Chapter 3

Financial Services: Finance

Companies

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 Overview
• This chapter discusses finance companies
– Services provided by finance companies
– Competitive/financial environment
– Size, structure, and composition
– Regulation
– Global issues

© McGraw-Hill Education. 3-2

 Historical Perspective
• First major finance company originated
during the Great Depression
– Installment credit
– General Electric Capital Corporation
– Competition from banks increased during
1950s
• Expansion of product lines
– GMAC

© McGraw-Hill Education. 3-3

 GMAC
• Controversial approval by the Fed of GMAC as
a bank holding company in December 2008
– Allowed access to $6 billion in government
bailout money
– Fed required GM to reduce its holdings in GMAC
to less than 10 percent, from 49 percent

© McGraw-Hill Education. 3-4

 Finance Companies
• 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
• Captive Finance Companies: e.g., Ford Motor
Credit Corp.
• Highly concentrated
– Largest 20 firms: 65 percent of assets

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Major Types of Finance Companies
• Sales finance institutions:
– Ford Motor Credit and Sears Roebuck
Acceptance Corp.
• Personal credit institutions:
– HSBC Finance and AIG American General
• Business credit institutions:
– CIT Group and U.S. Bancorp Equipment Finance
– Equipment leasing and factoring

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 Web Resources

• For information on finance companies, visit:

– GE www.ge.com
– Ally www.ally.com
– Ford Credit www.credit.ford.com
– HSBC www.us.hsbc.com
– Citigroup www.citigroup.com
• For information on home equity loans, visit:
– Consumer Bankers Association www.cbanet.org

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Largest Finance Companies (1 of 2)
Total Receivables Type of Finance
Company Name Ownership
($ millions) Company
Ally Financial $105,173 Sales finance NYSE-listed
independent
American Express 18,401 Personal credit NYSE-listed
independent that
also owns American
Express Bank
Bank of America 98,445 Personal credit Part of Bank of
(credit card America
business)
Capital One Financial 88,726 Personal credit NYSE-listed
independent that
also owns Capital
One Bank
CIT Group 20,448 Business credit NYSE-listed
independent
Citigroup (credit card 134,109 Personal credit Part of Citigroup
business)

© McGraw-Hill Education. 3-8

Largest Finance Companies (2 of 2)
Total Receivables Type of Finance
Company Name Ownership
($millions) Company
Discover Financial 68,335 Personal credit NYSE-listed
Services independent
Ford Motor Credit 85,699 Sales finance Captive of Ford
Company
General Electric 78,064 Sales finance and Captive of GE
Capital Corporation business credit
HSBC Finance Corp. 19,475 Personal credit Subsidiary of HSBC
Holdings
J.P Morgan Chase 126,979 Personal credit Part of J.P. Morgan
(credit card Chase
business)
Synchrony Financial 63,520 Personal credit NYSE-listed
independent

© McGraw-Hill Education. 3-9

 Balance Sheet and Trends
• Business and consumer loans are the major
assets
– 61.2% of total assets, 2015
– Reduced from 95.1% in 1977
• Increases in real estate loans and other assets
• Growth in leasing and business lending
• Finance companies face credit risk, interest
rate risk, and liquidity risk

© McGraw-Hill Education. 3-10

 Consumer Loans (1 of 2)
• Consumer loans
– Primarily motor vehicle loans and leases, other
consumer loans, and securitized loans
– Historically charged higher rates than for auto
loans than commercial banks
– Low auto finance company rates
 Following 9/11 attacks
 Attempts to boost new vehicle sales via 0.0%
loans lasting into 2005
 By 2002, finance company rates were more than
3% less than banks on new vehicles

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 Consumer Loans (2 of 2)
• Generally attract riskier customers than
commercial banks
– Subprime lender finance companies
– Jayhawk Acceptance Corp.
 From auto loans to tummy tucks and hair
transplants
• “Loan shark” firms with rates as high as 30%
or more

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 Payday Loans
• Payday loans
– 390 percent APR
– Regulated by states
– As of 2015, payday lending effectively banned
in 15 states
– Controlled in other states via usury limits
 Evaded bans by forming relationships with
nationally chartered banks, based in states that
do not have usury limits (e.g., South Dakota,
Delaware)

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 Mortgages
• Mortgages have become a major component
of finance company assets
– Both residential and commercial
• May be direct mortgages or securitized
mortgage assets

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 Home Equity Loans
• Growth in home equity loans following
passage of Tax Reform Act of 1986
– Tax deductibility issue
– Defaults in subprime and even relatively
strong credit mortgages in 2007-2008
 Root cause of the financial crisis of 2008-2009

© McGraw-Hill Education. 3-15

 Business Loans (1 of 2)
• Business loans comprise largest portion of
finance company loans (28.5%)
• 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

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 Business Loans (2 of 2)
• Major subcategories:
– Retail and wholesale motor vehicle loans and
leases
– Equipment loans
 Tax and other associated advantages when
finance company leases the equipment directly
to the customer as opposed to financing the
purchase
– Other business loans and securitized business
assets

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 Liabilities
• Major liabilities: Commercial paper and other
debt (longer-term notes and bonds)
• Finance firms are largest issuers of short-term
commercial paper (frequently through direct
sale programs)
• Management of liquidity risk differs from
commercial banks

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 Industry Performance (1 of 2)
• Strong loan demand and solid profits for the
largest firms in the early 2000s
– Effects of low interest rates
• Not surprisingly, the most successful became
takeover targets
– Citigroup/Associates First Capital
– AIG/American General
– HSBC Holdings/Household International

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 Industry Performance (2 of 2)
• Mid 2000s problems arose
– 2005, 2006: falling home prices and rising
interest rates
• Sharp pullback from subprime mortgage
lending
• End of 2009: National all time high for
mortgage delinquencies 6.89%
– Countrywide Financial and CIT Group failures

© McGraw-Hill Education. 3-20

 Regulation of Finance Companies
(1 of 2)
• Federal Reserve’s definition of finance
company
– A firm, other than a depository institution,
whose primary assets are loans to individuals
and businesses
• Subject to state-imposed usury ceilings
• Lower regulatory burden than DIs
– Not subject to Community Reinvestment Act of
1977

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 Regulation of Finance Companies
(2 of 2)
• Impact of nonbank FIs, including finance
companies, on the U.S. economy resulted in
greater scrutiny
• Fed rescue of several finance companies was
a factor
• 2010 Wall Street Reform and Consumer
Protection Act

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 Regulation Concluded
• With less regulatory scrutiny, finance
companies must signal safety and soundness
to capital markets in order to obtain funds
• Lower leverage than banks (12.8% capital-
assets versus 11.3% for commercial banks in
2015)
• Captive finance companies may employ
default protection guarantees from parent
company or other protection such as letters of
credit

© McGraw-Hill Education. 3-23

 Global Issues
• In foreign countries, finance companies are
generally subsidiaries of commercial banks or
industrial firms
• Importance of nonbank FIs has been
increasing over the past decade
– Latin America and Europe
– New Zealand: consolidation, collapse, and
restructuring of finance companies

© McGraw-Hill Education. 3-24

 Pertinent Websites
• American General - www.aigag.com
• Federal Reserve - www.federalreserve.gov
• Consumer Bankers Association -
www.cbanet.org
• Ford Motor Credit - www.credit.ford.com
• General Electric Capital Corp. -
www.gecapital.com
• Ally - www.ally.com
• HSBC Finance - www.us.hsbc.com

© McGraw-Hill Education. 3-25

 End of Presentation

© McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No
reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. 3-26