Vithayathil Enterprises is one of Kerala's 7,000-odd gold loan companies, located in Varapuzha village, at the mouth of the River Periyar near Kochi. Barely 7.75 sq. km. in area and tucked amid lush green coconut palms, Varapuzha is one of Kerala's gold pockets, boasting 42 gold loan firms, including branches of the top three in the country - Muthoot Finance, Muthoot Fincorp and Manappuram Finance. Like its rivals in the region, Vithayathil Enterprises - run by Vithayathil Gigimon Ummachan and his younger brother Aby, both of whom joined the family business soon after finishing school - extends credit to fishermen and farmers in the neighbourhood against pledged gold, including loans for wedding and education expenses.
For decades the business ran smoothly, but now an air of depression pervades its narrow 20-sq-metre office. The drop in the price of gold worries the brothers no end. "Since the price has fallen, customers are reluctant to redeem their gold loans," says Gigimon. Loans of more than Rs 35 lakh are past their repayment date. The brothers lend mostly from their family funds and the company's cash flow is affected if customers do not pay back in time. "Gold loans have to be redeemed on time for us to survive in this business," adds Gigimon. "Margins are small. Two gold loan companies in Varapuzha have shut down. Many others are staring at the same fate."The global price of 24 carat gold has fallen from a high of around $1,850 an ounce in early 2013 to about $1,084 (as of November 16) at present. In India, though the drop was partly offset by rupee depreciation during the same period, it still declined from a high of more than Rs 29,000 per 10 gm in January 2013 to Rs 23,010 (as of November 16). If the rupee strengthens, however, gold's outlook is bleak. "A combination of global gold price fall and rupee appreciation will increase defaults in the gold loan segment. But that is unlikely to happen in today's situation," says V.K. Vijayakumar, Investment Strategist, Geojit BNP Paribas. Unlike the smaller companies, Muthoot's and Manappuram's financials have, so far, held up well, though adverse market sentiment - following the gold price slide - has seen their stock price dip sharply. Muthoot Finance's revenue rose 88 per cent in the last four years to Rs 4,313.80 crore in 2014/15, while its profit increased 36 per cent to Rs 670.52 crore. Its portfolio has reduced by a modest 10 per cent in the last two years, but it still disburses 40,000 gold loans per day. Its share price, however, dropped 35.80 per cent from its 52-week-high of Rs 253.50 in February on the Bombay Stock Exchange to touch a low of Rs 152 on October 23, while its market capitalisation was down to Rs 6,050 crore from Rs 10,090 crore in the same period. However, the price recovered marginally during the recent Diwali season and is now hovering at around Rs 180 per share. George Alexander Muthoot, Managing Director, Muthoot Finance, denies any reason for concern. "The long-term perspective is always that the price of gold will rise," he says. "Gold has seen a dip for the last three to four years, but it will bounce back and touch new price peaks." In 2013, his company held 120 tonnes of pledged gold against total outstanding loans of Rs 26,000 crore. Currently, though the quantity of gold held is higher at 131 tonnes, the total loan value, due to the price drop, is down to Rs 24,000 crore.
Manappuram's share price fell by a whopping 79 per cent to a low of Rs 19.75 on October 10, from its all time peak of Rs 94.95 in November 2010, with market cap shrinking to Rs 1,661 crore from nearly Rs 8,000 crore. Its shares are now trading at around Rs 22. Its revenue, however, rose 70 per cent in the last four years to Rs 1,975 crore in 2014/15, though profit fell marginally, by four per cent, to Rs 270 crore. V.P. Nandakumar, CEO and Managing Director, Manappuram Finance, is similarly ebullient. "Gold ornaments have an emotional connect apart from their cash value," he says. "Often they comprise ancestral wealth which people do not want to lose. Even when the price is falling, around 90 per cent of our customers redeem their loans."
On this score, however, Muthoot feels differently. "The new generation is not that sentimental about ancestral ornaments," he says. "The number of people abandoning their pledged gold is increasing by two to three per cent each year." He is also critical of the growing propensity to splurge on status symbols rather than invest sensibly. "Earlier, people were putting their money in appreciable status, such as real estate and gold," he adds. "Fishermen and farmers lived through lean periods because of their gold investments. Today, people spend heavily on electronic items whose price can only depreciate. This may affect gold loan players in the future."
