1 Chapter 22 Consumer Finance Operations Financial Markets and Institutions, 7e, Jeff Madura Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved. 2 Chapter Outline  Types of finance companies  Sources of finance company funds  Uses of finance company funds  Regulation of finance companies  Risks faced by finance companies  Captive finance subsidiaries  Valuation of a finance company  Interaction with other financial institutions  Participation in financial markets  Multinational finance companies 3 Types of Finance Companies  Consumer finance companies focus on providing direct loans to consumers  Their main source of funds is long-term loans  Their main use of funds is providing relatively small loans  Sales finance companies concentrate on purchasing credit contracts from retailers and dealers  Their main source of funds is commercial paper  Their main use of funds is providing relatively large loans  Commercial finance companies have been created to provide loans to firms that cannot obtain financing from commercial banks  It is difficult to classify most finance companies as a particular type today 4 Sources of Finance Company Funds  Loans from banks  Finance companies commonly borrow from commercial banks and can consistently renew the loans over time  Some finance companies use bank loans mainly to accommodate seasonal swings in their business  Commercial paper  Only the most well-known finance companies have been able to issue commercial paper  As secured commercial paper has become more popular, most finance companies have access to this market  Most finance companies issue commercial paper using commercial paper dealers  The best-known finance companies can issue commercial paper through direct placement 5 Sources of Finance Company Funds (cont’d)  Deposits  Some states allow finance companies to offer customer deposits similar to those of depository institutions  Bonds  The decision to issue bonds versus some alternative short-term financing depends on the company’s balance sheet and expectations about future interest rates  When assets are less rate sensitive than liabilities and interest rates are expected to increase, bonds provide financing that is insulated from rising market rates  Capital  Finance companies can build capital by retaining earnings or by issuing stock  Finance companies maintain a low level of capital 6 Uses of Finance Company Funds  Consumer loans  One of the most popular consumer loans is the automobile loans offered by a finance company that is owned by a car manufacturer  e.g., General Motors Acceptance Corporation  Finance companies offer personal loans for home improvement, mobile homes, and a variety of other personal expenses  Consumer loans are often secured by a co-signer or by real property  Maturities on personal loans are typically less than five years  Some finance companies offer credit card loans through a particular retailer  The main competition in the consumer loan market is from commercial banks and credit unions 7 Uses of Finance Company Funds (cont’d)  Business loans and leasing  Commercial loans:  Are obtained by companies to finance the cash cycle  Are short term but may be renewed  Are often backed by inventory or accounts receivable  Are sometimes used to finance LBOs  Finance companies commonly act as factors for accounts receivable  They purchase a firm’s receivables at a discount and are responsible for processing and collecting the balances  Factoring reduces a business’s processing costs and provides short-term financing 8 Uses of Finance Company Funds (cont’d)  Business loans and leasing (cont’d)  Leasing  Finance companies can purchase machinery or equipment and then lease it to businesses  Real estate loans  Finance companies offer real estate loans in the form of mortgages on commercial real estate and second mortgages on residential real estate 9 Regulation of Finance Companies  When finance companies are acting as bank holding companies or are subsidiaries of bank holding companies, they are federally regulated  Otherwise, they are regulated by the state  Finance companies are subject to a loan ceiling, setting a maximum limit on the size of the loans they can make  Finance companies are subject to ceiling interest rates on loans provided and to a maximum length on the loan maturity  Finance companies are subject to state regulations on intrastate business 10 Risks Faced by Finance Companies  Liquidity risk  Finance companies generally do not hold assets that could be easily sold in the secondary market  Their balance sheet structure does not call for much liquidity since all of their funds are from borrowings  Overall, the liquidity risk of finance companies is less than that of other financial institutions  Interest rate risk  Both liability and asset maturities of finance companies are short or intermediate term  They are not susceptible to increasing interest rates as are savings institutions  They can still be adversely affects because their assets are typically not as rate sensitive as their liabilities . 1 Chapter 22 Consumer Finance Operations Financial Markets and Institutions, 7e, Jeff. ©2006 by South-Western, a division of Thomson Learning. All rights reserved. 2 Chapter Outline  Types of finance companies  Sources of finance company funds