Manappuram crash testifies what Moneylife has been saying for a very long time—that gold-loan companies are built on extremely shaky and fragile foundation with poor supervision
The share price of Manappuram Finance is down nearly 30% in just two days, tanking to Rs24.60 from Rs34.60. It is believed that the company will be expecting huge revenue losses for the current quarter due to declining gold prices. This exactly is the point Moneylife has been highlighting over the years about the gold loan companies. The business model of these companies cannot survive when gold prices are stagnant or when there is repayment stress for consumers due to a variety of reasons including lower growth and higher inflation.
Even brokers and financial institutions, who have been bullish on the company earlier, without understanding the fundamentals of gold-loan companies, seem to have woken up. For instance, Merrill Lynch expects the company to touch Rs20 and has downgraded it to “underperform” from “Buy”. Ambit Capital, earlier this year, had rated the company as a “buy” and put a target price of Rs51. Now it has put it under review. Bank of America and Religare have taken a similar stance and put the company under review.
In a regulatory statement, the gold loan company stated, “We expect an under-recovery of revenue on certain gold loan portfolios due to correction in the gold price. This may result in reduction in profit numbers for the 4th quarter ending 31 March 2013.” The episode also prompted resignation of a director, AR Sankaranarayanan who was the chairman of the Remuneration Committee.
This is not the first time that Moneylife has pointed out the flaws of gold loan companies. Way back in 2010, we ran an exclusive three-part exposé (Part 1
, Part 2
and Part 3
) on gold-loan companies where we had written about several flaws in their business model. In our second part
of the exposé, we had delved deeply into the numbers and questioned its sources of finance as well as how non-convertible debentures (NCDs) were no different from deposits.
Basically, gold-loan companies are non-banking finance companies (NBFCs), which cannot accept deposits. So where do they get their money from? They have to borrow from elsewhere, such as non-convertible debentures (NCDs) (in lieu of deposits). This is the money, they normally lend out to consumers. But in order to pay back creditors, it needs to lend more and more, so that the interest inflow is greater than the interest outflow and principal. The only way to lend more is to ‘securitise’ the gold received (even though it is not owned by them), lend that to more consumers, and hope gold prices go up (and of course, hope that consumers do not default!). Otherwise, Manappuram will have to put up more collateral.
Earlier, in an email, VP Nandkumar, executive chairman of Manappuram, had said, “It is true that receivables arising out of our gold loans are being funded in significant measure by the banks through bilateral assignments. It is also true that we are using the proceeds to further expand our gold loan portfolio. However, the crucial distinction to be made is that every stage of expansion of our gold loan portfolio is accompanied by a proportionate increase in the value of gold that we hold as security against default.”
Gold-loan companies do well when gold prices go on one direction—upwards. This is similar to the US sub-prime crisis when banks securitized homes thinking home prices only go upwards. However, there is another side to this story, which has not happened yet when consumers default. In this case, they will have to sell off the gold jewellery, which will lead to lower realisation. This is a double-whammy and sure to put a severe stress on Manappuram’s balance sheet. Under-recovery of revenues would apply on both sides of the equation.
“…we also believe a fall in gold prices would not automatically result in a rise in default rates. Most of the gold loans are given against household jewellery. However, finance is extended only to the extent of the bullion value of the jewellery less the applicable margin. Since the making charges in jewellery can constitute another 10 to 20% of the value, there is an additional cushion for the lender. Also important is the fact that the average duration of a gold loan is about three months. Keeping these factors in mind, an increase in default rates becomes likely only if the fall in price of gold is both sharp say, of the order of 30% or more and takes place suddenly over three months or less,” Mr Nandkumar had said.
This is not just restricted to Manappuram. We also have been repeatedly writing about the flaws of gold-loan companies’ business model. For more information on this, check the third part of our three-part exposé here.
Unfortunately, this went completely unnoticed by financial regulator, Reserve Bank of India (RBI) until last year, 14 months after our exposé. It issued a notice albeit too late, which stated: “Manappuram Finance, Thrissur, Kerala, is not permitted under the Reserve Bank of India Act, 1934, to accept/renew deposits from the public”. The fact that, in 2010 itself, over 90% of Manappuram's borrowings were secured against the very loan it gives out, which is akin to pyramiding which risks being toppled. And that is exactly what we are seeing now. We had written about this when RBI’s action came too late. Check here
to read how and why regulators act too late in interest of our consumers.
Earlier this year, again albeit too late, the RBI Working Group headed by KUB Rao also expressed concern
on some gold loan NBFCs, which have been raising public deposits surreptitiously through unincorporated bodies. It also said, “Based on the number of complaints received against such companies, it is apparent that the mammoth expansion had taken place at the cost of sound internal controls. Several undesirable features such as poor know your customer (KYC) compliance, poor storage facilities for gold accepted as collateral, increased incidences of frauds and robberies, opaque auction procedures, all pointed towards rising operational risk as well as consumer protection issues in such companies”.
The bottomline is that unless there is stringent regulation and supervision, gold-loan companies will always have a shaky business foundation, which is fraught with too much risk, not only to investors but also to consumers as well.