Web Chapter 27 Finance Companies

Copyright ©2015 Pearson Education, Inc. All rights reserved.27-1 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.

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

Copyright ©2015 Pearson Education, Inc. All rights reserved.27-3 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.

Copyright ©2015 Pearson Education, Inc. All rights reserved.27-4 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.)

Copyright ©2015 Pearson Education, Inc. All rights reserved.27-5 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).

Copyright ©2015 Pearson Education, Inc. All rights reserved.27-6 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.

Copyright ©2015 Pearson Education, Inc. All rights reserved.27-7 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.

Copyright ©2015 Pearson Education, Inc. All rights reserved.27-8 Finance Company Loans Figure 27.1 Types of Loans Made by Finance Companies, 2013

Copyright ©2015 Pearson Education, Inc. All rights reserved.27-9 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.

Copyright ©2015 Pearson Education, Inc. All rights reserved 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.

Copyright ©2015 Pearson Education, Inc. All rights reserved Business Finance Company Loans Figure 27.2 Types of Business Loans Made by Finance Companies (end of 2013)

Copyright ©2015 Pearson Education, Inc. All rights reserved Business Finance Company Loans Figure 27.3 Finance Company Business Loans, 1994–2013

Copyright ©2015 Pearson Education, Inc. All rights reserved 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.

Copyright ©2015 Pearson Education, Inc. All rights reserved Consumer Finance Companies A home equity loans can reduce borrowing costs:

Copyright ©2015 Pearson Education, Inc. All rights reserved 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.

Copyright ©2015 Pearson Education, Inc. All rights reserved 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.

Copyright ©2015 Pearson Education, Inc. All rights reserved Regulation State and federal regulation limit ability to collect on delinquent or defaulted loans. Few regulations in the business loan market.

Copyright ©2015 Pearson Education, Inc. All rights reserved Finance Company Balance Sheet Table 27.1 Consolidated Finance Company Balance Sheet, 2012

Copyright ©2015 Pearson Education, Inc. All rights reserved Finance Company Balance Sheet Assets. ─ Primary asset is their loan portfolio ─ Must maintain a contra-asset account reserve for loan losses to charge off expected loan defaults

Copyright ©2015 Pearson Education, Inc. All rights reserved Finance Company Balance Sheet Liabilities. ─ Equity (about 12% of assets) ─ Loans ─ Active in the commercial paper market ─ Captive finance companies can borrow directly from their parent company

Copyright ©2015 Pearson Education, Inc. All rights reserved Finance Company Balance Sheet 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

Copyright ©2015 Pearson Education, Inc. All rights reserved Finance Company Balance Sheet: Growth in Assets Figure 27.4 Growth of Finance Company Assets, 1980–2012

Copyright ©2015 Pearson Education, Inc. All rights reserved 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.

Copyright ©2015 Pearson Education, Inc. All rights reserved 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.

Copyright ©2015 Pearson Education, Inc. All rights reserved Chapter Summary Balance Sheet: we reviewed the breakdown of the assets and liabilities held by these companies.