Tài chính doanh nghiệp - Chapter 22: Consumer finance operations

Chapter 22Consumer Finance OperationsFinancial Markets and Institutions, 7e, Jeff MaduraCopyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.1Chapter OutlineTypes of finance companiesSources of finance company fundsUses of finance company fundsRegulation of finance companiesRisks faced by finance companiesCaptive finance subsidiariesValuation of a finance companyInteraction with other financial institutionsParticipation in financial marketsMultinational finance companies2Types of Finance CompaniesConsumer finance companies focus on providing direct loans to consumersTheir main source of funds is long-term loansTheir main use of funds is providing relatively small loansSales finance companies concentrate on purchasing credit contracts from retailers and dealersTheir main source of funds is commercial paperTheir main use of funds is providing relatively large loansCommercial finance companies have been created to provide loans to firms that cannot obtain financing from commercial banksIt is difficult to classify most finance companies as a particular type today3Sources of Finance Company FundsLoans from banksFinance companies commonly borrow from commercial banks and can consistently renew the loans over timeSome finance companies use bank loans mainly to accommodate seasonal swings in their businessCommercial paperOnly the most well-known finance companies have been able to issue commercial paperAs secured commercial paper has become more popular, most finance companies have access to this marketMost finance companies issue commercial paper using commercial paper dealersThe best-known finance companies can issue commercial paper through direct placement4Sources of Finance Company Funds (cont’d)DepositsSome states allow finance companies to offer customer deposits similar to those of depository institutionsBondsThe decision to issue bonds versus some alternative short-term financing depends on the company’s balance sheet and expectations about future interest ratesWhen assets are less rate sensitive than liabilities and interest rates are expected to increase, bonds provide financing that is insulated from rising market ratesCapitalFinance companies can build capital by retaining earnings or by issuing stockFinance companies maintain a low level of capital5Uses of Finance Company FundsConsumer loansOne of the most popular consumer loans is the automobile loans offered by a finance company that is owned by a car manufacturere.g., General Motors Acceptance CorporationFinance companies offer personal loans for home improvement, mobile homes, and a variety of other personal expensesConsumer loans are often secured by a co-signer or by real propertyMaturities on personal loans are typically less than five yearsSome finance companies offer credit card loans through a particular retailerThe main competition in the consumer loan market is from commercial banks and credit unions6Uses of Finance Company Funds (cont’d)Business loans and leasingCommercial loans:Are obtained by companies to finance the cash cycleAre short term but may be renewedAre often backed by inventory or accounts receivableAre sometimes used to finance LBOsFinance companies commonly act as factors for accounts receivableThey purchase a firm’s receivables at a discount and are responsible for processing and collecting the balancesFactoring reduces a business’s processing costs and provides short-term financing7Uses of Finance Company Funds (cont’d)Business loans and leasing (cont’d)LeasingFinance companies can purchase machinery or equipment and then lease it to businessesReal estate loansFinance companies offer real estate loans in the form of mortgages on commercial real estate and second mortgages on residential real estate8Regulation of Finance CompaniesWhen finance companies are acting as bank holding companies or are subsidiaries of bank holding companies, they are federally regulatedOtherwise, they are regulated by the stateFinance companies are subject to a loan ceiling, setting a maximum limit on the size of the loans they can makeFinance companies are subject to ceiling interest rates on loans provided and to a maximum length on the loan maturityFinance companies are subject to state regulations on intrastate business9Risks Faced by Finance CompaniesLiquidity riskFinance companies generally do not hold assets that could be easily sold in the secondary marketTheir balance sheet structure does not call for much liquidity since all of their funds are from borrowingsOverall, the liquidity risk of finance companies is less than that of other financial institutionsInterest rate riskBoth liability and asset maturities of finance companies are short or intermediate termThey are not susceptible to increasing interest rates as are savings institutionsThey can still be adversely affects because their assets are typically not as rate sensitive as their liabilities10Risks Faced by Finance Companies (cont’d)Credit riskCredit risk is a major concern since the majority of funds are allocated as loans to consumers and businessesCustomers who borrow from finance companies usually exhibit a moderate degree of riskThe loan delinquency rate of finance companies is typically higher than that of other financial institutionsThe performance of finance companies can be quite