The distress caused to the community of East Gippsland, unfortunately, is not unfamiliar, writes Georgia Wilkins.
It was written there for all to see in the company's prospectus. But for the 3500-odd investors in failed Gippsland Secured Investments, the company's financial woes came as a surprise.
For the mostly farmers, pensioners and small business owners who held money with the non-bank lender, GSI was a trusted institution with a vested interest in keeping the community secure.
But for those with the financial nous to understand the fine print, it had been pushed into the red by a series of bad loans.
"People were caught unaware," says Tim Shelton, a pharmacist in the Gippsland farming town of Bairnsdale.
"I don't think they realised that it wasn't protected in the same way as a bank."
The collapse of GSI this week after it froze its $143 million in funds in July has once again exposed the vulnerability of local communities who put their money in debenture firms that offer a high return for high risk.
Gippsland Angus cattle farmer Lea Worseldine, who has a substantial amount of money in GSI, says the community was anxiously waiting to find out what happened to the lender.
"Was it bad management? Is it the economy? You just don't know who to blame."
The distress caused to the community of East Gippsland is not unfamiliar. Less than a year ago, a similar scenario played out in the Victorian town of Kyabram with the collapse of Banksia Securities. Provident Capital and Wickham Securities have also left a trail of uncertainty for investors after they closed their doors in Sydney and Brisbane.
Now, the company acting as trustee in the Banksia and Gippsland cases - The Trust Company - is running the ruler over other firms it believes are heading down a similar road.
"We have a book of maybe half a dozen debenture issuers across regional parts of Australia," says Rupert Smoker, the Trust Company's head of corporate and debt capital markets trustee services. "Part of our job is regular and frequent contact with the issuers, and that's what we're doing at the moment."
The events that led up to GSI's collapse are now matters for receivers Adam Nikitins and Simon Cathro from Ernst and Young, appointed by the trustee on Tuesday. But public documents already reveal the dire state of GSI's finances before the company froze funds on July 19.
In a revised prospectus issued in April, the company disclosed that almost 10 per cent of its entire lending book - or $11.4 million - was in default. One of these outstanding loans was to Riviera Properties, a property development group within the Gippsland Lakes and East Gippsland region, whose director, John Stephenson, was also on the board of GSI. In a note to shareholders on August 20, Riviera said it had completed arrangements with GSI for a deed of forbearance and that Mr Stephenson had stepped down from the board.
While loans to directors and related parties - which totalled $4.3 million at January 31 and attracted a reduced interest rate of up to 2 per cent - face scrutiny by receivers, questions have also been raised about the actions taken by the trustee and the corporate regulator in the lead-up to the collapse.
Under financial lending laws, trusts have a legal responsibility to protect investors and ensure that a lender is solvent. The Australian Securities and Investments Commission can act against any trust that does not move quickly enough to protect investors.
But members of a rescue group that led an attempt in the Federal Court to bail GSI out say The Trust Company has moved beyond its duties in the case of Gippsland, while ASIC has been too restrained. Duncan Johnston, a spokesman for the rescue group and an investor and borrower with GSI, says the group was lobbying the federal member for Gippsland, Darren Chester, to propose a parliamentary inquiry into the matter.
"If ASIC was regulating the company two years ago and allowed GSI to recapitalise then, none of this would have happened," Mr Johnston says.
ASIC, which made submissions in the Federal Court case on GSI's solvency, would not say when it became aware of Gippsland's shaky financial situation.
The rules surrounding debenture firms in Australia allow for companies to go to market with complex and highly risky products, so long as they disclose the risks to investors. This means that the regulator can turn a blind eye to bad loans, so long as they are listed in a prospectus.
"In the case of GSI, looking at their prospectuses that they had on offer for considerable time, there is disclosure against ASIC's disclosure benchmarks, which includes capital and liquidity benchmarks," an ASIC spokesman said. "At the end of the day we are not a merit regulator."
ASIC put forth a proposal in February that would allow it to enforce mandatory capital and liquidity requirements on issuers in response to a call by the minister for financial services and superannuation to strengthen the $4 billion sector.
It also proposed that the role of trustees under the Corporations Act should be clarified, allowing companies such as the Trust Company to have even greater express powers to obtain the information they need from debenture issuing companies.
David Grbin, the Trust Company's group executive general manager of corporate client services, said it had a "good and solid relationship" with the regulator. "They contact us, we contact them," he says.
The company approached the board of GSI about their equity position late last year following the collapse of Banksia in October. A review by Ernst and Young in February revealed the company's debts were higher than expected.
The board agreed to property re-valuations in April and May, which priced the assets attached to the loans about 30 per cent lower than the company's books had indicated. This left the company with a net asset deficiency of $3.8 million
"Essentially, that confirmed some of our concerns around the company's level of equity," Mr Grbin said. "Once they faced up to reality in the middle of July, they had no choice but to freeze funds."
An attempt to stop the company falling into the hands of receivers was made by the rescue group, which included Mr Johnston and former Woolworths chairman John Dahlsen. However, the proposal was rejected by the Federal Court on Monday.
During court proceedings, the Trust Company described GSI's balance sheet as a "moveable feast" in the way it had documented impairments and provisions. It attempted to table a number of documents to the court as evidence of "incompetence" by management in the lead-up to the fund freeze.
On Thursday, Nikitins says GSI had doubled its loan book since 2010. "In order to get that growth, there is an inherent need to go up the risk curve," he says. "Ultimately GSI was too thinly capitalised."
BBY senior banking analyst Brett Le Mesurier says a company with an incidence of default as high as 10 per cent should set off alarm bells to anyone looking at the company's books. "[To say] 'alarm bells' is understating it. I would then want to see that it had absolute bucket loads of capital."
But other debenture firms across NSW and Victoria operate with similarly high default rates.
Westlawn Finance, based in the NSW town of Grafton, had $10.8 million in outstanding loans - or 9 per cent of its total loan book - as of December 2012.
This number jumped to $11.1 million - or 9.9 per cent - by March, according to a continuous disclosure report.
Similarly, Sewells Finance in Colac, Victoria, had 11 overdue loans of $5.5 million - or 9 per cent of its total loan book - at March.
Grbin says firms in regional areas were more exposed to fluctuations in the property market. "Generally, asset prices have been falling," he says. "We're in areas, in rural communities, where there are not the same deep and liquid property markets that there are in capital cities."
The receivers told GSI note-holders on Tuesday they expected returns to exceed 80c in the dollar.
Benambra resident Ben Buckley is also worried he will lose savings he has with the lender after it froze funds in July.
"I'm not going to starve ... but there will other people much worse off, particularly pensioners," he says.
While Shelton says he was not directly impacted by the collapse of GSI, he was already aware of the vacuum it had left in the local economy.
"It's had a negative impact on confidence," he says. "When a financial institution collapses there's a pretty wide ranging effect.
"There are people with their life savings in there, people who are employed by businesses who used GSI, people who have loans with them. They are worried."