The largest problem finance companies face is the uncertainty of existing investors about whether to reinvest as their funds mature, Dunedin financial planner Peter Smith says.
"There are so many unfounded rumours in the marketplace that investors are nervous.
"In turn, lack of reinvestment causes the companies to pull back from lending as the viability of the firm declines because of a lack of funds."
That eventually led to the company closing - not because it was in trouble but because it could no longer operate in the current environment, he said.
Finance company Fairview New Zealand (formerly Cymbis) was placed in receivership on Tuesday owing nearly $7 million to 797 investors. It was the 19th company to fail in the past two years.
Fairview was part of the wider Capital + Merchant Finance Group. The failure of Capital + Merchant at the end of last year meant Fairvew was unable to meet its interest payment commitments in December, last year.
Mr Smith, the principal in Peter Smith Financial Services, said finance companies could only stem the rumours by continuing to publish their results.
If balance sheets and financial data proved to be incorrect, then the company and directors were fraudulent.
"No director wants to be tainted with a criminal record for life. The penalties now are very large so care is being taken. It is only adding to the pull back in credit advances as caution is better than the 'She'll be right mate' attitude."
Myles Wealth Management director Craig Myles believes there will be a future for finance companies in New Zealand, but it will be a different one from recent years.
There had to be lenders to provide money in areas banks would not. Banks were asset lenders, but finance companies would lend for cash flow.
"If we are to grow the economy, we need to have people in the role of lending on cars or on more risky options than what a bank will do.
"The problem we have had is investors mispricing the risk.
People have been happy to hand over their hard-earned dollars for a rate of return less than it should have been."
A "wall of money" totalling about $13 billion had seen some companies lending money on riskier proposals than they normally would have accepted, he said.
Asked whether there would be more finance company failures in the future, Mr Myles said it would be "optimistic" to believe Fairview was the end of the line. But he would not elaborate.
It would take up to three years for the finance company market to settle down.
That could see some consolidation in the industry and leave the stronger companies in an even stronger position.
"There is sectorial pressure now. Everyone is under more pressure. It doesn't matter who you talk to - major trading banks or small finance companies - there is a degree of pressure everyone is talking about.
"These are the sorts of things you see when the economy comes to a slow down. It is part of a normal cycle. What I hope comes from this is people become more educated about what risk is worth taking."
Investors had been comforted by the fact they were investing in a "first ranking debenture".
What they often had not known was their money would be on lent for mezzanine finance which ranked after first and second mortgages, Mr Myles said.
When things went right, the mezzanine finance was the first to be repaid, but when things went wrong, it was the first to disappear.
Many players in property development had undertaken projects with no equity, fully borrowing 100% of the costs.
"That's why we have seen some tip over early in the process. Developers with 35% to 40% of equity are under lots less pressure."
Theoretically, a bank would take a first mortgage over a development and provide 65% of the funding.
A finance company would provide a second mortgage of about 20% and mezzanine finance would be used for the balance at a high rate of interest, typically about 20%.
The mezzanine finance was used as cash flow for the developer.
However, the credit crunch meant credit was much harder to get and banks and finance companies were funding significantly fewer mortgages, he said.
Mr Smith said he was aware of a developer who got turned down on his initial application for funding from a finance company as the company was not happy with the valuation given on the land put up for security.
"They did not refuse him outright, they just said they would not lend all that was asked for unless more security was offered.
"The detail on the additional security was not forthcoming before settlement and the deal failed as there were insufficient funds."
The developer then set out on a slur campaign saying the finance company had stopped lending and therefore was in trouble. That was untrue. The finance company was willing to provide reduced finance for the development, he said.
It was rumours like that which caused a "fear factor" in the market place.
"I would expect the company who was maligned would ring several other finance companies and mention the developer's name to the extent that he would find he is unable to borrow anywhere."
Mr Smith understood that the same sort of applications were travelling the country as developers found it hard to obtain funds for projects that were not as viable as they were before the credit crunch.
Larger companies would survive because the quality of their assets and their prudent management would win out, he said.
There were good projects on drawing boards and the larger companies would continue to lend although they would be more careful with their criteria.
"Just because they have lent to a client before will not necessarily mean they will advance more funds based on just a handshake."
Eventually, credit lines would reopen as banks became awash with funds which would have to be lent or they would go broke paying too much interest to depositors at times of small margins. The only direction deposit interest rates could go was down, Mr Smith said.
"The cycle will begin again as bank deposit rates will become unattractive. Finance companies will again be in favour and those that survive will be stronger."
