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Chapter 6 Finance Companies.docx

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FIN 701
Patricia Mc Graw

FIN701 Financial Institutions Management CHAPTER 6 Finance Companies  Function of finance companies is to provide consumer lending, business lending, and mortgage financing  Assets of finance companies subject to credit risk, but this risk is mitigated because their loans are backed by collateral  Differ from banks in that they are not permitted to accept deposits but instead rely on STD and LTD as source of funding, often raising these funds in international markets SIZE, STRUCTURE, AND COMPOSITION OF THE INDUSTRY  Finance companies offer lending services similar to banks but are unregulated private institutions o Mortgages (e.g. residential and commercial) o Loans (e.g. asset-based financing (ABF)/asset-based lending (ABL) – loan extended to borrower based on assets held as collateral – consumer loans, and structured finance – unique loan and/or equity financing tailored to meet specific needs of the borrower) o Leasing (e.g. automobile, aircraft) o Credit cards  Crown corporation – corporation owned by federal government or by provincial or territorial government  Mortgage broker – firm which, for a fee, shops around to other FIs to find most suitable mortgage at the best rate  These FIs are less transparent in their activities, but they are performing more traditional, asset-based lending and providing competition for large Canadian FIs  Instalment credit is a loan that is paid back to the lender with periodic payments (instalments) consisting of varying amounts of interest and principal  Three types of finance companies: i. Sales finance institutions – specialize in making loans to customers of particular retailer or manufacturer  Competes directly with DTIs for consumer loans because can frequently process loans faster and conveniently ii. Personal credit institutions – specialize in making instalment and other loans to customers  Makes loans to higher risk consumers by charging higher interest rates or accepting collateral iii. Business credit institutions – specialize in making business loans  Through equipment leasing or factoring, which finance companies purchasing AR from corporation, usually with no recourse to seller if receivables go bad  Captive finance company – finance company that is wholly owned by parent corporation o Parent company is often a source of debt for captive finance company; benefit to parent company is diversification in revenue stream BALANCE SHEET AND RECENT TRENDS Assets  Business and consumer loans are major assets held by finance companies, with increasing amounts of real estate loans and other assets  Creates credit risk, interest rate risk, and liquidity risk Consumer Loans  Consists of motor vehicle loans and leases, other consumer loans, and securitized loans from each category  Subprime lender – finance company that lends to high-risk customers even with bankruptcy on their records  Loan sharks – subprime lenders that charge unfairly exorbitant rates to desperate subprime borrowers o Industry has to fight against reputation for engaging in loansharking and charging customers a criminal rate in excess of 60%, which is a criminal offence  Payday loans – short-term, small-sum, unsecured consumer loans Mortgages  Issue mortgages to riskier borrowers than banks by charging higher interest rate fees because they are not subject ot extensive regulations  Canada Mortgage and Household Corporation (CMHC), a Crown corporation, provides mortgage insurance for high-ratio residential mortgages, a mortgage loan in which down payment is less than 20% o FIs (banks, credit unions, caisses populaires) approved by CMHC are able to provide mortgages to homebuyers that are insured by CMHC, reducing default risk for lender FIN701 Financial Institutions Management  Lien – legal charge on real estate property to secure loans  Securitized mo
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