sensitive to prevailing economic conditions because their loans entail both relative high returns and high riskImpact of the September 11 CrisisSeptember 11 caused businesses to cut their expansion plans and reduce their need for loans11Captive Finance SubsidiariesA captive finance subsidiary (CFS) is a wholly owned subsidiary whose primary purpose is to:Finance sales of the parent company’s products and servicesProvide wholesale financing to distributors of the parents company’s productsPurchase receivables of the parent companyAn operating agreement between the captive and the parent company contains specific stipulationsThe numbers of CFSs grew rapidly between 1946 and 1960 as a result of liberalized credit policies and a need to finance growing inventories12Captive Finance Subsidiaries (cont’d)A CFS:Can be used to finance distributor or dealer inventories until a sale occursCan serve as an effective marketing tool by providing retail financingAdvantages of captive finance subsidiariesA CFS allows a corporation to clearly separate its manufacturing and retailing activities from its financing activitiesA CFS has no reserve requirements and no legal prohibitions on how it obtains funds or uses fundsSale items such as cars may depend on the financing arrangements availableCFSs have diversified their financing activities to include more than just the parent company’s products13Valuation of a Finance CompanyThe value of a finance company is the present value of its future cash flowsThe value should change if expected cash flows or the required rate of return change:Factors that affect cash flows:14Valuation of a Finance Company (cont’d)Factors that affect cash flows (cont’d)Economic growthEconomic growth increases cash flows via increased household demand for consumer loansFinance companies are very sensitive to economic conditions because they offer relatively risky loansChange in the risk-free interest rateA finance company’s cash flows are inversely related to interest rate movementsStronger demand for loans with fixed ratesFinance companies rely on short-term funds15Valuation of a Finance Company (cont’d)Factors that affect cash flows (cont’d)Change in industry conditionsSome finance companies may be valued higher if state regulators give them the opportunity to generate economies of scale by expanding throughout the stateExpansions create more competition, which causes some finance companies to gain at the expense of othersChange in management abilitiesManagers attempt to make internal decisions that will capitalize on the external forces that the institution cannot controlFinance companies need skilled managers to analyze the creditworthiness of borrowers and assess how future economic conditions may affect their ability to repay their loans16Valuation of a Finance Company (cont’d)Factors that affect the required rate of return by investors:The risk-free rate is positively related to inflation, economic growth, and the budget deficit, but inversely related to money supply growthThe risk premium is inversely related to economic growth and to the company’s management skills17Interaction with Other Financial InstitutionsType of Financial InstitutionInteraction with Finance CompaniesCommercial banks and SIsFinance companies compete with banks and SIs for consumer loan business (including credit cards), commercial loans, and leasingFinance companies obtain loans from commercial banksFinance companies have acquired some commercial banksSome finance companies are subsidiaries of commercial banksCredit unionsFinance companies compete with credit unions for consumer loansInvestment banking firmsFinance companies issue bonds that are underwritten by investment banking firmsPension fundsInsurance subsidiaries of finance companies manage pension plans of corporations and therefore compete with pension fundsInsurance companiesInsurance subsidiaries of finance companies compete directly with other insurance companies18Participation in Financial MarketsType of Financial MarketParticipation by Finance CompaniesMoney marketsFinance companies obtain funds by issuing commercial paperBond marketsFinance companies issue bonds to obtain long-term fundsSubsidiaries of finance companies purchase corporate and Treasury bondsMortgage marketsFinance companies purchase real estate and provide loans to real estate investorsSubsidiaries of finance companies purchase mortgagesStock marketsFinance companies issue stockSubsidiaries of finance companies purchase stocksFutures marketsSubsidiaries of finance companies use futures contracts to reduce the sensitivity of their bond portfolio to interest rate movements and may trade stock index futures to reduce the sensitivity of their stock portfolio to stock market movementsOptions marketsSubsidiaries of finance companies sometimes use options contracts to protect against declines in particular stock holdingsSwap marketsFinance companies engage in interest rate swaps to hedge interest rate risk19Multinational Finance CompaniesSome finance companies are large multinational corporations with subsidiaries in several countriese.g., the consumer finance division of Household International has more than 1,000 offices in the U.S., Canada, Germany, and the U.K.Finance companies enter foreign countries to enter new markets and to reduce their exposure to U.S. economic conditions20