Finance Companies Finance Companies About finance companies Finance companies originated during depression. Installment credit General Electric

Transcription

1 Finance Companies Finance Companies About finance companies Finance companies originated during depression. Installment credit General Electric Capital Corporation. Competition from banks increased during 1950s. GMAC (currently Ally Financial) was largest commercial mortgage lender in U.S. Industry is highly concentrated: Largest 20 firms account for more than 65% of assets. 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. Major types of finance companies Sales finance institutions: Ford Motor Credit and Sears Roebuck Acceptance Corp. Personal credit institutions: Household Finance Corp. and American General Finance Business credit institutions: CIT Group and Heller Financial. Equipment leasing and factoring. Balance Sheet and Trends Business and consumer loans are the major assets 70% of total assets, Reduced from 95.1% in Consumer loans Primarily motor vehicle loans and leases. Recent low auto finance company rates are anomalous. Generally riskier customers than banks serve (including subprime mortgage lenders) Mortgages Recent addition to finance company assets Smaller regulatory burden than banks May be direct mortgages, or as securitized mortgage assets. Growth in home equity loans Defaults in subprime and relatively strong credit mortgages after 2007 Business Loans Business loans comprise largest portion of finance company loans. Advantages over commercial banks:» Fewer regulatory impediments to types of products and services.» Not depository institutions hence less regulatory scrutiny and lower overheads. 1

2 » Often have substantial expertise and greater willingness to accept riskier clients. Major liabilities: commercial paper and other debt (longer-term notes and bonds). Finance firms are largest issuers of commercial paper Commercial paper maturities up to 270 days. Industry Performance Strong loan demand Strong profits for the largest firms e.g. Household International, Associates First Capital, Beneficial Most successful have become takeover targets Citigroup/Associates First Capital, Tyco International/CIT Group High risk has a downside: Regulation of Finance Companies Federal Reserve definition of Finance Company Firm, other than depository institution, whose primary assets are loans to individuals and businesses. Much lower regulatory burden than depository institutions. Not subject to Community Reinvestment Act. With less regulatory scrutiny, finance companies must signal safety and soundness to capital markets in order to obtain funds. Lower leverage than banks (13% capital-assets versus 11% for commercial banks in 2015) 2

3 Securities Firms and Investment Banks Securities Firms and Investment Banks Nature of business: Underwrite securities. Market making. Advising (example: M&A, restructurings). Growth in mergers and acquisitions: Less than $200 billion in $1.83 trillion in 2000 (reflecting more then 10,000 deals) Decline after (458 billion in 2002, 1.3 trillion in 2006 and 1.5 trillion in 2015) Size, Structure and Composition Dramatic increase in number of firms from 1980 to Decline of 24% following the 1987 crash, to 2000s. Many recent inter-industry mergers (i.e., insurance companies and investment banks). Role of Financial Services Modernization Act, 1999 Types and relative sizes of firms National full-line firms are largest. National full-line firms specializing in corporate finance are second in size. Remainder of industry: Specialized investment subsidiaries of BHCs. Discount brokers. Regional securities firms (subdivided into large, medium and small). Specialized electronic trading securities firms Key Activities Investing Investment banking Activities related to underwriting and distributing new issues of debt and equity. Market making Trading Position trading, pure arbitrage, risk arbitrage, program trading Cash management Assisting with mergers and acquisitions Back-office and service functions. Balance Sheet Key assets: Long positions in securities and commodities. Reverse repurchase agreements. Key liabilities: Repurchase agreements major source of funds. Securities and commodities sold short. Broker call loans from banks 3

4 Capital levels much lower than levels in banks Regulation Primary regulator: SEC Reiterated by National Securities Markets Improvement Act (NSMIA) of Prior to NSMIA, regulated by SEC and states. Regulate trading activities such as shelf registration Day-to-day trading practices regulated by the NYSE and NASD. Investor protection & other monitoring Securities Investors Protection Corporation (SIPC). Protection level of $500,000 Federal Reserve also has role in overseeing securities firms and investment banks 4

