All Rights Reserved Dr David P Echevarria 1 CONSUMER FINANCE OPERATIONS CHAPTER 22

All Rights Reserved Dr David P Echevarria 2 FINANCE COMPANIES A. A.An enterprise engaged in the lending of money against collateral or speculatively 1. 1.To manufacturers 2. 2.To retailers a. a.esp. one specializing in the financing of hire- purchase contracts B.Lending Capital Raised in the Marketplace

FINANCE COMPANIES C.Types of Finance Companies 1.Non depository financial institution - a financial institution that funds their investment activities from the sale of securities or insurance 2.Consumer finance company, small loan company - a finance company that makes loans to people who have trouble getting a bank loan 3.Captive finance company - a finance company owned by a manufacturer to finance dealers' inventories or to make loans to consumers buying the company's products 4.Sales finance company - a finance company that buys (at a discount) the installment sales contracts of retail merchants (factoring) 5.Commercial credit company, commercial finance company - a finance company that makes loans to manufacturers and wholesalers All Rights Reserved Dr David P Echevarria 3

All Rights Reserved Dr David P Echevarria 4 FINANCE COMPANIES D.Evolution of Finance Companies 1.Cowperwait & Sons (1807) provide installment credit to spur furniture sales 2.Singer Sewing Machine Co. began offering I.C. in Sears, Roebuck and Company in Major expansion of market coincides with marketing of automobiles (c.a. 1915) a.Floor-planning for dealers b.Installment plans for car buyers

All Rights Reserved Dr David P Echevarria 5 SOURCES OF FINANCE COMPANY (FC) FUNDS A.Bank Loans 1.FC borrow money from banks to relend to customers 2.Installment contracts frequently discounted and sold to banks 3.When volume of business exceeded bank abilities FC issued commercial paper B.Commercial Paper (CP) as a Source of Lendable Funds 1.Credit ratings are essential to raising funds via CP 2.Average issue is $120,000,000 with a maturity of 30 days or less 3.Only 1200 of more than 2 million companies issue CP in the US 4.Half is sold through dealers and the rest is directly placed with investors 5.Commercial Paper is principal source of funds for finance companies C.Sales of Securities: stocks, bonds

All Rights Reserved Dr David P Echevarria 6 USES OF FINANCE COMPANY FUNDS A.Consumer Loans 1.Banks now dominate in this area (2006) 84% versus 16% for F.C.s 2.Many finance companies have entered second mortgage markets a.Home equity loan b.Tax Reform Act of 1986 ended deductibility of non-mortgage interest B.Business Loans 1.Factoring; buying receivables from manufacturers a.Recourse is important aspect of factoring b.Can be a very expensive way to obtain immediate cash flow 2.Leasing to mid-size companies a.Loans secured by asset leased. Repossess if default b.Tax benefits (depreciation) accrue to F.C c.May also provide for exchange of tax benefits via lower rates

All Rights Reserved Dr David P Echevarria 7 RISK MANAGEMENT A.Consumer Finance companies face the same risks as Banks and Thrifts 1.Liquidity risk 2.Interest rate risk 3.Credit risk

All Rights Reserved Dr David P Echevarria 8 REGULATION OF FINANCE COMPANIES A.Finance Company activities largely state regulated 1.Some restrictions on branching or inter-state expansion 2.Main form of regulation is in lending to consumers (i.e., Truth-in- Lending Laws) 3.State usury laws only restrictions B.A Few Words on Captive Finance Subsidiaries (CFS) 1.CFS exist to finance parent company's sales (GE, GM, Ford, etc.) 2.CFS are very profitable; ROE of % not uncommon 3.CFS offer competitive advantage to parent 4.CFS may also extend financing activity beyond parent (GECC)

Recent Developments CFPB Proposes New Federal Oversight of Nonbank Auto Finance Companies WASHINGTON, D.C. – The Consumer Financial Protection Bureau (CFPB) is proposing to oversee larger nonbank auto finance companies for the first time at the federal level. The Bureau also released a supervision report that details the auto- lending discrimination that the Bureau has uncovered at banks. The report highlights that the Bureau’s supervisory actions against banks will result in about $56 million in redress for up to 190,000 consumers harmed by discriminatory practices. All Rights Reserved Dr David P Echevarria 9

Federal Oversight 1. 1.Fairly marketing and disclosing auto financing   No deceptive practices 2. 2.Providing accurate information to credit bureaus   Distorted consumer credit records by inaccurately reporting information like the consumer’s payment history and delinquency status to credit bureaus 3. 3.Treating consumers fairly when collecting debts   Make sure that auto finance companies are not using illegal debt collection tactics All Rights Reserved Dr David P Echevarria 10

All Rights Reserved Dr David P Echevarria 11 HOMEWORK QUESTIONS A.Why did finance companies come into being? B.How do finance companies raise lendable capital? C.What two markets are served by finance companies? D.Into what areas have finance companies expanded their activities from straight lending? E.In what way(s) does federal regulation impact finance companies? Who regulates finance companies? F.What is a captive finance subsidiary and how does it benefit its corporate parent?