As gold prices continue to fall, gold loan companies could find the going increasingly difficult. An analysis by The Indian Express shows that these companies have kept a very thin margin for themselves while giving the loans, far lower than the limit set by the Reserve Bank of India.
For the companies, the potential losses are on two fronts. Slim margins are getting wiped out, but the interest cost of loans they have taken from banks and non-banking financial companies remains high ? even as the value of the gold held by them dips sharply.
The risks are real. Just six months ago when the price of spot gold had reached a lifetime high of Rs 3,159 per gram in November, the companies were offering loans with effective margins of 23% against the 40% mandated by RBI. That cushion had slipped to 5.6% by Wednesday. When offering the loans, the companies had expected the price to remain the same, or even rise.
The companies accept that the average turnover for the loans is about six months. With current gold prices at Rs 2,569.5 per gram at the MCX, an investor who had taken out a loan against gold in November 2012 now has attractive options at the end of six months. Since her gold was pledged at a higher price, the difference is enough to make good on the interest charges as well. Or she can forego the redemption, as the value of the loan she took out is higher than the price of the gold she mortgaged.
Companies like Manappuram Finance Ltd, one of the two largest operating in the field, are however, certain they are on safe ground, because of the Indian way of thinking.
“There is an emotional attachment to the collateral for the family members and this overrules all other factors and induces the borrower to close the loan and take back the jewellery. Since average life of the gold loan is less than six months maintaining an LTV of 60 per cent, the asset will be sufficient to recover the interest and principal,” said I Unnikrishnan, executive director and deputy CEO of the company.
The markets think otherwise. Manappuram shares have been hammered 20.5 per cent since Friday at the BSE; they closed at Rs 15.40 apiece on Wednesday. The larger Muthoot Finance has been down 20.6 per cent in the same period, closing at Rs 120.60 a share. As the chart shows, the companies have consistently overvalued the value of the gold pledged with them to create the headroom of 60 per cent loan-to-value demanded by the RBI.
Prakash Agarwal of India Ratings said there is no good evidence to suggest investors will redeem gold just for emotional reasons.
But George Alexander Muthoot, MD of the eponymously named company, too is convinced their business model would hold. “Though price is an important factor, the business model should not be misunderstood as a business of financing of bullion or shares where mark to market could affect the repayment behaviour. Since we are financing only household jewellery, the impact of such fluctuations is minimal.”
The problem is, however, deeper. A Bank of America-Merrill Lynch report says the current dip is inexplicable. “The gold price collapse is hard to explain when looking at traditional variables such as the trade-weighted dollar or interest rates, raising concerns that the reputation of gold as an alternative to fiat currency may have been damaged,” says the report.
In plain language, this means that the pain will be prolonged. Analysts have factored in a further fall from here.
