FINANCE
COMPANIES
What are
Finance
Companies?
Finance Companies
can be partnerships or corporations which are organized to
extend credit lines to customers and to industrial, commercial or
agricultural companies by:
-discounting and factoring commercial papers and account
receivables
-buying or selling contracts, bases, chattel mortgages and
other evidences of indebtedness
-lending motor vehicles, heavy equipment, office machines
and appliances.
Finance companies in general tend to be
interest rate-sensitive - increases and
decreases in market interest rates affect
their profits directly.
For this reason, publicly held finance
companies are sometimes referred to as
money stocks.
Unlike a bank, it does not receive deposits but rather obtains
its financing from banks, institutions, and other money
market sources.
Finance
companies
also
grant
small
loans
directly
to
consumers at a relatively high rate of interest. They
typically enjoy high credit ratings and are thus able to
borrow at the lowest market rates, enabling them to make
loans at rates not much higher than banks.
Finance companies arose during the late 19th century because
some firms and consumers were refused bank credit.
Until then, the need for consumer loans had been met
primarily by illegal “loan shark” activities because it was
unprofitable for banks to make small loans at rates below
legally set usury levels.
Today many companies engage both in the sales-finance
business and in making loans directly to consumers.
Large-sales
finance
companies,
which
operate
by
purchasing unpaid customer accounts at a discount from
merchants and collecting payments due from consumers,
were a response to the need for installment financing for
the purchase of automobiles in the early 1900s.
The General Motors Acceptance Corporation, for example,
was established in 1919 to purchase automobile accounts
receivable from car dealers who were themselves unable
to finance time purchases.
Commercial finance companies have
grown because they are more
flexible in arranging loan
repayment schedules than are
banks.
Generally, finance companies
fall into three categories:
CONSUMER FINANCE
COMPANIES
-also known as small loan or direct loan
companies
-make small loans against personal assets
and provide an option for individuals
with poor credit ratings.
SALES FINANCE
COMPANIES
-also called acceptance companies
-purchase retail and wholesale paper
from automobile and other consumer
and capital goods dealers;
COMMERCIAL FINANCE
COMPANIES
-also
called commercial credit companies
-make loans to manufacturers and
wholesalers; these loans are secured by
accounts receivable, inventories, and
equipment.
Commercial finance companies have
in recent years become a favorite option
for entrepreneurs seeking small business
loans. These institutions generally charge
higher interest rates than banks and
credit unions, but they also are more
likely to approve a loan request.
Larger commercial finance companies often offer small
business owners a variety of lending options from which to
choose. These include:

factoring (buying a firm’s accounts receivables)

working capital loans

equipment financing and leasing

specialized equity investments

collateral-based financing

cash-flow financing

Some also offer additional services in connection with
those loans, such as assistance with collections.
different
finance
company
structures:
BANK AFFILIATED
This finance company frequently can
provide very competitive interest rates.
INDEPENDENT
An independent finance company has the
greatest flexibility, will finance almost any
type of equipment, and can offer very
competitive rates although not usually as
low as the banks or the captives
(equipment suppliers).
BROKERS
This is generally considered the most
expensive form of leasing as they
typically turn a transaction around and
sell it to an independent leasing company
or bank affiliated company.
CAPTIVE
These are owned by the equipment
suppliers and can provide very low rates
because of their familiarity with the
product.
Finance Companies
• Finance companies are non-depository lending institutions.
• Some finance companies are independent corporations.
Other
“captive” finance companies are subsidiaries of bank or financial
services holding companies or of manufacturers.
• Because they do not issue deposits (else they would be
considered
banks),
finance
companies
have
the
following
disadvantages and advantages relative to banks.
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DISADVANTAGEs
Their liabilities do not have government (FDIC) insurance. Since
deposit insurance is usually provided at subsidized rates, this
implies that finance companies likely have a higher cost of
funding.
Finance companies pay competitive rates on their
liabilities.
Often, finance companies provide installment loans, which were
viewed by society as immoral.
Installment credit was
thought to lead consumers to unmanageable debt burdens.
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ADVANTAGES
Because
their
liabilities
are
not
government
insured, they are subject to less government
regulation than banks. In particular, they may
be able to lend to riskier borrowers that
regulators would not want banks to lend to.
Captive finance companies have better access
than banks to financing the goods and services
sold by their parents.
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•
In recent years, finance companies were the major
issuers of commercial paper.
•
Because finance companies do not issue deposits, they
cannot provide the transactions services (e.g., checking
accounts) offered by banks.
•
Since finance companies lack a branch office network,
they typically make loans to borrowers located farther
away.
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The typical practice of finance company lending is described as
transaction lending. This involves:
» making one-time secured loans, often where the collateral is
the borrower’s accounts receivable, inventory, or an asset sold
by the finance company’s parent or affiliate.
» monitoring the value of the borrower’s collateral (asset-based
lending), not his cash flow
» foreclosing promptly on a loan should the borrower default
(miss making a loan payment).
» providing leases, especially to risky borrowers. A lease allows
the finance company to easily repossess the leased asset if the
borrower misses a lease payment.
» factoring, which is buying a firm’s accounts receivable (at a
discount) and then managing the bill collections.
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Empirical evidence in Carey, Post, and Sharpe (1998) Journal of
Finance also supports differences in lending due to reputational
concerns and regulation differences. They find:
» Relative to banks, a greater proportion of finance companies’
loans are to higher-leveraged corporations.
» Finance company loans are, on average, longer maturity (3
vs. 2 years) and more frequently collateralized (92 vs. 70 %)
compared to bank loans. 
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