Gold Loan business is very old in
India, person holding gold use to pledge it for loan for emergency or business
purposes.
Gold Loan Market in India: In India, there is about 25000
tonnes of gold, of which 80% is held by temples, household as jewellery and
banks reserve. Remaining 20% of the gold, about 5000tonnes is only used as
collateral for loan. Of this, 5000tonne, about 80% Gold Loan business is done
by local money lender & pawnbroker, which is unorganized lending, only
1000tones gold loan business is done by NBFC and Banks.
Generally gold loan is regarded
as emergency or need based loan and their customer base is semi-urban and rural
areas. These customers are generally not catered by the regular banking
channels and their financing needs are mostly met through unorganized segment.
South Indian market, is well penetrated for Gold Loan, somehow the trend of
gold financing is more prevalent in South compared to North India. Kerala leads
in the business of Gold loan, India’s leading player, Muthoot finance,
Manappuram are headquartered in Kerala. Even one of India’s oldest private
bank, South Indian Bank, which has large amount of Gold loan book is based there.
Unorganized vs Organized: The unorganized sector lending is
done at very high interest rate 30-40%, sometimes at even 50%. These money
lenders are not under any regulation from RBI and can do business as they feel
like. In comparison to them, Gold finance NBFC use to lend at 20-25% interest
rate.
The business of organized gold
financing is growing steadily in India for past many years. As organized player
indulge into fair practice with borrower, customers from unorganized sector will
gradually shift towards organized segment. Since the customer size remain very
large in the unorganized segment as we discussed earlier almost 80% is
unorganized, this shift will continue gradually for many years to come. Hence,
the business for most of the gold finance companies should continue to
increase, although slowly.
Operational Parameters Let’s touch upon some operating
parameters one should look. Loan per branch, loan per employees or loan officers
and loan per customers are three important metrics. When loan per branch is
steadily increasing, it means company with similar number of branches and cost
structure is doing more business and hence should be earning higher profit. Now
a days, company doesn’t need as extensive branch network with the use of
technology, company can do larger business from same number of branches, hence
we should also look at loan per employee. Another metrics to look at is Loan
per customer, since this is small ticket size loan, it should be seen that loan
per customer shouldn’t grow beyond nominal GDP growth in India. Faster growth
here, should raise a concern that loan are given to customer with higher risk
profile.
Key Financial Parameters As next step, we will look at
each of the item that’s makes into Profit and Loss account.
Suppose, with every gram of gold,
whose price is about Rs 3200 in India, companies can lend some amount to
borrower. RBI has set that limit upto 75% of the value of gold. This 75% limit
is called Loan to Value (LTV in NBFC companies).
The interest rate at which loan
is given is called Yield. Interest rate ranges in the range of 20-25%. In this
segment, Muthoot charges lower interest rate compared to Manappuram as the size
of the loan at Muthoot is bigger and hence lower interest rate are offered to
attract big ticket loan.
2nd item is Interest
cost: This is the interest rate at which gold finance companies borrow from the
market. Generally, they borrow from banks, capital market and mutual funds by
way of debentures and commercial papers to meet their near term liabilities. Currently,
borrowing rate for two large companies lies broadly in the range of 9.0 – 9.5%
So, it looks like these companies
makes a very large spread because they are borrowing at 9 – 9.5% and lending at
20-25%. While if you compare the same with banks, they would be earning much
lesser spread.
Operationally Heavy Business: There is reason for such large
spread in Gold finance companies. Gold financing is very operational heavy
business with low ticket size and quick churning of loan. Gold are kept at the
same branch where customer deposit their gold, huge operational cost is
incurred for doing the business. The loan per customer is very small, average
ticket size will be 30000 – 50000, hence it takes high cost for acquisition and
managing customers. Both the companies have over 3000 – 4000 branches to
conduct the business. So, the opex ratio for gold finance companies is high at
7-8%, which means 7-8cr is spend on operations for loan book of 100cr. with
more technologies usage and lesser requirement of cash at every branches due to
online disbursement of loan opex ratio will gradually come down. Primarily,
there is three item taken as cost in operations of the company. Employee cost,
Deprecation and other operating expenses at the branch level.
Once, cost is deducted, we arrive
at Pre provision operating profit, also known as PPOP. As we all know, in
lending business, there is always a chance that customer will not return money
on time. Hence, company has to provide provision for anticipated loss on loan
amount. This is widely known as credit cost in NBFC. Generally, in gold finance
companies credit cost is very small as gold is very liquid and easily saleable
assets. In case, money is not returned on time, lender can sell gold in market
and recover their loan amount. After deducting credit cost we arrive at PBT.
Return on Assets, RoA is defined
as how much Profit generated in a year over Loan book. RoA is generally high in
gold finance companies, somewhere in the range of 4 – 5%. With leverage of 4 –
5x, Companies can take the return on equity easily above 20%, which is very
good for any kind of companies in India.
Risk Next, let’s look at the risk
which gold finance companies faces, and how they are equipped to deal with
those risk.
1. First
risk could be from banks. As we saw, gold financing is secured lending and
companies are making high spread. It can attract banks to enter aggressively in
this space. But banks are not focused on Gold finance, Banks are mostly focused
on larger ticket size loan.
2. Rural
distress: If Indian rural economy slows down there will be lesser economic
activity in the country side and hence less demand for fund.
3. Farm
loan waiver: Whenever, we will see distress in rural economy, politician will
bring farm loan or rural loan waiver into discussion. This not only increases
the credit cost we discussed in P&L, it also distort the credit culture in
the country.
4. Price
reduction in Gold. Since, gold is the collateral for loan, if gold price comes
down, lower amount of loan will be given for the same quantity of gold.
Valuation: Lets spent sometime on valuation.
RoE, we calculated in P&L is very important in finding out the fair value
for the company. Suppose there is govt securities G-Sec, which gives us yield
of 8%. So, we pay pari-pasu for investment or Rs. 100 in G-Sec securities and
we take 8% as our base rate of risk free return. Gold Finance companies can
generate 20% RoE, which is about 2.5x of risk free interest rate. If we were
valuing govt securities at pari-pasu, we can value gold finance companies at
2.5x of net worth or book value. This is only one metrics, to value NBFC, but
other than RoE one has to look growth potential in the long term, future risk
and competition to see if valuation should be done at higher or lower than 2.5x.
