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In this second part of our investigation into the workings of gold loan companies, we delve into the financial model of an industry leader, Manappuram Finance, which is listed on the BSE
Going by their recent blockbuster performances, it would seem that gold loan companies are poised for exponential growth for a long time to come. Many of these companies have been quoting astronomical growth figures, supported by unrelenting demand from a public increasingly looking at gold more as an investment than as a piece of jewellery. Indeed, players in the gold loan business are increasingly trying to spread awareness on how lower income families can leverage their gold holdings instead of keeping their valuables idle or borrowing at sky-high rates from pawnbrokers.
Leaving aside Manappuram Finance, other prominent non-banking financial companies (NBFCs) like Muthoot Finance and Muthoot Fincorp are not yet listed entities, and hence do not need to disclose their financials to the public. But their performance too, by all accounts, is very good. The question is, would these growth figures remain robust under changed circumstances, such as a significant fall in gold price?
Let us try to get a grip on the financials of these companies by looking at the only listed entity - Manappuram Finance. This Kerala-born company has been on a phenomenal growth curve for over a decade now. Over the past five years, its revenues have surged 2,322% from a modest Rs19.74 crore as on 31 March 2006 to Rs478.2 crore as on 31 March 2010. Profits have zoomed 2,923% in this period, from Rs3.96 crore to Rs119.72 crore. The company's loan book has grown by leaps and bounds from Rs63.16 crore to Rs1,890.71 crore during this period.
This fantastic growth momentum has continued in the June quarter of the current fiscal year. Income surged 177% to Rs186 crore while net profits zoomed 225% to Rs46 crore over the corresponding quarter last year. Thanks to such vigorous growth in turnover and profits, Manappuram's shares have shot up from Rs13 in April 2009 to Rs116 (on 19th August). By the end of the June quarter, the company's loan book stood at Rs2,681 crore. The management has indicated that they plan to achieve a size of Rs8,000 crore by the end of this fiscal year.
What makes this business so lucrative is the sizeable spread that the company can earn and the low non-performing loans, until now. For Manappuram, the spread between the yield on advances and the cost of funds is as high as 16%. Another highlight of the business is the strikingly low incidence of non-performing loans (NPLs). Apparently, gold loans rarely become NPLs primarily because of the low average loan duration, the desire to repay the loan and reposses the jewellery and the ease of disposing the jewellery for loans which are defaulting. Manappuram's gross NPAs stood at a mere 0.19% of the total assets for the June quarter.
Where do NBFCs like Manappuram get the funds to loan you at an
ever-increasing pace? Unlike traditional NBFCs, they do not rely on fixed deposits. Of late, they have also attracted attention from private equity players. Last month, Muthoot Finance raised Rs157 crore through private placement from leading PE firms Baring Private Equity Partners India and Matrix Partners India. Over the past few years, Manappuram has also received patronage from several PE firms including Sequoia, India Equity Partners, Ashmore Alchemy and Granite-Hill. Manappuram received around Rs70 crore from Sequoia and India Equity Partners in 2008, with another Rs70.8 crore coming into their books in 2009 from Ashmore Alchemy and Granite-Hill, together with the previous PE investors. This year, Sequoia exited the company with returns of nearly 7.4 times. In May this year, Manappuram made a placement to Qualified Institutional Investors raising Rs245 crore. According to a report in the Economic Times today, Manappuram is further looking to raise Rs1,000 crore through the QIP route in the third quarter of this fiscal. This fund-raising spree is the outcome of an ever-increasing gold loan book.
But while this can explain the fact that lenders would be more confident in dealing with Manappuram, it does not explain the main source of funding. After all, Manappuram has a loan book of around Rs2,000 crore and we are talking of a few hundred crores raised from PE investors.
Look at the balance sheet and you will find that the source of funds for these companies is mostly borrowings from banks, bonds, debentures or commercial paper and also private equity funds. On 31 March 2010, Manappuram had advances of Rs1,891 crore. The majority of this was gold loans. This was funded by equity capital of Rs34 crore, reserves of Rs576 crore (including share premium reserves) and loans funds of Rs1,836 crore. The bulk of the loan funds was secured borrowings from banks (Rs1,367 crore) and funds through bonds/debentures (Rs262 crore) and commercial paper (Rs65 crore). It is worth focusing on what is the security that Manappuram has given to get a "secured" loan? After all, it has no productive assets. Fixed assets including intangibles amount to only Rs57 crore. The gold in its locker does not belong to the company. Well, the answer to this question leads us to the very secret of the current success of gold loan companies.
As we found out, some 90% of Manappuram's borrowings are secured against the very loan it gives out, in a remarkable case of pyramiding. Banks are funding its receivables arising out of gold loans even though the underlying gold does not belong to it. In effect, thanks to an interesting piece of financial engineering and support from banks, the gold people loan out to Manappuram becomes an asset for the company! This looks like a pyramid scheme but everyone believes that the pyramid will not topple as long as the going is good. While we have no forecast on the price of gold, we certainly believe that a business model, built by pyramiding money, entirely based on the speculative price of a single product, has huge potential risks. What are these risks? That's in our third part.
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