This chapter discusses finance companies Activities of finance companies



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Chap003

  • Overview
  • This chapter discusses finance companies
    • Activities of finance companies
    • Competitive environment
    • Size, structure, and composition
    • Regulation
    • Global issues
  • Ch 3-
  • Historical Perspective
  • Finance companies originated during the Great Depression
    • Installment credit
    • General Electric Capital Corporation
    • Competition from banks increased during 1950s
  • Expansion of product lines
    • GMAC
  • Ch 3-
  • GMAC
  • Controversial approval by the Fed of GMAC as a bank holding company
    • Allowed access to $6 billion in government bailout money
    • Fed required GM to reduce its holdings in GMAC to less than10 percent, from 49 percent
  • Ch 3-
  • 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
  • Ch 3-
  • Finance Companies (continued)
  • Captive Finance Companies: e.g., Ford Motor Credit Corp.
  • Highly concentrated
    • Largest 20 firms: 65 percent of assets
  • Ch 3-
  • 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 U.S. Bancorp Equipment Finance
    • Equipment leasing and factoring
  • Ch 3-
  • Web Resources
  • For information on finance companies, visit:
  • GE www.ge.com
  • GMAC www.gmacfs.com
  • www.ally.com
  • Ford Credit www.fordcredit.com
  • HSBC www.us.hsbc.com
  • Citigroup www.citigroup.com
  • Ch 3-
  • Largest Finance Companies
  • Ch 3-
  • Balance Sheet and Trends
  • Business and consumer loans are the major assets
    • 58.0% of total assets, 2012
    • Reduced from 95.1% in 1977
  • Increases in real estate loans and other assets
  • Growth in leasing and business lending
  • Finance companies face credit risk, interest rate risk, and liquidity risk
  • Ch 3-
  • Consumer Loans
  • Consumer loans
    • Primarily motor vehicle loans and leases
    • Historically charged higher rates than commercial banks
    • Low auto finance company rates
      • Following 9/11 attacks
      • Attempts to boost new vehicle sales via 0.0% loans lasted into 2005
      • By 2002, rates were 3.3% lower than banks on new vehicles
  • Ch 3-
  • Consumer Loans (continued)
  • Generally riskier customers than banks
    • Subprime lender finance companies
    • Jayhawk Acceptance Corp.
      • From auto loans to tummy tucks and nose jobs
  • “Loan shark” firms with rates as high as 30% or more
  • Ch 3-
  • Payday Loans
  • Payday loans
    • 390 percent APR
    • Regulated by states
    • As of 2012, payday loans effectively banned in 18 states
    • Controlled in other states via usury limits
      • Evaded by forming relationships with nationally chartered banks, based in states that do not have usury limits (e.g., South Dakota, Delaware)
  • Ch 3-
  • Mortgages
  • Mortgages have become a major component of finance company assets
  • May be direct mortgages, or as securitized mortgage assets
  • Ch 3-
  • Home Equity Loans
    • Growth in home equity loans following passage of Tax Reform Act of 1986
      • Tax deductibility issue
      • Defaults in subprime and even relatively strong credit mortgages in 2007-2008
        • Root cause of the financial crisis in 2008-2009
  • Ch 3-
  • Web Resources
  • For information on home equity loans, visit:
  • Consumer Bankers Association www.cbanet.org
  • Ch 3-
  • Business Loans
  • Business loans comprise largest portion of finance company loans (~30%)
  • 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
  • Ch 3-
  • Business Loans
  • Major subcategories:
    • Retail and wholesale motor vehicle loans and leases
    • Equipment loans
      • Tax and other associated advantages when finance company leases the equipment directly to the customer
    • Other business loans and securitized business assets
  • Ch 3-
  • 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)
  • Management of liquidity risk differs from commercial banks
  • Ch 3-
  • 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
    • AIG/American General
    • HSBC Holdings/Household International
  • Ch 3-
  • Industry Performance
  • Mid 2000s problems arose
    • 2005, 2006: falling home prices and rising interest rates
  • Sharp pullback from subprime mortgage lending
  • End of 2009: National all time high for mortgage delinquencies 6.89%
    • Countrywide Financial and CIT Group failure
  • Ch 3-
  • Regulation of Finance Companies
  • Federal Reserve’s definition of finance company
    • A firm, other than a depository institution, whose primary assets are loans to individuals and businesses
  • Subject to state-imposed usury ceilings
  • Lower regulatory burden than DIs
    • Not subject to Community Reinvestment Act of 1977
  • Ch 3-
  • Impact of nonbank FIs, including finance companies, on the U.S. economy resulted in greater scrutiny
  • Fed rescue of several finance companies was a factor
  • 2010 Wall Street Reform and Consumer Protection Act
  • Ch 3-
  • Regulation of Finance Companies
  • Regulation
  • With less regulatory scrutiny, finance companies must signal safety and soundness to capital markets in order to obtain funds
  • Lower leverage than banks (14.3% capital-assets versus 11.5% for commercial banks in 2012)
  • Captive finance companies may employ default protection guarantees from parent company or other protection such as letters of credit
  • Ch 3-
  • Global Issues
  • In foreign countries, finance companies are generally subsidiaries of commercial banks or industrials
  • Importance of nonbank FIs has been increasing over the past decade
    • Latin America and Europe
    • New Zealand: consolidation, collapse, and restructuring of finance companies
  • Ch 3-
  • Pertinent Websites
  • American General
  • Federal Reserve
  • Citigroup
  • Consumer Bankers Association
  • Ford Motor Credit
  • General Electric Capital Corp.
  • General Motors Acceptance Corp.
  • HSBC Finance
  • Ch 3-
  • www.aigag.com
  • www.federalreserve.gov
  • www.citigroup.com
  • www.cbanet.org
  • www.fordcredit.com
  • www.gecapital.com
  • www.gmacfs.com
  • www.us.hsbc.com

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