1 Chapter 22 Consumer Finance Operations © 2001 South-Western College Publishing Company

2 Types of Finance Companies nConsumer finance companies make direct loans to consumers nSales finance companies concentrate on purchasing credit contracts from retailers and dealers nCommercial finance companies provide loans to firms that can not obtain financing from commercial banks

3 Sources of Finance Company Funds nFinance companies use loans from banks as a source of funds and consistently renew the loans over time nCommercial paper 4A short-term source but finance companies roll over their issues to create a permanent source of funds 4Secured commercial paper allows smaller and medium-sized firms access to the market 4Well-known firms use direct placement

4 Sources of Finance Company Funds nSome states allow finance companies to accept customer deposits nBonds are used as a long-term source of funds and the use of this source depends on 4Expectations about future interest rates 4The balance sheet structure nCapital comes from retained earnings or issuing stock

5 Uses of Finance Company Funds nFinance companies make many kinds of consumer loans in the form of personal loans 4Auto loans offered by a finance company owned by the manufacturer 4Home improvement, mobile home and other kinds of personal loans 4Credit cards which can be used at a variety of retail stores

6 Uses of Finance Company Funds 4Credit card loans in which a retailer sells a credit contract to a finance company Customers make payments to the finance company Gives the finance company access to new customers

7 Uses of Finance Company Funds nBusiness loans and leasing are used to finance the cash cycle of companies 4Cash cycle is the amount of time it takes between when inventory is purchased, the product is sold and customers pay 4This financing is often backed by accounts receivable or inventory nLeveraged buy out loans nFactor accounts receivable

8 Uses of Finance Company Funds nLeasing 4Finance company purchases equipment 4Leases it to businesses nReal estate loans 4Mortgages on commercial real estate 4Second mortgages on residential real estate nRelative importance of uses of funds

9 Regulation of Finance Companies nFederal regulations apply if finance companies are acting as bank holding companies or are subsidiaries of bank holding companies nState regulations apply otherwise nHave ceilings which put a maximum on the loan’s size nSubject to interest rate ceilings and a maximum term for the loan

10 Risks Faced by Finance Companies nLiquidity risk 4Finance companies do not hold assets that can be easily sold in the secondary market 4To raise funds they must borrow 4Balance sheet structure does not call for much liquidity because they would not have unexpected deposit withdrawals

11 Risks Faced by Finance Companies nInterest rate risk is less than for depository institutions because the maturity of assets and liabilities is relatively short nAssets are typically not as rate sensitive as liabilities nCan use adjustable rates and shorter maturities on their loans to manage the risks

12 Risks Faced by Finance Companies nCredit risk 4Represents an important source of risk 4Loan delinquency rates are typically higher than for other kinds of institutions 4Charge a higher interest rate to compensate for the risk 4High return, high risk nature of loans makes performance sensitive to prevailing economic conditions