It seems like a bomb has gone off in the finance company sector and things are total chaos. Seems like Iraq. The reality is quite different.

The two latest companies are collateral damage in the whole finance company explosion

One feels for Propertyfinance (PFS). My impression of them is that they were a good company with an innovative approach to business. When I say innovative, I mean it in the true sense.

PFS has been caught out by the global credit crisis.

There are three ways a finance company can fund their operations. One is through investors (either direct or through advisers), the second is to have a wholesale funding line and the third is securitisation.

With the latter companies package up loans and sell them to institutional investors. Following the sub-prime collapse in the US institutional investors aren’t interested in buying loans from crowds like PFS.

I have heard news that Marac was looking to do some securitisation, but I guess those plans maybe shelved now.

Five Star looks like collateral damage. It only had one funding line – investors. Reports seem that reinvestment rates and new money dried up pretty quickly.

No money in the door spells trouble. As regular Blog readers will know this was part of the problem with Bridgecorp.

Around two thirds of their money came from advisers. Over the past few months support fell and they ended up with a liquidity problem.

The two big things for me are that not all finance companies are bad or at risk of falling over. The good, big companies are increasing their disclosure and showing they are in good shape. The caveat here is that one still has to be careful about what finance companies are saying about themselves. At least two, Nathans and Five Star, had made public comments days before their collapse saying they were in good shape.

Secondly, investor panic will cause a widespread collapse.

If everyone clamours for their money back there is only one outcome. Chaos.

My suggestion is that investors make an informed decisions about whether their company is sound or at risk.

Readers of depositrates.co.nz know I outlined a five point plan people should consider when looking at finance companies. Use it as a starting point to understand each company.