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Historical Perspective

Historical Perspective. Finance companies originated during the depression. Installment credit General Electric Capital Corporation. Competition from banks increased during 1950s. Expansion of product lines GMACCM is largest commercial mortgage lender in U.S. Industry is highly concentrated

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Historical Perspective

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  1. Historical Perspective • Finance companies originated during the depression. • Installment credit • General Electric Capital Corporation. • Competition from banks increased during 1950s. • Expansion of product lines • GMACCM is largest commercial mortgage lender in U.S. • Industry is highly concentrated • Largest 20 firms account for more than 75% of assets.

  2. 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. • Captive Finance Companies: e.g. GMAC

  3. Major Types of Finance Companies • Personal credit institutions • Household International Corp. and AIG American General • Sales finance institutions • Ford Motor Credit and Sears Roebuck Acceptance Corp. • Business credit institutions • CIT Group and Fleet Boston Financial. • Equipment leasing and factoring.

  4. Largest Finance Companies

  5. Balance Sheet and Trends • Business and consumer loans are the major assets • 51.9% of total assets, 2003. • Reduced from 95.1% in 1977. • Increases in real estate loans and other assets. • Growth in leasing (largely due to tax incentives of 1981 Economic Recovery Act). • Finance companies face credit risk, interest rate risk and liquidity risk.

  6. Balance Sheet and Trends • Consumer loans • Primarily motor vehicle loans and leases. • Recent low auto finance company rates are anomalous—partly due to 9/11 effects. • Attempts to boost new vehicle sales via 0.0% loans lasted into 2004. • By 2003, rates 3.5% lower than banks on new vehicle rates

  7. Consumer loans (continued) • Generally riskier customers than banks serve. • Subprime mortgage lenders • Jayhawk Acceptance Corp. • From auto loans to tummy tucks and nose jobs • Increase in “loan shark” firms with rates as high as 30% or more. • Other consumer loans about 24.7% of consumer loan portfolio, 2003.

  8. Balance Sheet and Trends • Mortgages • Recent addition to finance company assets • Smaller regulatory burden than banks • May be direct mortgages, or as securitized mortgage assets. • Growth in home equity loans since passage of Tax Reform Act of 1986. • Tax deductibility issue. • Conversion of credit card debt • 2003 average home equity loan $69,513

  9. Business Loans • Business loans comprise largest portion of finance company loans. • 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.

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

  11. 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. • Consequently, management of liquidity risk differs from commercial banks relying on deposits

  12. Industry Performance • Strong loan demand • Strong profits for the largest firms • e.g. Household International, Associates First Capital, Beneficial • Effects of low interest rates • Most successful have become takeover targets • Citigroup/Associates First Capital, • Household International/HSBC Holdings

  13. Industry Performance • High risk has a downside: • Subprime lending: Jayhawk Acceptance Corporation • Cityscape Financial Corp., Aames Financial Corp., Advanta, FirstPlus Financial Group, The Money Store, Associates First Capital • FTC scrutiny of subprime lending practices violating Truth in Lending Act, Fair Credit Reporting Act, Equal Opportunity Act • 2002, Citigroup $200 million settlement for predatory lending via Associates First Capital

  14. Electronic Lending • Mainly mortgages completed over the Internet • E-Loan • Suffered with the dot-com downturn

  15. Regulation of Finance Companies • Federal Reserve definition of Finance Company • Firm, other than depository institution, whose primary assets are loans to individuals and businesses. • Subject to state-imposed usury ceilings. • Much lower regulatory burden than depository institutions. • Not subject to Community Reinvestment Act. • Lack the banks’ regulatory safety-net

  16. Regulation • With less regulatory scrutiny, finance companies must signal safety and soundness to capital markets in order to obtain funds. • Lower leverage than banks (15.1% capital-assets versus 9.1% for commercial banks). • Captive finance companies may employ default protection guarantees from parent company or other protection such as letters of credit.

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