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CONSUMER FINANCE OPERATIONS

CONSUMER FINANCE OPERATIONS. CHAPTER 22 . FINANCE COMPANIES . Primary Business is Lending Lending Capital Raised in the Marketplace Types of Finance Companies Consumer finance; direct personal loans with or without collateral and credit cards

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CONSUMER FINANCE OPERATIONS

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  1. CONSUMER FINANCE OPERATIONS CHAPTER 22 Dr David P Echevarria

  2. FINANCE COMPANIES • Primary Business is Lending • Lending Capital Raised in the Marketplace • Types of Finance Companies • Consumer finance; direct personal loans with or without collateral and credit cards • Business finance; buying installment sales contracts • Recent expansion into capital leasing Dr David P Echevarria

  3. FINANCE COMPANIES • Evolution of Finance Companies • Cowperwait & Sons (1807) provide installment credit to spur furniture sales • Singer Sewing Machine Co. began offering I.C. in 1850 • Sears, Roebuck and Company in 1911 • Major expansion of market coincides with marketing of automobiles (c.a. 1915) • Floor-planning for dealers • Installment plans for car buyers • Captive Finance Subsidiaries • Wholly owned subsidiaries providing financing to parent's customers • Examples: GMAC, FMC, DCC, GECC Dr David P Echevarria

  4. SOURCES OF FINANCE COMPANY (FC) FUNDS • Bank Loans • FC borrow money from banks to relend to customers • Installment contracts frequently discounted and sold to banks • When volume of business exceeded bank abilities FC issued commercial paper • Commercial Paper (CP) as a Source of Lendable Funds • Credit ratings are essential to raising funds via CP • Average issue is $120,000,000 with a maturity of 30 days or less • Only 1200 of more than 2 million companies issue CP in the US • Half is sold through dealers and the rest is directly placed with investors • Commercial Paper is principal source of funds for finance companies • Sales of Securities: stocks, bonds Dr David P Echevarria

  5. USES OF FINANCE COMPANY FUNDS • Consumer Loans • Banks now dominate in this area (1991) 72% versus 28% for F.C.s • Many finance companies have entered second mortgage markets • Home equity loan • Tax Reform Act of 1986 ended deductibility of non-mortgage interest • Business Loans • Factoring; buying receivables from manufacturers • Recourse is important aspect of factoring • Can be a very expensive way to obtain immediate cash flow • Leasing to mid-size companies • Loans secured by asset leased. Repossess if default • Tax benefits (depreciation) accrue to F.C • May also provide for exchange of tax benefits via lower rates Dr David P Echevarria

  6. RISK MANAGEMENT • Consumer Finance companies face the same risks as Banks and Thrifts • Liquidity risk • Interest rate risk • Credit risk Dr David P Echevarria

  7. REGULATION OF FINANCE COMPANIES • Finance Company activities largely state regulated • Some restrictions on branching or inter-state expansion • Main form of regulation is in lending to consumers (i.e., Truth-in-Lending Laws) • State usury laws only restrictions • A Few Words on Captive Finance Subsidiaries (CFS) • CFS exist to finance parent company's sales • CFS are very profitable; ROE of 12 - 15 % not uncommon • CFS offer competitive advantage to parent • CFS may also extend financing activity beyond parent (GECC) Dr David P Echevarria

  8. HOMEWORK QUESTIONS • Why did finance companies come into being? • How do finance companies raise lendable capital? • What two markets are served by finance companies? • Into what areas have finance companies expanded their activities from straight lending? • In what way(s) does federal regulation impact finance companies? Who regulates finance companies? • What is a captive finance subsidiary and how does it benefit its corporate parent? Dr David P Echevarria

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