Finance Companies Chapter 5

1. Finance CompaniesChapter 5 Financial Institutions Management, 3/e By Anthony Saunders

2. Historical Perspective • Finance companies originated during the depression. • General Electric Capital Corporation. • Competition from banks increased during the 1950s. • Expansion of product lines • GMAC is the largest commercial mortgage lender in U.S. • Industry is highly concentrated • The largest 20 firms account for more than 80% of assets.

3. Finance Companies • Their activities are similar to banks, but they have 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 a key source of funds. • Captive Finance Companies: e.g. GMAC

4. Major Types of Finance Companies • Sales finance institutions • Ford Motor Credit and Sears Roebuck Acceptance Corp. • Personal credit institutions • Household Finance Corp. and American General Finance • Business credit institutions • CIT Group and Heller Financial • Equipment leasing and factoring

5. Balance Sheet and Trends • Business and consumer loans are the major assets • 63.4% at 3rd quarter of 1997. • Reduced from 95.1% in 1977. • Increases in real estate loans and other assets. • Growth in leasing (largely due to tax incentives of 1981 Economic Recovery Act).

6. Balance Sheet and Trends • Consumer loans • Primarily motor vehicle loans and leases. • Current low rates from auto finance companies are anomalous. • Generally riskier customers than banks serve. • Recent increase in “loan shark” firms with rates as high as 30% or more. • Other consumer loans about 27.5% of consumer loan portfolio, August 1997.

7. Balance Sheet and Trends • Mortgages • Recent addition to finance company assets. • 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.

8. 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.

9. Liabilities and Recent Trends • 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). • The most successful finance companies are becoming takeover targets. • Example: Money Store / First Union Bank

10. 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.

11. Regulation • With less regulatory scrutiny, finance companies must signal safety and soundness to capital markets in order to obtain funds. • Lower leverage than banks (11.0% capital-assets versus 8.80% for commercial banks). • Captive finance companies may employ default protection guarantees from a parent company or other protection such as letters of credit.