulators
– have substantial industry and product expertise
– more willing to accept risky customers
– generally have lower overheads
• Business lending also includes equipment loans or
leasing, purchase accounts receivable, small farm loans,
wholesale loans/leases of mobile homes
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Regulation
• Federal Reserve defines finance company as a firm
whose primary assets are loans to individuals and
businesses
• Are financial intermediaries that borrow funds to profit
on the difference between the rates paid on borrowed
funds and charged on loans
• May be subject to state-imposed usury ceilings on the
maximum loan rates assigned to individuals
• Being heavy borrowers in capital markets, they need to
signal their safety and solvency to investors
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