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Overview

Overview. This chapter discusses finance companies Activities of finance companies Competitive environment Size, structure, and composition Regulation Global issues. Historical Perspective. Finance companies originated during the Great Depression Installment credit

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Overview

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  1. Overview • This chapter discusses finance companies • Activities of finance companies • Competitive environment • Size, structure, and composition • Regulation • Global issues

  2. 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 • GMACCM is one of the largest commercial mortgage lenders in U.S.

  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 10 percent, from 49 percent

  4. 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

  5. Finance Companies (continued) • Captive Finance Companies: e.g., GMAC • Highly concentrated • Largest 20 firms: 65 percent of assets

  6. 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. Bank Equipment Finance • Equipment leasing and factoring

  7. Web Resources • For information on finance companies, visit: GE www.ge.com GMAC www.gmacfs.com Ford Credit www.fordcredit.com HSBC www.us.hsbc.com American General www.americangeneral.com Citigroup www.citgroup.com

  8. Largest Finance Companies

  9. Balance Sheet and Trends • Business and consumer loans are the major assets • 56.0% of total assets, 2009 • 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

  10. Consumer Loans • Consumer loans • Primarily motor vehicle loans and leases • Historically charged higher rates than commercial banks • Low auto finance company rates are anomalous 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

  11. 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

  12. Payday Loans • Payday loans • 390 percent APR (Implication for EAR?) • Regulated by states • As of 2009, payday loans effectively banned in 13 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)

  13. Mortgages • Mortgages have become a major component of finance company assets • May be direct mortgages, or as securitized mortgage assets

  14. Home Equity Loans • Growth in home equity loans following passage of Tax Reform Act of 1986 • Tax deductibility issue • Conversion of credit card debt • Defaults in subprime and relatively strong credit mortgages in 2007-2008 • Root cause of the financial crisis in 2008-2009

  15. Web Resources • For information on home equity loans, visit: Consumer Bankers Association www.cbanet.org

  16. 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

  17. Business Loans • Major subcategories: • Retail and wholesale motor vehicle loans and leases • Equipment loans • Tax issues and other associated advantages when finance company leases the equipment directly to the customer • Other business loans and securitized business assets

  18. 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) • Commercial paper maturities up to 270 days • Management of liquidity risk differs from commercial banks

  19. 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, • Household International/HSBC Holdings

  20. 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 acquired by BOA • Major losses by HSBC and others

  21. 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

  22. Regulation of Finance Companies • 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 Financial Services Regulatory Overhaul Bill

  23. Regulation • With less regulatory scrutiny, finance companies must signal safety and soundness to capital markets in order to obtain funds • Lower leverage than banks (12.3% capital-assets versus 11.1% for commercial banks in 2009) • Captive finance companies may employ default protection guarantees from parent company or other protection such as letters of credit

  24. 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 central Europe • New Zealand: consolidation, collapse, and restructuring of finance companies

  25. Pertinent Websites 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 American General Federal Reserve Citigroup Consumer Bankers Association Ford Motor Credit General Electric Capital Corp. General Motors Acceptance Corp. HSBC Finance

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