5 Mutual Funds Mutual Funds Size, structure and composition First mutual fund: Boston, Total assets in stock and bond mutual funds: 1940: $0.4 billion. 1990: $568.5 billion End of 2015: More than 8,000 stock and bonds mutual companies. Total assets of $16 trillion. By asset size, mutual fund industry second most important FI group. Recent inroads by commercial banks and insurance companies Types of Mutual Funds Long-term funds (77% of assets, 2015) Bond and income funds. Equity funds. Hybrid Short-term funds (23% of assets, 2015) Generally higher returns than bank deposits but uninsured Returns to Mutual Funds Income and dividends of underlying portfolio. Capital gains on trades by mutual fund management. Capital appreciation in values of assets held in the portfolio. Marked-to-market. Net-asset value (NAV). Types of Funds Open-ended funds: Closed-end investment companies: Fixed number of shares May trade at premium or discount Load versus no-load funds. Mutual Fund Costs Two types of fees: Sales loads Generally, negative effect on performance outweighs benefits Fund operating expenses Management fee 12b-1 fees Front end and back end fees (Sweeping decreases in fees, 2005 and 2006) Balance Sheet and Trends Money Market Funds Key assets are short-term securities (consistent with deposit-like nature) Long-term Funds Stocks comprise over 70 % of asset portfolios in

6 Shift to U.S. Treasuries, municipal bonds etc. when equity markets not performing as well. Regulation One of the most closely regulated among non-depository FIs. Primary regulator: SEC Emphasis on full disclosure and anti-fraud measures to protect small investors. NASD supervises mutual fund share distributions. Securities Act 1933, 1934 Investment Advisers Act,

7 Insurance Companies Size, Structure and Composition of the Industry Insurance Industry s Structure Life Insurance Property/Casualty Insurance Other Types of Nonlife Insurance Firms and Products Financial guarantee insurance Credit insurance (for short-term trade receivables) Private mortgage guaranty insurance (PMI) Reinsurance Catastrophe bonds Weather-related derivatives and insurance Life Insurance Companies In 1988: 2,300 life insurance companies with aggregate assets of $1.12 trillion. 2015: 830 companies / $6.5 trillion; 4 largest wrote 33% of new premium business. Demutualization Adverse selection Insured have higher risk than general population Alleviated by grouping of policyholders into risk pools Life Insurance Products: Ordinary life Term life, Whole life, Endowment life. Variable life, Universal life, Variable universal life. Group life Others Annuities Private pension funds Accident and health insurance Property and casualty (liability) insurance companies Currently about 2,700 companies/1.8 trillion. Highly concentrated. Top 10 firms have 50% of market in terms of premiums written. Top 200: 95% Balance Sheets of Insurance Companies Insurance Company Operations Source of revenues Premiums received on insurance policies Investment earnings on reserves Major expenses Benefit (loss) payments Additions to reserves Operating expenses Investment expenses 7

8 Balance sheets of Life Insurance companies Long-term liabilities: Net policy reserves to meet policyholders claims Long-term assets Need to generate competitive returns on savings components of life insurance policies Bonds, equities, government securities Policy loans Balance sheets of P/C Insurance companies Similar to life insurance cos. But, P/C hold shorter-term securities since claims are unexpected (greater liquidity risk) Hold less reserves. Have much more equity relative to assets Performance evaluation of P/C companies Performance ratios Loss Ratio = Loss Expenses / Total Premiums Earned Expense Ratio = Operating Expenses / Total Premiums Earned Combined Ratio = Loss Ratio + Expense Ratio Operating Ratio = Combined Ration (after dividends) Investment Yield Overall Profitability = 100% - Operating ratio Loss ratio has changed over time: 60% in 1951; 80% in 1996; 69% in2015 Expense ratio has fallen over time: 34% in 1951; 26.2% in 1996; 28% in 2015 Combined ratio has increased over time: 94.3% in 1951; Since 1981, over 100%; 97.2% in Regulation of Insurance Companies Insurance Company Regulation Regulated at state not federal level Licensing & solvency requirements Mutual insurance funds by state Rate regulation Product regulation 8