1. McGraw-Hill /Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 17-1 Chapter Seventeen Finance Companies

2. McGraw-Hill /Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 17-2 Finance Company Functions Originated during the Depression when General Electric Corp. created GE Capital Corp. to finance appliance sales to cash-strapped customers In the late 1950’s, banks became more willing to make installment loans so finance companies branched out into leasing and leveraged buyouts Willing to lend to riskier borrowers Often are directly affiliated with manufacturing Limited regulation Originated during the Depression when General Electric Corp. created GE Capital Corp. to finance appliance sales to cash-strapped customers In the late 1950’s, banks became more willing to make installment loans so finance companies branched out into leasing and leveraged buyouts Willing to lend to riskier borrowers Often are directly affiliated with manufacturing Limited regulation

3. McGraw-Hill /Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 17-3 Three Major Types of Finance Companies Sales finance institutions –finance companies specializing in loans to customers of a particular retailer or manufacturer (e.g., Ford Motor Credit and Sears Roebuck Acceptance Corp.) Person credit institutions –finance companies specializing in installment and other loans to consumers (e.g., Household Finance Corp. and American General Finance) Business credit institutions –finance companies specializing in business loans, leasing, and factoring (e.g., CIT Group and Heller Financial) Sales finance institutions –finance companies specializing in loans to customers of a particular retailer or manufacturer (e.g., Ford Motor Credit and Sears Roebuck Acceptance Corp.) Person credit institutions –finance companies specializing in installment and other loans to consumers (e.g., Household Finance Corp. and American General Finance) Business credit institutions –finance companies specializing in business loans, leasing, and factoring (e.g., CIT Group and Heller Financial)

4. McGraw-Hill /Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 17-4 Balance Sheet Assets –Business and consumer loans (called accounts receivable) are the major assets Liabilities and equity –FCs cannot accept deposits, so they rely heavily on issuing short-term commercial paper to finance assets Assets –Business and consumer loans (called accounts receivable) are the major assets Liabilities and equity –FCs cannot accept deposits, so they rely heavily on issuing short-term commercial paper to finance assets

5. McGraw-Hill /Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 17-5 Assets of U.S. Finance Companies (December 31, 2001) ($Bn) Accounts receivable gross …………… $970.9 69.9% Consumer …………………………. 340.2 24.5 Business …………………………… 447.0 32.2 Real estate …………………………. 183.7 13.2 Less reserves for unearned income …… (60.7) (4.4) Less reserves for losses ………………. (20.2) (1.5) Accounts receivable net ………………. 890.1 64.0 All other ………………………………. 500.1 36.0 Total Assets $1,390.1 100.0 Accounts receivable gross …………… $970.9 69.9% Consumer …………………………. 340.2 24.5 Business …………………………… 447.0 32.2 Real estate …………………………. 183.7 13.2 Less reserves for unearned income …… (60.7) (4.4) Less reserves for losses ………………. (20.2) (1.5) Accounts receivable net ………………. 890.1 64.0 All other ………………………………. 500.1 36.0 Total Assets $1,390.1 100.0

6. McGraw-Hill /Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 17-6 Liabilities of U.S. Finance Companies (December 31, 2001) ($Bn) Bank loans …………………………… $ 49.4 3.5% Commercial paper ……………………. 157.3 11.3 Debt due to parent ……………………. 99.5 7.2 Debt not elsewhere classified ………… 564.1 40.6 All other liabilities ……………………. 330.8 23.8 Capital, surplus, undivided profits ……. 189.1 13.6 Total Liabilities $1,390.1 100.0 Bank loans …………………………… $ 49.4 3.5% Commercial paper ……………………. 157.3 11.3 Debt due to parent ……………………. 99.5 7.2 Debt not elsewhere classified ………… 564.1 40.6 All other liabilities ……………………. 330.8 23.8 Capital, surplus, undivided profits ……. 189.1 13.6 Total Liabilities $1,390.1 100.0

7. McGraw-Hill /Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 17-7 Consumer Loans Motor vehicle loans and leases are the major type of consumer loan (80.4% in 2001) Subprime lender - a finance company that lends to high- risk customers Loan sharks - subprime lenders that charge unfairly exorbitant rates to desperate, subprime borrowers Other consumer loans (19.6% in 2001) –personal cash loans –mobile home loans –loans for consumer goods Motor vehicle loans and leases are the major type of consumer loan (80.4% in 2001) Subprime lender - a finance company that lends to high- risk customers Loan sharks - subprime lenders that charge unfairly exorbitant rates to desperate, subprime borrowers Other consumer loans (19.6% in 2001) –personal cash loans –mobile home loans –loans for consumer goods

8. McGraw-Hill /Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 17-8 Mortgages Residential and commercial mortgages have become a major component of finance companies’ assets Often issued to riskier borrowers and charge a higher interest rate for that risk Securitized mortgage assets: mortgages packaged and used as assets backing secondary market securities Bad debt expense and administrative costs of home equity loans are lower and have become a very attractive product for finance companies Residential and commercial mortgages have become a major component of finance companies’ assets Often issued to riskier borrowers and charge a higher interest rate for that risk Securitized mortgage assets: mortgages packaged and used as assets backing secondary market securities Bad debt expense and administrative costs of home equity loans are lower and have become a very attractive product for finance companies

9. McGraw-Hill /Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 17-9 Business Loans Represent the largest portion of the loan portfolio Several advantages over commercial banks offered to small-business customers –they are not subject to regulations that restrict the type of products and services –do not accept deposits so no bank regulators –have substantial industry and product expertise –more willing to accept risky customers –generally have lower overheads Business lending also includes equipment loans or leasing, purchase accounts receivable, small farm loans, wholesale loans/leases of mobile homes Represent the largest portion of the loan portfolio Several advantages over commercial banks offered to small-business customers –they are not subject to regulations that restrict the type of products and services –do not accept deposits so no bank regulators –have substantial industry and product expertise –more willing to accept risky customers –generally have lower overheads Business lending also includes equipment loans or leasing, purchase accounts receivable, small farm loans, wholesale loans/leases of mobile homes

10. McGraw-Hill /Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 17-10 Regulation Federal Reserve defines finance company as a firm whose primary assets are loans to individuals and businesses Are financial intermediaries that borrow funds to profit on the difference between the rates paid on borrowed funds and charged on loans May be subject to state-imposed usury ceilings on the maximum loan rates assigned to individuals Being heavy borrowers in capital markets, they need to signal their safety and solvency to investors Federal Reserve defines finance company as a firm whose primary assets are loans to individuals and businesses Are financial intermediaries that borrow funds to profit on the difference between the rates paid on borrowed funds and charged on loans May be subject to state-imposed usury ceilings on the maximum loan rates assigned to individuals Being heavy borrowers in capital markets, they need to signal their safety and solvency to investors