Chapter-22 - Finance Company Operations

CHAPTER 22
Finance Company
Operations
Chapter Objectives
 Identify the main sources and uses of finance

company funds
 Describe the risk exposure of finance
companies
 Explain how finance companies interact with
other financial institutions
Types of Finance Companies
Consumer
Finance
Companies
Business Captive
 Consumer finance companies provide

financing for customers of retail stores or
wholesalers.
 Business finance companies offer loans to
small businesses
 Captive finance companies, subsidiaries of
manufacturers, lend to support sales of their
parent company and other areas
 A captive finance subsidiary (CFS) is a wholly

owned subsidiary whose primary purpose is to
finance sales of the parent company’s
products and services, provide wholesale
financing to distributors of the parent
company’s products, and purchase receivables
of the parent company.
Captive Finance Subsidiaries
 Captive finance subsidiaries (CFS) have

several characteristics
 They are a wholly owned subsidiary with the
primary purpose to finance sales of the parent
company’s products and services
 Provide financing to distributors of the parent
company’s products
 Purchase receivables of the parent company
 May diversify into other lending/leasing
operations
Sources of Finance Company Funds
Bank
Loans
Commercial
Paper
Deposits and Capital

Market Financing
Capital
 Finance companies use bank loans as a source

of funds and consistently renew the loans over
time
 Commercial paper
 A short-term money market source but finance
companies roll over their issues to create a
permanent source of funds
 Secured commercial paper allows smaller and
medium-sized firms access to the market.
 Some states allow finance companies to

accept customer deposits
 Bonds are used as a long-term source of funds
and the use of this source depends on
 Expectations about future interest rates
 Capital comes from retained earnings or

issuing stock.
Uses of Finance Company Funds
 Consumer loans: Finance companies make
many kinds of consumer loans in the form of
personal loans
 Auto loans/leases offered by a finance company
owned by the manufacturer: direct or sales financed
 Home improvement (second mortgage), and other
kinds of personal loans.
 Credit cards which can be used at a variety of retail
stores
 The maturities on personal loans are typically less
than five years.
 Business loans and leasing are used to finance

the cash cycle of companies
 Cash cycle is the amount of time it takes between
when inventory is purchased, the product is sold
and customers pay
 This financing is often backed by accounts
receivable or inventory
 Leasing
 Finance company purchases equipment
 Leases it to businesses
 Real estate loans

 Mortgages on commercial real estate
 Second mortgages on residential real estate
Finance companies offer real estate loans in the

form of mortgages on commercial real estate and
second mortgages on residential real estate.
Risks Faced by Finance Companies
 Liquidity risk
 Finance companies do not hold assets that can be
easily sold in the secondary market
 Balance sheet structure does not call for much
liquidity.
 Virtually all of their funds are from borrowings
rather than deposits.
 Interest rate risk

 Both liability and asset maturities of finance
companies are short or intermediate term.
 Therefore, they are not as susceptible to
increasing interest rates as are savings
institutions. Finance companies can still be
adversely affected, however, because their
assets are typically not as rate sensitive as
liabilities.
 Credit risk
 The major risk faced by finance companies
 Loan delinquency rates are typically higher than
that of other lending financial institutions
 Charge a higher interest rate to compensate for the
risk
 High return, high risk nature of loans makes
performance sensitive to prevailing economic
conditions.
Interaction with Other Financial
Institutions
 Interact in various ways with other financial
institutions
 Concentration in commercial lending means they
are closely related to commercial banks, savings
institutions and credit unions
 Compete with savings institutions and increase
market share when their competitors have
problems
Exhibit 22.2 - Interaction between Finance
Companies and Other Financial Institutions.
Participation in Financial Markets
 Participate in a wide range of financial markets
 Money markets
 Bond markets
 Mortgage markets
 Stock markets
 Futures markets
 Options markets
 Swap markets
Exhibit 22.3 - Participation of Finance Companies in Financial

Market

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CHAPTER 22

 Identify the main sources and uses of finance

 Consumer finance companies provide

 A captive finance subsidiary (CFS) is a wholly

 Captive finance subsidiaries (CFS) have

Deposits and Capital

 Finance companies use bank loans as a source

 Some states allow finance companies to

 Capital comes from retained earnings or

 Business loans and leasing are used to finance

 Real estate loans

Finance companies offer real estate loans in the

 Interest rate risk

Exhibit 22.3 - Participation of Finance Companies in Financial

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