web chapter 27 finance companies. copyright ©2015 pearson education, inc. all rights reserved.27-1...
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Chapter Preview
• Suppose you need to buy a car, but don’t have the $20,000 handy. Most dealers will help arrange financing for you, using a finance company. Along with consumer loans, finance companies are involved in lease finance and other business services.
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Chapter Preview
• In this chapter, we examine how finance companies evolved and what they do. Topics include: ─ History of Finance Companies─ Purpose of Finance Companies─ Risk of Finance Companies─ Types of Finance Companies─ Regulation of Finance Companies─ Finance Company Balance Sheet
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History of Finance Companies
• Finance companies date back to the 1800s when retailers started offering installment credit.
• Autos loans really developed the industry, since banks didn’t offer car loans in the early 1990s.
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History of Finance Companies
• By the beginning of 2013, banks held $1,191 billion in consumer loans, while finance companies held $804 billion.
• Finance companies moved into business financing (lease financing, etc.)
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Purpose of Finance Companies
• Issue commercial paper and use the proceeds to make loans.
• Largely unregulated, some states limit the size of a loan contract to a consumer borrower.
• Service both consumers and businesses with tailored products (usually not offered by banks).
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Risk in Finance Companies
• Default risk is the greatest risk, and finance companies often lend to those who can’t get financing otherwise.
• Liquidity risk can be an issue, as their assets (loans) are not easily sold. A need for cash can cause problems.
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Risk in Finance Companies
• Roll over risk refers to the need to continue to borrow in the commercial paper market.
• Interest rate risk is also present. Assets are medium-term loans, funded by short-term commercial paper.
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Finance Company Loans
Figure 27.1 Types of Loans Made by Finance Companies, 2013
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Types of Finance Companies
• Business Finance Companies offer loans secured by accounts receivable and other business.
• They also factor accounts receivable - giving companies, say, 90% of the book value of A/R.
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Types of Finance Companies
• They also specialize in leasing, often buying the asset and then lease it back to the company. Possible tax play.
• Floor plans help, for example, car dealers pay for all the cars on their lot.
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Business Finance Company Loans
Figure 27.2 Types of Business Loans Made by Finance Companies (end of 2013)
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Business Finance Company Loans
Figure 27.3 Finance Company Business Loans, 1994–2013
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Consumer Finance Companies
• Consumer finance companies offer consumer loans to for furniture, home improvements, etc.
• Consumers often can’t get credit elsewhere.• Two exceptions are home equity loans and
retail credit cards.
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Consumer Finance Companies
• A home equity loans can reduce borrowing costs:
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Sales Finance Companies
A sales finance company is owned by the manufacturer to promote its sales. •If you want to buy a GM car, GMAC will be happy to assist with the financing. •Also known as captive finance companies.
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Regulation
• Since there are no depositors or government insurance, regulation is limited.
• Regulation is typically designed to protect consumers. For example, Regulation Z requires the disclosure of the APR on loans.
• Usury laws limit the interest rate that can be charged.
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Regulation
• State and federal regulation limit ability to collect on delinquent or defaulted loans.
• Few regulations in the business loan market.
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Finance Company Balance Sheet
Table 27.1 Consolidated Finance Company Balance Sheet, 2012
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Finance Company Balance Sheet
• Assets. ─ Primary asset is their loan portfolio─Must maintain a contra-asset account reserve
for loan losses to charge off expected loan defaults
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Finance Company Balance Sheet
• Liabilities. ─ Equity (about 12% of assets)─ Loans ─ Active in the commercial paper market─ Captive finance companies can borrow directly
from their parent company
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Finance Company Balance Sheet
• Income. Their income comes from several sources:─ Interest income from their loan portfolio─ Loan origination fees─ Credit insurance premiums─ Some have also expanded into income tax
preparation services
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Finance Company Balance Sheet: Growth in Assets
Figure 27.4 Growth of Finance Company Assets, 1980–2012
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Chapter Summary
• History and Purpose: the history and background of these companies was presented - essentially, how they filled the void left by banks.
• Risk: the essential risks faced by finance companies was covered: roll over and interest rate risk.
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Chapter Summary
• Types: the basic classification of finance companies was reviewed, primarily by the type of customer served.
• Regulations: other than consumer protections laws, we discussed why finance companies aren’t heavily regulated.