Overview of Finance Companies

Finance Companies

 About finance companies

 Finance companies originated during depression.

 Installment credit

 General Electric Capital Corporation.

 Competition from banks increased during 1950s.

• GMAC is largest commercial mortgage lender in U.S.

• Industry is highly concentrated: Largest 20 firms account for more than 65% of assets.

 Activities similar to banks, but 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 key source of funds.

 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.

 Balance Sheet and Trends

 Business and consumer loans are the major assets

 58% of total assets, 2012.

 Reduced from 95.1% in 1977.

 Consumer loans

• Primarily motor vehicle loans and leases.

• Recent low auto finance company rates are anomalous.

• Generally riskier customers than banks serve (including subprime mortgage lenders)

 Mortgages

• Recent addition to finance company assets

• Smaller regulatory burden than banks

• May be direct mortgages, or as securitized mortgage assets.

• Growth in home equity loans

• Defaults in subprime and relatively strong credit mortgages after 2007

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.

 Major liabilities: commercial paper and other debt (longer-term notes and bonds).

 Finance firms are largest issuers of commercial paper

• Commercial paper maturities up to 270 days.

 Industry Performance

 Strong loan demand

 Strong profits for the largest firms

 e.g. Household International, Associates First Capital, Beneficial

 Most successful have become takeover targets

 Citigroup/Associates First Capital,

 Tyco International/CIT Group

 High risk has a downside:

 Regulation of Finance Companies

 Federal Reserve definition of Finance Company

 Firm, other than depository institution, whose primary assets are loans to individuals and businesses.

 Much lower regulatory burden than depository institutions.

 Not subject to Community Reinvestment Act.

 With less regulatory scrutiny, finance companies must signal safety and soundness to capital markets in order to obtain funds.

 Lower leverage than banks (14% capital-assets versus 11% for commercial banks in 2012)