Should you bet on gold loan companies?
A 5 per cent drop in gold prices should not be cause for alarm since it can be seen as a temporary correction, right? Yet, gold loan companies are scurrying for cover, with ManappuramBSE 3.00 % Finance, a prominent lender against the security of gold, witnessing the fallout of this price drop last week. Its shares lost 30 per cent of value in just two trading sessions, a reaction to the company's declaration that it was expecting revenue losses in the current quarter due to the dip.
The shares of Muthoot FinanceBSE -1.18 % also took a slight hit. Though all gold loan companies claim to have a sufficient cushion against the decline in gold prices, are their business models sturdy enough to withstand a sustained fall? More importantly, should you be putting your money in the stocks and bonds of these lenders?
A rigid model
The business proposition of gold loan companies is simple: they disburse loans to people who are willing to offer their gold possessions as collateral. The sanctioned loan is lesser than the worth of the pledged jewellery, which acts as a safety margin for the lender. Should the borrower default on the loan, the company can sell the pledged gold in the market through an auction. Since the value of the actual loan is less than the value of gold, a slight drop in gold price does not come in the way of the company recovering its money.
However, the model's simplicity makes it susceptible since the profitability of the company hinges entirely on a low default rate and stability in gold prices. The lender bets on the fact that the borrower is not likely to default as he is typically attached to the jewellery and would want it back. However, this argument does not hold much water. If, for some reason, gold prices tank by, say, more than 20 per cent, it would actually be an incentive for the borrower to default.
Suppose a company gives Rs 80 as loan against gold jewellery worth Rs 100. Assuming a 25 per cent rate of interest, the borrower would owe the company Rs 100. Now, if gold prices fall by 15 per cent, the value of the gold pledged as collateral comes down to Rs 85. A person who is struggling to make ends meet will no longer have an incentive to pay back the money. This is another problem with gold loan companies: most of their clients are not credit worthy, pledging their jewellery since they they are badly strapped for cash and have no other alternative.
For the company, too, the credit profile of the borrower takes a backseat since growth comes from lending more and more. If, however, gold prices fall, it is a potential minefield for the company. In the case of Manappuram, the problem is acute because the loan-tovalue (LTV) ratio is very high.
Since March 2012, the revised Reserve Bank of Indiaguidelines require the loans to be capped at 60 per cent of the value of pledged gold. Prior to this, most companies were lending at much higher LTVs (up to 85 per cent in some cases) as soaring gold prices did not warrant caution.
About 15 per cent of the loans disbursed byManappuramBSE 3.00 % in the third quarter of the fiscal year are now under stress as these were lent at high LTVs, with the average LTV for its outstanding loans being 70 per cent. Even at a higher LTV, the risk to the lender's principal remains low unless gold prices fall much more sharply.
However, it also means that if the borrower defaults, the lender has to forgo the anticipated interest income on the loan. Since lenders account for these receivables in their books, a default or under-recovery means a large-scale reversal in interest income. Besides, the bullet nature of repayment, where borrowers repay the entire sum at one go at the end of the tenure, means that one cannot predict a default till such a time.
Another problem faced by gold loan companies is the availability of low-cost funds. These firms had been on a growth spree as they had access to cheap funds from banks, which were allowed to fund NBFCs for lending against gold as part of priority sector lending activity. However, now that the RBI has excluded this category from priority sector lending, their source of low-cost funding has dried up.
These companies are now forced to borrow at a much higher cost in the form of non-convertible debentures and bank credit lines, which has led to reduction in margins.
Should you invest?
It is evident that gold loan companies don't take kindly to a price fall. Even if defaults don't rise sharply with every dip in gold price, the business is affected as the loan size also reduces in tandem with the value of gold. The revised RBI lending norms have also taken the sheen off the gold loan companies, with the customer base shrinking slightly.
The slashing of the LTV and the higher auction of gold jewellery have led to the decline in customer base. Says Ambareesh Baliga, a market expert: "The growth expectations for these companies will have to be tempered in line with the lower disbursements after the revised guidelines. Several brokerages have pruned the earnings estimates for gold loan companies for the fiscal year 2013."
The credit profiles of these companies could also face a threat in case of a sustained fall in gold prices. With reference to Manappuram, IcraBSE 3.88 % observes, "If the lenders were to become cautious and restrict access to these limits or hold back on fresh limits, the credit profile of the company could be adversely affected."
However, some believe that the problems are not likely to persist since stringent lending norms have come into effect. A research note on ManappuramBSE 3.00 % byAmbit Capital states, "Such instances of income reversal should not recur due to lower LTVs andinterest rates on the loans issued after February 2012", provided gold prices do not fall by more than 10 per cent within a year.
Unless you believe in the misplaced notion that gold prices are only meant to go up, it would be wise to limit the exposure to such firms.
Source : SANKET DHANORKAR,ET BUREAU
After the revised RBI norms and the adverse impact of fall in gold prices, it would be prudent to limit your exposure to such firms.