How the Business Works
The money gold loan companies lend comes from different sources, the largest usually being commercial banks, which charge interest of 10-11 per cent. (Three years ago, when gold prices were at their highest, the average rate was 13 per cent.) Muthoot, for instance, has 36 per cent of its borrowings (Rs 7,241.80 crore) from 25 banks and financial institutions, and in the case of Manappuram, it is 78 per cent (Rs 6,725.3 crore). Muthoot also raises funds through non-convertible debentures (NCDs) - it is in the process of raising Rs 250 crore from the primary market - and commercial papers.Muthoot's lending rate varies between 12 and 22 per cent (and even higher for delayed repayments), with an average yield of 19 per cent. (When prices were high, the average was 22 per cent.) "Among NBFCs, the gold loan ones have the lowest interest rates," says Muthoot. "We want to be reasonable to our loyal customers. The interest is low because of the large volumes, which bring down overheads and borrowing costs." His net interest margin is around nine per cent - down from 10 per cent when business had peaked. "My bank borrowing cost is lower because of the size of borrowings and our company's AA- credit rating," he adds.
Reserve Bank of India (RBI) rules allow NBFCs to lend only up to 75 per cent of the value of collateral (loan to value) provided. "The remaining 25 per cent provides a cushion against price fall," says Vijayakumar of Geojit BNP Paribas. "Thereby, the related risks are lower." The loaned amount falls further depending on the loan's duration. "We give 75 per cent for a three month period, but for a six month period, it comes down to 69 per cent. It falls further to 63 per cent for a nine month period and 57 per cent for one year," says Nandakumar of Manappuram. Thus, if the gold price falls, so does the amount lent per customer and the gold loan company needs more customers to keep its profit level the same. If pledged gold is not redeemed beyond a specified period, it is auctioned.
Smaller players like Vithayathil provide loan size varying between Rs 5,000 and Rs 50,000 and that would go above 80 per cent value of the collateral. They hold gold for more time to maintain relationships with customers. The Kerala Money Lenders Act allows them to charge up to 18 per cent interest. "But I don't charge that much as I have known all my borrowers for decades," says Gigimon.
Challenge from Banks
Banks are major lenders to the gold loan companies, but they are also rivals, disbursing gold loans themselves. Indeed, a 2012 RBI report, Issues Related to Gold Imports and Gold Loans by NBFCs, notes that it is banks that have the dominant share in this market. "There is a general feeling that NBFCs account for the majority of gold loans disbursed. However, contrary to popular belief, the share of banks in total gold loans is the highest at 72.3 per cent on March 31, 2012," it said. Many allege, however, that banks take unfair advantage by providing loans against pledged gold to farmers as agricultural loans, where interest is just four to seven per cent.In 2007/08, when gold loan companies were expanding rapidly across the country, the RBI, suspecting money laundering activities behind their rapid rise, imposed various restrictions on them, which too have helped their bank rivals. The central bank capped bank exposure to NBFCs across the board - except for asset financing and infrastructure financing companies - at 10 per cent of the bank's capital funds. The 75 per cent limit imposed on loan to value for gold loan companies also helped the banks. "It was an acid test," says Muthoot. "There was a dip in business. But no company went under, unlike airlines or chit funds, demonstrating the inherent strength of the business. We have survived both the regulatory as well as the industry related checks."
The four Southern states account for 40 per cent of the country's gold demand, followed by the West, which makes up 25 per cent, the North with another 20-25 per cent and the East with 10-15 per cent. "As long as gold exists, this business will flourish," says Arundhati Bhattacharya, Chairman, State Bank of India. "NBFCs have traditional presence in this sector, but banks have caught up fast, because of their scale and scope. The market is going rural nowadays. The South has large exposure to gold and the North is also picking up."
