RBI WG Report on Gold Loan NBFCs

RBI WG Report on Gold Loan NBFCs 

Gold Loans by NBFCs and banks, need not be discouraged: RBI’s working group, in its report, has given its opinion that lending against gold has not led to increase in gold prices and higher gold imports, and indicated that it believes lending against gold by NBFCs and banks is important to the financial system, as these organizations channelize monetization of idle gold lying in the country and provide timely credit to low and middle class people who instead would have sought loans from pawnbrokers. In our view, these observations in the report would help in reducing the worries regarding the regulatory overhang on gold loan NBFCs, which was the primary reason for the relative underperformance of listed gold loan companies. 

LTV to be raised to 75% from 60% currently, but calculated explicitly on the ‘value of metal’: 

The working group recommends raising of loan- to value (LTV) for gold loan NBFCs, as they believe a) constricted LTV has/would lead to borrowers shifting again to pawnbrokers and b) there is minimal threat to financial stability of these companies, considering remote  possibilities of steep correction in gold price and current low NPA levels in this business. Additionally they recommend LTV to be calculated explicitly on the  ‘value of gold’ linked to a benchmark. Currently,  many  gold  loan  NBFCs  add  making  charges  to  value  of  metal  in jewelry to calculate 60% LTV, thereby leading to an effective LTV of 70-75% on the value of the metal.   Earlier, this was a grey area, with a risk that RBI may arrest the loophole. Now even if it does mandate the ‘value of metal’ as the benchmark, but if the rate is fixed at 75%, then it would not lead to any material change on ground as to the amount of loan the NBFCs can disburse against jewelry, while concerns regarding the grey area would be eliminated.   

Lending rates to be capped:

The working group recommends limiting the lending rates of gold loan NBFCs by linking them to a benchmark rate. We note that the RBI in the past had capped the interest rates on MFI loans to 24%. In our view, considering the relatively higher comfort on asset quality front, the cap could be lower for gold loan NBFCs. The calculated yield on assets for listed gold loan companies is ~20-25% currently. In our view, capped lending rates could impact

the profitability of gold loan NBFCs in the near term, though the final fine print on this remains to be seen.   

Apprehensions on retail NCD funding:  

The working group expressed apprehensions about funding done by gold loan NBFCs via NCDs from branches, as in their view, it equates to taking public deposits, which such NBFCs are not allowed. Hence, the committee recommends increasing the ticket size of such NCDs to keep retail investors away. In our view, restrictions on NCDs could affect the growth and profitability of such NBFCs. Amongst listed entities, as we understand, the impact would be lower for Manappuram Finance than Muthoot Finance, as the proportion of retail NCDs to total borrowing is much higher for the latter.  

Tighter KYC norms for higher transaction size:

The working group also proposes to formalize and tighten the existing KYC norms by mandating use of PAN card and cheques for loans disbursals above `200,000. As we understand, less than 10% of loan book of the listed NBFCs is above this ticket size, thereby making it relatively less challenging to comply operationally.   

Unbridled branch expansion to be moderated:

With a view to moderate the rapid  spread of branch network for some of the gold loan NBFCs, so as to ensure  adherence to proper risk management practices and procedures, the group  recommends restricting opening of new branches once a level of 1,000 branches  a year is reached. But it remains to be seen if such regulation gets implemented,  that artificially curbs growth of the larger players.  

Outlook and Valuation:

Of the various recommendations, depending on how  stringently they are implemented, those regarding cap on interest rates and branch  expansion could pose a risk to growth and profitability of the gold NBFCs. However otherwise, the basic affirmation that the country’s increasing gold imports  are not being further fueled by these NBFCs, but rather that they could have a positive role to play, would provide significant comfort to the investors regarding  the regulatory overhang that has plagued the sector. Removing the grey area  surrounding LTV would also be positive, provided the LTV cap is finally set at  at least 75%. Even after the sharp run up in stock prices, Manappuram Finance trades at 1.4x TTM P/BV, while Muthoot Finance trades at a higher 2.5x TTM P/BV. If and when implemented, there could be further upsides in these stocks, especially in Manappuram Finance, as it is trading at a large discount to Muthoot Finance.  

DISCLAIMER 

This document is solely for the personal information of the recipient, and must not be singularly used as the basis of any investment decision. Nothing in this document should be construed as investment or financial advice. Each recipient of this document should make  such investigations as they deem necessary to arrive at an independent evaluation of an investment in the securities of the companies referred to in this document (including the merits and risks involved), and should consult their own advisors to determine the merits and risks of such an investment.