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Chapter Seventeen

Chapter Seventeen. Finance Companies. Finance Company Functions. Originated during the Depression when General Electric Corp. created General Electric Capital Corp. to finance appliance sales to cash-strapped customers

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Chapter Seventeen

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  1. Chapter Seventeen Finance Companies

  2. Finance Company Functions • Originated during the Depression when General Electric Corp. created General Electric Capital Corp. to finance appliance sales to cash-strapped customers • Late 1950’s, banks more willing to make installment loans so finance companies branched out into leasing and leveraged buyouts • Willing to lend to riskier borrowers • Often are directly affiliated with manufacturing • Limited amount of regulation

  3. Three Major Types of Finance Companies • Sales finance institutions • finance companies specializing in loans to customers of a particular retailer or manufacturer (e.g., Ford Motor Credit and Sears Roebuck Acceptance Corp.) • Person credit institutions • finance companies specializing in installment and other loans to consumers (e.g., Household Finance Corp. and American General Finance) • Business credit institutions • finance companies specializing in business loans (e.g., CIT Group and Heller Financial)

  4. Balance Sheet • Assets • Business and consumer loans (called accounts receivable) are the major assets • Liabilities and equity • cannot accept deposits so rely heavily on issuing short-term commercial paper to finance assets

  5. Consumer Loans • Motor vehicle loans and leases are the major type of consumer loan (75% in June 1999) • Subprime lender - a finance company that lends to high-risk customers • Loan sharks - subprime lenders that charge unfairly exorbitant rates to desperate, subprime borrowers • Other consumer loans (25% in June 1999) • personal cash loans • mobile home loans • loans for consumer goods

  6. Mortgages • Residential and commercial mortgages have become a major component of finance companies’ asset portfolios • Often issued to riskier borrowers and charge a higher interest rate for that risk • Securitized mortgage assets - mortgages packaged and used as assets backing secondary market securities • Bad debt expense and administrative costs of home equity loans are lower and have become a very attractive product for finance companies

  7. Business Loans • Represent the largest portion of the loan portfolio • Several advantages over commercial banks offered to small-business customers • they are not subject to regulations that restrict the type of products and services • do not accept deposits so no bank regulators • have substantial industry and product expertise • more willing to accept risky customers • generally have lower overheads • Business-lending also includes equipment loans or leasing, purchase accounts receivable, small farm loans, wholesale loans/leases of mobile homes, campers and trailers

  8. Regulation • Federal Reserve defines finance company as a firm whose primary assets are loans to individuals and businesses • Are financial intermediaries that borrow funds to profit on the difference between the rates paid on borrowed funds and charged on loans • May be subject to state-imposed usury ceilings on the maximum loan rates assigned to individuals • Being heavy borrowers in capital markets, they need to signal their safety and solvency to investors

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