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Finance Companies Chapter 5

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1 Finance Companies Chapter 5
Financial Institutions Management, 3/e By Anthony Saunders

2 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.

3 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

4 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

5 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).

6 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.

7 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.

8 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.

9 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

10 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.

11 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% capital-assets 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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