all rights reserved dr david p echevarria 1 consumer finance operations chapter 22

Dr David P Echevarria 1All Rights Reserved

CONSUMER FINANCE OPERATIONS

CHAPTER 22


FINANCE COMPANIES

A. An enterprise engaged in the lending of money against collateral or speculatively

1. To manufacturers

2. To retailersa. esp. one specializing in the financing of hire-

purchase contracts

B. Lending Capital Raised in the Marketplace

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FINANCE COMPANIES

C. Types of Finance Companies1. Non depository financial institution - a financial institution that funds their

investment activities from the sale of securities or insurance

2. Consumer finance company, small loan company - a finance company that makes loans to people who have trouble getting a bank loan

3. Captive finance company - a finance company owned by a manufacturer to finance dealers' inventories or to make loans to consumers buying the company's products

4. Sales finance company - a finance company that buys (at a discount) the installment sales contracts of retail merchants (factoring)

5. Commercial credit company, commercial finance company - a finance company that makes loans to manufacturers and wholesalers

http://www.consumeraffairs.com/finance/loan_companies.html

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FINANCE COMPANIES

D. Evolution of Finance Companies1. Cowperwait & Sons (1807) provide installment credit to

spur furniture sales2. Singer Sewing Machine Co. began offering I.C. in 18503. Sears, Roebuck and Company in 19114. Major expansion of market coincides with marketing of

automobiles (c.a. 1915)a. Floor-planning for dealersb. Installment plans for car buyers


SOURCES OF FINANCE COMPANY (FC) FUNDS

A. Bank Loans1. FC borrow money from banks to relend to customers2. Installment contracts frequently discounted and sold to

banks3. When volume of business exceeded bank abilities FC

issued commercial paperB. Commercial Paper (CP) as a Source of Lendable Funds

1. Credit ratings are essential to raising funds via CP2. Average issue is $120,000,000 with a maturity of 30 days or less3. Only 1200 of more than 2 million companies issue CP in the US4. Half is sold through dealers and the rest is directly placed with investors5. Commercial Paper is principal source of funds for finance companies

C. Sales of Securities: stocks, bonds


USES OF FINANCE COMPANY FUNDS

A. Consumer Loans1. Banks now dominate in this area (2006) 84% versus 16% for F.C.s2. Many finance companies have entered second mortgage markets

a. Home equity loanb. Tax Reform Act of 1986 ended deductibility of non-mortgage interest

B. Business Loans1. Factoring; buying receivables from manufacturers

a. Recourse is important aspect of factoringb. Can be a very expensive way to obtain immediate cash flow

2. Leasing to mid-size companiesa. Loans secured by asset leased. Repossess if defaultb. Tax benefits (depreciation) accrue to F.Cc. May also provide for exchange of tax benefits via lower rates


RISK MANAGEMENT

A. Consumer Finance companies face the same risks as Banks and Thrifts

1. Liquidity risk

2. Interest rate risk

3. Credit risk


REGULATION OF FINANCE COMPANIES

A. Finance Company activities largely state regulated1. Some restrictions on branching or inter-state expansion2. Main form of regulation is in lending to consumers (i.e., Truth-in-

Lending Laws)3. State usury laws only restrictions

B. A Few Words on Captive Finance Subsidiaries (CFS)1. CFS exist to finance parent company's sales (GE, GM, Ford, etc.)2. CFS are very profitable; ROE of 12 - 15 % not uncommon3. CFS offer competitive advantage to parent4. CFS may also extend financing activity beyond parent (GECC)


Recent Developments

CFPB Proposes New Federal Oversight of Nonbank Auto Finance Companies

WASHINGTON, D.C. – The Consumer Financial Protection Bureau (CFPB) is proposing to oversee larger nonbank auto finance companies for the first time at the federal level. The Bureau also released a supervision report that details the auto-lending discrimination that the Bureau has uncovered at banks. The report highlights that the Bureau’s supervisory actions against banks will result in about $56 million in redress for up to 190,000 consumers harmed by discriminatory practices.

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Federal Oversight

1. Fairly marketing and disclosing auto financing No deceptive practices

2. Providing accurate information to credit bureaus Distorted consumer credit records by inaccurately

reporting information like the consumer’s payment history and delinquency status to credit bureaus

3. Treating consumers fairly when collecting debts Make sure that auto finance companies are not using

illegal debt collection tactics

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HOMEWORK QUESTIONS

A. Why did finance companies come into being?B. How do finance companies raise lendable capital?C. What two markets are served by finance companies?D. Into what areas have finance companies expanded their

activities from straight lending?E. In what way(s) does federal regulation impact finance

companies? Who regulates finance companies?F. What is a captive finance subsidiary and how does it benefit

its corporate parent?

all rights reserved dr david p echevarria 1 consumer finance operations chapter 22

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