A 5 per cent drop in gold prices should not be cause for alarm since it can be seen as a temporary correction, right? Yet, gold loan companies are scurrying for cover, with ManappuramBSE 3.00 % Finance, a prominent lender against the security of gold, witnessing the fallout of this price drop last week. Its shares lost 30 per cent of value in just two trading sessions, a reaction to the company's declaration that it was expecting revenue losses in the current quarter due to the dip.
The shares of Muthoot FinanceBSE -1.18 % also took a slight hit. Though all gold loan companies claim to have a sufficient cushion against the decline in gold prices, are their business models sturdy enough to withstand a sustained fall? More importantly, should you be putting your money in the stocks and bonds of these lenders?
A rigid model
The business proposition of gold loan companies is simple: they disburse loans to people who are willing to offer their gold possessions as collateral. The sanctioned loan is lesser than the worth of the pledged jewellery, which acts as a safety margin for the lender. Should the borrower default on the loan, the company can sell the pledged gold in the market through an auction. Since the value of the actual loan is less than the value of gold, a slight drop in gold price does not come in the way of the company recovering its money.
However, the model's simplicity makes it susceptible since the profitability of the company hinges entirely on a low default rate and stability in gold prices. The lender bets on the fact that the borrower is not likely to default as he is typically attached to the jewellery and would want it back. However, this argument does not hold much water. If, for some reason, gold prices tank by, say, more than 20 per cent, it would actually be an incentive for the borrower to default.
Suppose a company gives Rs 80 as loan against gold jewellery worth Rs 100. Assuming a 25 per cent rate of interest, the borrower would owe the company Rs 100. Now, if gold prices fall by 15 per cent, the value of the gold pledged as collateral comes down to Rs 85. A person who is struggling to make ends meet will no longer have an incentive to pay back the money. This is another problem with gold loan companies: most of their clients are not credit worthy, pledging their jewellery since they they are badly strapped for cash and have no other alternative.
For the company, too, the credit profile of the borrower takes a backseat since growth comes from lending more and more. If, however, gold prices fall, it is a potential minefield for the company. In the case of Manappuram, the problem is acute because the loan-tovalue (LTV) ratio is very high.
Since March 2012, the revised Reserve Bank of Indiaguidelines require the loans to be capped at 60 per cent of the value of pledged gold. Prior to this, most companies were lending at much higher LTVs (up to 85 per cent in some cases) as soaring gold prices did not warrant caution.
About 15 per cent of the loans disbursed byManappuramBSE 3.00 % in the third quarter of the fiscal year are now under stress as these were lent at high LTVs, with the average LTV for its outstanding loans being 70 per cent. Even at a higher LTV, the risk to the lender's principal remains low unless gold prices fall much more sharply.
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However, it also means that if the borrower defaults, the lender has to forgo the anticipated interest income on the loan. Since lenders account for these receivables in their books, a default or under-recovery means a large-scale reversal in interest income. Besides, the bullet nature of repayment, where borrowers repay the entire sum at one go at the end of the tenure, means that one cannot predict a default till such a time.
Another problem faced by gold loan companies is the availability of low-cost funds. These firms had been on a growth spree as they had access to cheap funds from banks, which were allowed to fund NBFCs for lending against gold as part of priority sector lending activity. However, now that the RBI has excluded this category from priority sector lending, their source of low-cost funding has dried up.
These companies are now forced to borrow at a much higher cost in the form of non-convertible debentures and bank credit lines, which has led to reduction in margins.
Should you invest?
It is evident that gold loan companies don't take kindly to a price fall. Even if defaults don't rise sharply with every dip in gold price, the business is affected as the loan size also reduces in tandem with the value of gold. The revised RBI lending norms have also taken the sheen off the gold loan companies, with the customer base shrinking slightly.
The slashing of the LTV and the higher auction of gold jewellery have led to the decline in customer base. Says Ambareesh Baliga, a market expert: "The growth expectations for these companies will have to be tempered in line with the lower disbursements after the revised guidelines. Several brokerages have pruned the earnings estimates for gold loan companies for the fiscal year 2013."
The credit profiles of these companies could also face a threat in case of a sustained fall in gold prices. With reference to Manappuram, IcraBSE 3.88 % observes, "If the lenders were to become cautious and restrict access to these limits or hold back on fresh limits, the credit profile of the company could be adversely affected."
However, some believe that the problems are not likely to persist since stringent lending norms have come into effect. A research note on ManappuramBSE 3.00 % byAmbit Capital states, "Such instances of income reversal should not recur due to lower LTVs andinterest rates on the loans issued after February 2012", provided gold prices do not fall by more than 10 per cent within a year.
Unless you believe in the misplaced notion that gold prices are only meant to go up, it would be wise to limit the exposure to such firms.
Source : SANKET DHANORKAR,ET BUREAU
