The remarkable financial pyramid of gold loan companies
Debashis Basu, Sanket Dhanorkar  and  Pratibha Kamat 22 November 2010

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.

10 years ago
The above information gives prescribed information about the gold listed companies. I totally agree with the above statement Manappuram and Muthoot performance are good but now the gold prices become lower than what circumstance will occur in the gold market.
1 decade ago
?? This article is full of mistakes, and misleading information. Skewed in order to make some kind of a sensationlist headline.
1 decade ago
thanks for providing details of exactly how a gold loan company works.
1 decade ago
In case of banks/finance companies, Loans and Advances will be the major item in assets side of Balance sheet.
Home Loans for Housing finance, Vehicle Loans for Vehicle Finance, Gold Loan for Gold Loan Company
The money raised by banks/finance companies in the form Deposits,NCDs,Bank borrowings,CPs etc.. for providing Loans are secured by a charge on the recievables/Sundry Debtors and not by House,Vehicle,Gold Jewellery which is the property of individual borrower.
Where is Pyramiding? Rubbish.

Replied to TD comment 1 decade ago
TD is right. these companies have the highest corporate governance and the best today for long term investment. their owners are doing god's work.
1 decade ago
I agree with Mahesh. The authors have not explained why they call this 'pyramiding'.
Replied to Kumar comment 1 decade ago
gold loan companies are serving a social cause. their owners should be given padma bhushan
Raghu G
1 decade ago
Indians have close to 15000 tonnes of gold under their custody, the value of the same will be close multiple trillions, and these NBFC plays a crucial role in unearthing these treasure and injecting the same to the financial system, and now these NBFC have gold close to 200 tonnes, if they grow at the current pace, within 5- 10 yrs of time these NBFC (GOLD Loan NBFC) will surpass few of the nationalised banks in terms of turnover, PAT and Wealth creation. I admit that Risk is there in this business, but these gold loan NBFC, espcially Manappuram are pioneers in GOLD Loan, and they have sophisticated method of Risk Management System, including hedging, fraud monitoring cells, Market Intelligence, sohisticated security system, and so on
Replied to Raghu G comment 1 decade ago
absolutely. perfect arguments.
what would it take to change your mind? nothing? is it made up, fixed - under all circumstances?
Raghu G
1 decade ago
Don't under estimate Gold Loan companies, above all these companies are NBFC and one of the priliminary function of a financial companies are borrowing funds and lending the same at margin, and if you can ensure zero percent NPA, this will be one of the best managed financial companies, for a financial companies, investment in fixed assets should be minimum and the maximum amount should utilised for lending, from this scenario these companies are excellent, so investment in these companies to my knowledge is very safe
Replied to Raghu G comment 1 decade ago
One interesting strategy of successful investing is looking for the opposite fact. This is framed as: What would it take to change your mind? In other words, what should happen for you to think that gold loan companies are no longer safe?
Replied to Raghu G comment 1 decade ago
You are correct , these NBFC are the future drivers of Indian Economy,
thomas kuruvilla
Replied to Praveen comment 1 decade ago
Manappuram and Muthoot are the next Reliance
1 decade ago
when an asset price goes up JUST because somebody else WILL buy it at a higher price, the scheme is a Ponzi scheme. A house has underlying cash flow (yes it may not justify the price), but theoretically if I am getting 5% return, it means in a WORST case scenario I can get the full price paid for the house come back to me in 20 years. Gold has not such supporting cash flow. Of course gold lovers say...see 4000 years history. Well we all know history repeats itself...we do not know how often and how many times.
Cherian Verghese
1 decade ago
interesting analysis. waiting for the third part
Tushar Choksi
1 decade ago
I appreciate the insight given by you
atleast investor will think twice before investing in such companies. for your info muthoot is also listed.
1 decade ago
the authors dont seem to understand what "pyramiding" means. banks also provide loans to transport finance companies against the securities of the trucks which lies with the transport finance companies - doesnt mean there is pyramiding there. in fact all bank loans will be classified as pyramiding by these authors
Replied to mahesh comment 1 decade ago
please read the last line as:
" in fact all bank loans to HDFC will be classified as pyramiding by these authors"
Replied to mahesh comment 1 decade ago
well mahesh the fact is the TRUCKS BELONG to HDFC till the last installment is paid
now is THAT diffrent enough for you to understand
ps are you eapen
1 decade ago
Gold is known for its big crashes? Are these people properly hedged or protected against any crash in gold prices.
If such a crash happens, forget about the borrowers, what happens to the institutions who have lent to these companies?
K Narayanan
1 decade ago
If the source of finance of the co is share capital,reserves including PE and bank finance then we shd not bother much.The co borrowing against the gold pledged by the customers is called refinancing in banking parlance and it is perfectly legitimate and permitted by RBI..Banks give loans to SMEs and get it refinanced by SIDBI(earlier for industrial loans they used to get refinance from IDBI).It is better than SKF micro finance getting bank loans at 12% and lending at 24%to small ticket borrowing where the security is the honesty and group guarantee of the poor people.The only question is how far the mgt is trust worthy.Well, it is like asking whether Tata finance and Shriram transport finance who have mobilized FDs would
honour their commitment.It is for the banks to supervise the borrowers vizthe company and the end use of money by the co just like any other loan the banks give to individuals,traders,industries etc.
Tony Joe
1 decade ago
Hi Mr. Unnikrishnan,

What makes asset creation a great thing? If asset creation was the best thing in loans, how did the subprime crisis happen in US? All those loans were for the best asset creation - homes. And what makes you feel that money from gold loan can't be used for asset creation? Funds from these small-ticket gold loans are used for everything from buying cows, to leasing auto-rickshaws, to paying for children's education. The fact of the matter is that gold loans are the most secure of all loans. That also means that even Lehman Brothers and Goldman Sachs wouldn't have lost money on gold loans. But their bet was on asset creation, and see what happened. That is why safety-first players like Sequoia, Capital World, & Nomura made a beeline for Manappuram during the economic crisis, and this is continuing.
1 decade ago
Your in-depth analysis is good. It was time somebody did an analysis on this subject. One reader has compared gold loans to housing loans or auto loans. In the case of housing loans or auto loans, a new asset will be created out of the loan which will be the prime security for the loaner whereas in the case of gold loans no such asset is created. About reputed PE funds putting their investment in the gold loan companies, one is only reminded of Lehman Brothers or Goldman Sachs which were also reputed names a year ago. I believe some co-operative societies/banks are also in the gold loan business but perhaps they are covered by the Societies Act and are regulated by the Registrar of Cooperative Societies.
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