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CHAPTER 26
Finance
Companies

Copyright © 2012 Pearson Prentice Hall.

All rights reserved.
 Chapter Preview
 Suppose you need to buy a car, but don’t
have the $20,000 handy. Most dealers will
help arrange financing for you. And the
companies they often use are finance
companies. Along with consumer loans,
finance companies are involved in lease
finance and other business services.

© 2012 Pearson Prentice Hall. All rights reserved. 26-2

 Chapter Preview
 In this chapter, we examine how finance
companies evolved and what they do. Topics
include:
─ History of Finance Companies
─ Purpose of Finance Companies
─ Risk of Finance Companies
─ Types of Finance Companies
─ Regulation of Finance Companies
─ Finance Company Balance Sheet

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 History of Finance Companies
 Finance companies date back to the 1800s
when retailers started offering installment
credit, requiring equal payments to repay
loans. Prior to this, loans were typically
balloon loans.
 Mass marketing of autos really developed the
industry. Since banks didn’t offer car loans in
the early 1990s, finance companies
developed to fill the void.
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 History of Finance Companies
 By the beginning of 2010, banks held
$1,177 billion in consumer loans, while
finance companies held $684 billion.
Clearly banks didn’t stay out of consumer
financing for long.
 Finance companies moved into business
financing (lease financing, etc.).

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 Purpose of Finance Companies
 Most finance companies issue commercial paper
and use the proceeds to make loans.
 Unlike banks, finance companies are largely
unregulated. States may limit the size of a loan
contract to a consumer borrower, but that is
about it.
 Exist to service both consumers and businesses
with tailored products (usually not offered by
banks).

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 Risk in Finance Companies
 Default risk is the greatest risk, and
finance companies often lend to those who
can’t get financing otherwise.
 Liquidity risk can be an issue, as their
assets (loans) are not easily sold. A need
for cash can cause problems.

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 Risk in Finance Companies
 Roll over risk refers to the need to
continue to borrow in the commercial paper
market. If the market dries up, they may not
be able to maintain their loans.
 Interest rate risk is also present. Most of
their assets are medium-term loans, funded
by short-term commercial paper.

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 Types of Finance Companies
 Figure 26.1 on the next slide shows the
distribution of loans made by the three
types of finance companies: business,
sales, and consumer.

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 Finance Company Loans

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 Types of Finance Companies
 Business Finance Companies offer loans
secured by accounts receivable and other
business assets—something banks were
reluctant to do prior to the 1940s.
 They also factor accounts receivable—
giving companies, say, 90% of the book
value of A/R in return for the actual payments
when received—essentially a secured loan.

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 Types of Finance Companies
 They also specialize in leasing. They often
buy the asset and then lease it back to the
company (helps in repossession for late
payments). This may be a tax advantage if
the company needing the asset cannot
benefit from the depreciation expense.
 Floor plans help, for example, car dealers
pay for all the cars on their lot.

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 Types of Finance Companies
 Figure 26.2 on the next slide shows the
types of loans made by business finance
companies. The dollar value of business
loans outstanding then follows in Figure
26.3.

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 Business Finance
Company Loans

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 Business Finance
Company Loans

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 Consumer Finance Companies

Consumer finance companies offer loans

to help consumers buy furniture, home
improvements, and refinance small debts.
Typically, consumers can’t get credit
elsewhere—and may be high credit risks.
Two exceptions are home equity loans and
retail credit cards.

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 Sales Finance Companies

Another type of finance company is the sales

finance company. For example, if you want
to buy a GM car, GMAC will be happy to
assist with the financing. Also known as
captive finance companies, these
companies are owned by the manufacturer to
help with the sale of the manufacturer’s
products.

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 Regulation
 Since there are no depositors or government
insurance, regulation is limited.
 Regulation is typically designed to protect
consumers. For example, Regulation Z
requires the disclosure of the APR on loans.
 Usury laws limit the interest rate that can be
charged.

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 Regulation
 State and federal regulation do limit their
ability to collect on delinquent or defaulted
loans. However, there are few regulations in
the business loan market—government
assumes that business are sophisticated
enough to protect themselves.

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 Finance Company
Balance Sheet
 Table 26.1 on the next slide presents the
aggregate balance sheet for finance
companies as of 2007.

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 Finance Company
Balance Sheet

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 Finance Company
Balance Sheet
 Assets. Their primary asset is their loan
portfolio, although they do need to maintain
a contra-asset account reserve for loan
losses to charge off expected loan
defaults.

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 Finance Company
Balance Sheet
 Liabilities. Their primary source of funding
is either equity (about 12% of assets) or
loans. As mentioned already, finance
companies are active in the commercial
paper market. Captive finance companies
can also borrow directly from their parent
company.

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 Finance Company
Balance Sheet
 Income. Their income comes from several
sources:
─ Interest income from their loan portfolio
─ Loan origination fees
─ Credit insurance premiums
─ Some have also expanded into income tax
preparation services

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 Finance Company
Balance Sheet
 Figure 26.4 on the next slide shows the
growth in finance company assets from
1980 through 2009.

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 Finance Company Balance
Sheet: Growth in Assets

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 Chapter Summary
 History and Purpose: the history and
background of these companies was
presented—essentially, how they filled the
void left by banks.
 Risk: the essential risks faced by finance
companies was covered: roll over and
interest rate risk.

© 2012 Pearson Prentice Hall. All rights reserved. 26-27

 Chapter Summary
 Types: the basic classification of finance
companies was reviewed, primarily by the
type of customer served.
 Regulations: other than consumer
protections laws, we discussed why finance
companies aren’t heavily regulated.

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 Chapter Summary
 Balance Sheet: we reviewed the breakdown
of the assets and liabilities held by these
companies.

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