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