Finance Companies
Chapter 5
Financial Institutions Management, 3/e
By Anthony Saunders
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Historical Perspective
• Finance companies originated during the
depression.
» General Electric Capital Corporation.
» Competition from banks increased during the 1950s.
• Expansion of product lines
» GMAC is the largest commercial mortgage lender in U.S.
• Industry is highly concentrated
» The largest 20 firms account for more than 80% of assets.
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Finance Companies
• Their activities are similar to banks, but they
have 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 a key source of funds.
• Captive Finance Companies: e.g. GMAC
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Major Types of Finance Companies
• Sales finance institutions
» Ford Motor Credit and Sears Roebuck Acceptance
Corp.
• Personal credit institutions
» Household Finance Corp. and American General
Finance
• Business credit institutions
» CIT Group and Heller Financial
» Equipment leasing and factoring
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Balance Sheet and Trends
• Business and consumer loans are the major
assets
» 63.4% at 3rd quarter of 1997.
» 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).
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Balance Sheet and Trends
• Consumer loans
» Primarily motor vehicle loans and leases.
» Current low rates from auto finance companies are
anomalous.
» Generally riskier customers than banks serve.
» Recent increase in “loan shark” firms with rates as
high as 30% or more.
» Other consumer loans about 27.5% of consumer
loan portfolio, August 1997.
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Balance Sheet and Trends
• Mortgages
» Recent addition to finance company assets.
» 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.
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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.
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Liabilities and Recent Trends
• 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).
• The most successful finance companies are
becoming takeover targets.
» Example: Money Store / First Union Bank
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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.
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Regulation
• With less regulatory scrutiny, finance
companies must signal safety and soundness to
capital markets in order to obtain funds.
• Lower leverage than banks (11.0% capitalassets versus 8.80% for commercial banks).
• Captive finance companies may employ default
protection guarantees from a parent company or
other protection such as letters of credit.
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