The Way Out
Assuming gold prices will continue to waver, how can the gold business be revived? As interest accumulates and the price of gold falls, the customer's inclination to abandon the loan rises. Gold loan companies will have to gauge not only the repayment capacity of a borrower, but also his interest in servicing the loan and getting back his gold. "We don't want people saying they don't need the gold back," says the managing director of another major NBFC in the business.Being mostly short-term loans, gold loans are usually paid back in one shot - interest and principal together - at the end of the loan term (what is called 'bullet repayment'). They can even be returned, at minimum interest cost, within a week of disbursement. Industry experts believe this has to change. "We will have to include equated monthly installments (EMIs) or, perhaps, quarterly servicing of loans as a clause in future contracts," says Muthoot. This will make gold loans no different from vehicle loans or personal loans, though without the elaborate paperwork and documents the latter require. "Every business has to change with time or else it will perish," adds Muthoot.
With an eye on the future, gold loan companies have also begun diversifying. Manappuram has launched new verticals such as home loans, commercial vehicle loans and loans against property for SMEs. With the acquisition of Asirvad Micro Finance in February this year, it has entered microfinance as well. "Diversification is the next phase for gold loan companies, but it is not because of saturation in the gold loan business," says Nandakumar. Muthoot too has forayed into housing and vehicle loans, as well as foreign exchange transfer. It acquired majority stake in Asia Asset Finance, a Sri Lanka-based vehicle finance company in end-2014. It tried for a payment bank licence as well, but was not successful.
The rapid expansion of branches by gold loan companies, right up to 2011/12, has stopped. Now the focus is on keeping operational costs at every branch low. Muthoot, which has 4,250 branches across the country, will, in future, open new ones only in the Northeast, where its presence is still limited. "We are focused on increasing business per branch now," says Muthoot. "The peak of average loan outstanding per branch was Rs 6.5 core, which has fallen to Rs 5.5 crore. Expansion is the least of our priorities."
The smaller players have high borrowing costs, but they too can survive if they act judiciously. They can be divided into two categories - the registered ones like Vithayathil Enterprises, who are regulated by the Kerala Money Lenders Act, and those outside the government's radar. The latter, who are often involved in dubious dealings, are likely to go bust fast.
FAILING TO DELIVER
The government's new gold monetisation schemes have opened to a poor response The government had come up with two Gold Monetisation Schemes (GMS) in the 2015 budget with an aim to bring an estimated Rs 50 lakh crore worth of the yellow metal (22,000 tonnes) lying idle with Indian households and religious institutions, like temples, into the economic system. But, both have failed to make an impact.
The gold deposit scheme has had a poor response so far with only 400 gm of gold monetised nationally. The first tranche of the sovereign gold bond scheme, open for subscription from November 5 to November 20 with an offer of 2.75 per cent interest to buyers, also met with a tepid response, grossing only about Rs 150 crore.
Industry observers highlight that customers of gold loan companies are mainly individuals who pledge one of their most precious assets, jewellery. But in the gold deposit scheme, one can deposit only pure gold to join the scheme. If it is jewellery, it has to be melted to assess the quantity and purity of gold. This does not go down well with a vast majority of Indians.
Experts point out that a lion's share of the gold in India is in the form of jewellery with households. Jewellery has an emotional connect, especially with women. In states like Kerala and Tamil Nadu, which account for over half of the jewellery sales in India, traditionally, jewellery is handed down from generation to generation. Another issue is the loss of 'making charges' value while melting gold ornaments. If one buys jewellery worth one lakh rupees, about 15 per cent of that value is the making charge and the actual gold in the ornament values only 85 per cent.
"If you sell a gold ornament even after less than an hour of purchase, straightaway it loses 15 per cent value. So the scheme is not economical as well," says Dr V. K. Vijayakumar, Investment Strategist, Geojit BNP Paribas. He says the scheme may be of interest to institutions like temples, but not for all their ornaments, since sentiments of devotees will be an issue for them as well. A UBS research report, based on a survey, had predicted that the new gold monetisation schemes have the potential to perform better than previous initiatives. However, it had asserted that it would take some time for them to gain traction, especially in rural areas.