Chapter 6
Finance Companies
McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Historical Perspective

Finance companies originated during the
depression.
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

Installment credit
General Electric Capital Corporation.
Competition from banks increased during
1950s.
Expansion of product lines

GMACCM is one of the largest commercial
mortgage lenders in U.S.
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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
 Highly concentrated


Largest 20 firms: 65 percent of assets
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Major Types of Finance Companies

Sales finance institutions

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Personal credit institutions

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Ford Motor Credit and Sears Roebuck
Acceptance Corp.
HSBC Finance and AIG American General.
Business credit institutions

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CIT Group and FleetBoston Financial.
Equipment leasing and factoring
 Key Bank locally
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https://www.hfc.com/learn-aboutloans/home/default_customer.html?WT_srch=&DCSext_sot=SelfDirected&WT_seg_1=Prospect
http://www.hsh.com/not-the-associates.html
https://www.beneficial.com/learn-aboutloans/home/default_customer.html?WT_srch=&DCSext_sot=SelfDirected&WT_seg_1=Prospect
http://www.kefonline.com/
http://www.docshop.com/education/vision/refractive/lasik/financing/
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Largest Finance Companies
Company Name
Total Assets
(Millions)
General Electric Capital
Services
$333,780
Citigroup
164,205
GMAC
154,764
Ford Motor Credit Company
153,000
J. P. Morgan Chase
144,835
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Balance Sheet and Trends

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Business and consumer loans are the major
assets


52.8% of total assets, 2006.
Reduced from 95.1% in 1977.
Increases in real estate loans and other
assets.
 Growth in leasing
 Finance companies face credit risk, interest
rate risk and liquidity risk.

Balance Sheet and Trends

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Consumer loans


Primarily motor vehicle loans and leases.
Anomalous low auto finance company rates are
anomalous following 9/11 attacks.


Attempts to boost new vehicle sales via 0.0% loans
lasted into 2005.
By 2003, rates 3.5% lower than banks on new
vehicle rates
Consumer loans (continued)

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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.
 Payday loans


390 percent APR (Implication for EAR is
staggering!)
Balance Sheet and Trends

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Mortgages



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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
 2006 average home equity loan $82,872
 Defaults in subprime and relatively strong
credit mortgages in 2007
Business Loans
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Business loans comprise largest portion of
finance company loans.
 Advantages over commercial banks:


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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.
Business Loans

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Major subcategories:


Retail and wholesale motor vehicle loans and
leases
Equipment loans


tax issues and other associated advantages when
finance company leases the equipment directly to the
customer
Other business loans and securitized business
assets
Liabilities
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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).
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Commercial paper maturities up to 270 days.
Consequently, management of liquidity risk
differs from commercial banks relying on
deposits
Industry Performance

Strong loan demand and solid profits for the
largest firms in the early 2000s

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Effects of low interest rates
Not surprisingly, the most successful
became takeover targets
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
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Citigroup/Associates First Capital,
Household International/HSBC Holdings
Mid 2000s problems arose


2005, 2006: falling home prices and rising
interest rates
Pullback from subprime loans
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.

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Not subject to Community Reinvestment Act.
Lack the banks’ regulatory safety-net
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Regulation
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With less regulatory scrutiny, finance
companies must signal safety and
soundness to capital markets in order to
obtain funds.
 Lower leverage than banks (11.4% capitalassets versus 10.36% for commercial banks
in 2006).
 Captive finance companies may employ
default protection guarantees from parent
company or other protection such as letters
of credit.

Global Issues
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In foreign countries, Finance companies are
generally subsidiaries of commercial banks
or industrials
 In Japan, ownership of finance companies
by banks created opportunities when banks
hit by increase in nonperforming loans


GE Capital/Japan Leasing Corporation
Pertinent Websites
American General www.aigag.com
Federal Reserve www.federalreserve.gov
Citigroup www.citigroup.com
Consumer Bankers Association www.cbanet.org
Ford Motor Credit www.fordcredit.com
General Electric Capital Corp. www.gecapital.com
General Motors Acceptance Corp. www.gmacfs.com
HSBC Finance www.hfc.com
Household International www.household.com
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