web chapter 27 finance companies. copyright ©2015 pearson education, inc. all rights reserved.27-1...

Web Chapter 27

Finance Companies

Copyright ©2015 Pearson Education, Inc. All rights reserved. 27-2

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.


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


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.


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.)


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).


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.


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.


Finance Company Loans

Figure 27.1 Types of Loans Made by Finance Companies, 2013


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.


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.


Business Finance Company Loans

Figure 27.2 Types of Business Loans Made by Finance Companies (end of 2013)


Business Finance Company Loans

Figure 27.3 Finance Company Business Loans, 1994–2013


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.


Consumer Finance Companies

• A home equity loans can reduce borrowing costs:


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.


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.


Regulation

• State and federal regulation limit ability to collect on delinquent or defaulted loans.

• Few regulations in the business loan market.


Finance Company Balance Sheet

Table 27.1 Consolidated Finance Company Balance Sheet, 2012



• Assets. ─ Primary asset is their loan portfolio─Must maintain a contra-asset account reserve

for loan losses to charge off expected loan defaults



• Liabilities. ─ Equity (about 12% of assets)─ Loans ─ Active in the commercial paper market─ Captive finance companies can borrow directly

from their parent company



• 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


Finance Company Balance Sheet: Growth in Assets

Figure 27.4 Growth of Finance Company Assets, 1980–2012


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.


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.


Chapter Summary

• Balance Sheet: we reviewed the breakdown of the assets and liabilities held by these companies.

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