An Analysis of Finance Company Ratios in 1994

By Artz, William A.; Neihengen, Raymond M., Jr. | Journal of Commercial Lending, September 1995 | Go to article overview

An Analysis of Finance Company Ratios in 1994


Artz, William A., Neihengen, Raymond M., Jr., Journal of Commercial Lending


This article presents data from First National Bank of Chicago's fifty-ninth annual survey of finance company performance. While a healthy economy gave a boost to finance companies in 1994, the authors speculate that 1994 may have been the peak in finance industry's economic cycle. The authors commence the article by discussing the growing use of asset securitization as an off-balance-sheet funding vehicle by finance companies.

Asset Securitization

The use of asset securitization as a funding vehicle has grown dramatically during the past five years. In 1989, total new asset-backed issuances equaled approximately $48 billion. The estimated new issuances for 1994 were roughly $109 billion.

Individual public rating agencies differ in their approaches to evaluating the risks associated with asset securitization. Fitch uses a complex quantitative methodology that specifically identifies each component of retained risk. Fitch assesses standard capital charges for each risk component to determine a total capital requirement for securitizations. On the other hand, Standard & Poor's recently indicated that an allocation of capital for various risk elements retained by sellers cannot be governed by broadly based guidelines because of the growing diversity among transaction types, accounting methodologies, asset pools, and performance possibilities. Standard & Poor's further indicated that quantifying risk and required capital needs relies heavily on analytical judgment and entails a case-by-case evaluation of each issuer and transaction. (Duff & Phelps' approach is similar to Standard & Poor's approach.)

The methodology at First Chicago for evaluating asset securitizations is still evolving, but some general principles have emerged. First, in situations in which securitization results in definable risks that have not been transferred to the buyer by the seller (that is, a put for defaulted receivables), First Chicago deducts such amounts from the seller's equity when evaluating the seller's on-balance-sheet leverage. Second, in cases in which securitization results in a true transfer of risk except for "performance-type" risks, First Chicago does not adjust seller's equity when evaluating a seller's on-balance-sheet leverage.

Finally, First Chicago encourages all users of securitization to provide sufficient disclosure so that lenders and analysts have the information necessary to make informed judgments about the transfer of risk in these complicated transactions.

Consumer Finance Companies

Earnings

The consumer direct cash lending sector enjoyed a banner year during 1994 with profitability and asset quality at or above record levels. Return on equity (ROE) has steadily risen during the past six years from 15.8% in 1989 to 21.6% in 1994. (See Table 1, Line 31). A relatively healthy U.S. economy during the past five years resulted in strong consumer demand for debt. This strong demand, coupled with improvement in operating efficiency (Line 28) and higher leverage (Lines 21, 22, 23), underpinned the improvement in ROE.

Table 1. Consumer Finance Company Ratios

Statement Date                                 12-31    12-31
                                               1990     1991

ASSETS
Volume for Period (Millions)               1   24,431   24,621
Total Outstanding (Millions)               2   40,437   41,539
Average Net Receivables
(Millions)                                 3    2,863    3,644
% Direct Cash Loans (Real
Estate Collateral) to Total                4     36.1     41.8
Receivables
% Direct Cash Loans
(Unsecured or Collateral                   5     46.9     42.2
other than Real Estate) to
Total Receivables
% Retail Contracts to Total
Receivables                                6     15.1     15.4
Average Amount of Individual Loan
Balances                                   7    2,844    2,989
% Loans to Present Borrowers               8     66. … 

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