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CHAPTER 22 Consumer Finance Operations Types of Finance Companies 1. Consumer finance companies Personal loans (credit cards, cars, furniture, mobile homes, even home loans . . .) 2. Commercial or business finance companies Leasing, lines of credit, receivable and inventory financing, etc. http://www.cit.com/index.htm 3. Captive sales finance companies Help finance goods sold by parent company http://credit.ford.com/ NOTE: Large finance companies may consist of all three types http://www.gecapital.com/ Copyright© 2002 Thomson Publishing. All rights reserved. Typical Finance Company Balance Sheet ASSETS (uses) Cash & Equivalents and S/T Investments 10% Consumer and/or Business Loans 88% Allowance for Loan Losses -6% Other Assets (e.g. Bldgs & Equip.) 8% LIABILITIES & CAPITAL (sources) Bank Loans 5% Commercial Paper 25% Bonds & other 60% Capital 10% Copyright© 2002 Thomson Publishing. All rights reserved. Sources of Finance Company Funds Bank loans Commercial paper Some states allow finance companies to accept customer deposits Bonds are used as a long-term source of funds Capital comes from retained earnings or issuing stock and serves as a base for leveraging Copyright© 2002 Thomson Publishing. All rights reserved. Typical Finance Company Balance Sheet ASSETS (uses) Cash & Equivalents and S/T Investments 10% Consumer and/or Business Loans 88% Allowance for Loan Losses -6% Other Assets (e.g. Bldgs & Equip.) 8% LIABILITIES & CAPITAL (sources) Bank Loans 5% Commercial Paper 25% Bonds & other 60% Capital 10% Copyright© 2002 Thomson Publishing. All rights reserved. Uses of Finance Company Funds Consumer or personal loans Payday loans, check cashing loans About a quarter of American households have little or no access to banks (e.g. inner-city, where banks refuse to go). Some 22k payday loan stores in U.S. (more than McDonald stores) serve the banking needs of these people 12 million borrowers turn to payday lenders each year, 86% of which cannot afford to repay the average payday loan. 15 states have banned the predatory, high-interest loans that payday lenders offer to low-income borrowers, but offshore lenders are increasingly getting around state laws by issuing predatory loans over the Internet. Horrendous interest rates: suppose you can’t wait for your $500 paycheck a week away, so you borrow $470 now for one week ($500 less $30 fee). In a week, your paycheck goes to payday store. Annual interest rate: 30/500 * 52 = 312%! Furniture, appliance, and other personal loans Copyright© 2002 Thomson Publishing. All rights reserved. Uses of Finance Company Funds Consumer or personal loans Auto loans/leases GM, Ford, and Chrysler all have their own finance companies Many independent auto dealerships work with independent finance companies Finance companies create credit cards used at a variety of retail stores (company logo cards such as Macy’s Card, etc.) Home improvement (second mortgage), mobile home, even home mortgages in some cases Sponsor a credit card for a retailer (Macy’s, etc.) E.g. http://www.moneytreeinc.com Copyright© 2002 Thomson Publishing. All rights reserved. Uses of Finance Company Funds Consumer loans can either be direct from finance company to borrower Or sales financed, in which a retailer sells a credit contract to a finance company Customers make payments to the finance company Support “Ninety-days Same As Cash” loans Allows the retailer to sell on credit Gives the finance company access to new customers Copyright© 2002 Thomson Publishing. All rights reserved. Uses of Finance Company Funds Business Loans Wholesale financing (floor-plan financing) Retail financing Dealers borrow to pay for inventory (e.g. appliances) and the payback when sale occurs Finance sales to customers who pay on installment basis (e.g. farm equipment) Leasing (largest growth in fund use) Finances the purchases property/equipment (airplanes, farm equipment, computers, etc.) Has tax and other advantages Copyright© 2002 Thomson Publishing. All rights reserved. Uses of Finance Company Funds Business Loans (cont.) Lines of credit Factoring (sale) of accounts receivable Assignment of account receivable (collateralized loan) Commercial real estate loans (apartments, strip malls, office buildings, warehouses, factories, etc.) Copyright© 2002 Thomson Publishing. All rights reserved. Regulation of Finance Companies Finance companies are state regulated However, the Dodd-Frank Act of 2010 established a Bureau of Consumer Financial Protection which may end up regulating finance companies at the federal level, but nothing has really been done yet. Consumer loans are much more regulated than business loans (assumes businesses should be smart on their own) Subject to interest rate ceilings (usury law) and a maximum term and amount for the loan in some states Example of payday loan restrictions in WA: Max. loan term: 45 days Max loan amount: $700 Max fee: 15% on first $500 and 10% on rest Must be licensed by DFI http://paydayloanlegislation.com/washington.html Copyright© 2002 Thomson Publishing. All rights reserved. Regulation of Finance Companies Interstate lending restrictions apply to all finance companies; however, finance companies can offer services nationwide if done thru a a bank holding company Up to this point, Federal regulations only apply if finance companies are acting as bank holding companies or are subsidiaries of bank holding companies (Wells Fargo Financial) http://financial.wellsfargo.com/ However, Dodd-Frank Wall Street Reform and Consumer Protect Act of 2010 created the Consumer Financial Protection Bureau (CFPB) and provided the new agency with the authority to regulate payday loans generally. Copyright© 2002 Thomson Publishing. All rights reserved. Risks Faced by Finance Companies Liquidity risk Finance companies do not hold assets that can be easily sold in the secondary market But their balance sheet structure does not call for much liquidity because of little deposit outflow Maintaining access to money and capital markets is the primary liquidity management focus Copyright© 2002 Thomson Publishing. All rights reserved. Risks Faced by Finance Companies Interest-rate risk is less for finance companies than for depository institutions because the maturity of assets and liabilities may be matched closely Can use adjustable rates, shorter maturities on their loans, and derivative contracts to manage interest-rate risk Exchange-rate risk is usually not applicable, since finance companies do business locally or nationally, rarely internationally (notable exceptions: GE Capital, Caterpillar Financial Service, etc. http://finance.cat.com/cda/components/fullArticleNoNav?id=316005 Copyright© 2002 Thomson Publishing. All rights reserved. Risks Faced by Finance Companies Credit (default) risk Default risk can be significant at finance companies Loan delinquency rates are typically higher than for other kinds of institutions Charge a higher interest rate to compensate for the risk (usury laws can be circumvented) High return, high risk nature of loans makes performance sensitive to prevailing economic conditions Copyright© 2002 Thomson Publishing. All rights reserved.