Gold loans: The “Titan” Moment in Gold loan business

Gold loans: The “Titan” Moment in Gold loan business

Q1FY22 represented a perfect storm for the gold loan sector. Gold prices had crashed 15% towards the end of Q4FY21, lock-downs had impacted demand as well as ability of customers to earn & repay, and banks had to deal with additional problem of lowering LTVs from 83% to 68%. It was no surprise that most players witnessed de-growth in loan book, rise in NPAs and subdued profitability for the quarter. Tough times generally separate the men from boys. Muthoot Finance & Manappuram had emerged as “men” in the last downcycle (FY13-16). Let us observe what the current cycle is trying to tell us.

Banks: Gold loan has never been a high priority product for banks due to the operational challenges surrounding this business. But the rally in gold prices since 2019, lack of avenues to grow elsewhere in the post IL&FS economy and RBI relaxation on LTVs during the Covid year nudged a few banks to go aggressive on gold loans. SBI and CSB were at the forefront, lending at 83% LTVs and grew 460% and 61% respectively in FY21.

Then came the perfect storm of Q1FY22. While AUM growth was flat to negative, NPAs spiked sharply. CSB clearly articulated that they will be focusing on collections and auctions in the coming quarters rather than growth. While SBI didn’t talk much on gold loans, they may also have to spend some time in learning “how to manage the down cycle”

Loan book (INR bn) GNPA
Mar'21 Jun'21 % QoQ Mar'21 Jun'21
SBI 210 213 1.4% 0.8% 2.2%
CSB 61 56 -8.2% 0.8% 6.3%
HDFC Bk 72 72 0.1%

*Investor presentations & concalls

NBFCs: NBFCs didn’t have to deal with LTV changes as they were not granted any special dispensation either. Yet, the other two storms i.e. gold price fall and lockdowns had to be grappled with. Except for Manappuram, the large gold loan NBFCs fared much better than their banking counter parts, thanks to their learnings from the previous cycles.

Loan (INR bn) GNPA
Mar'21 Jun'21 % QoQ Mar'21 Jun'21 Portfolio yield
Muthoot Fin 519 521 0.3% 0.88% 1.22% 21%
Manappuram 191 165 -13.3% 1.90% 2.00% 26%
IIFL Finance 131 133 0.8% 0.90% 0.90% 18%

*Investor presentations & concalls

Why is Muthoot Finance’s performance exceptional?

Unscathed by the storm: Despite the strong loan book growth over past two years, Muthoot could manage this storm with flat loan book, negligible rise in NPAs, negligible auctions at INR1.3bn and a double-digit growth guidance for the whole of FY22! Management is clearly indicating that they are not damaged in the storm but are ready for future growth. While there are many reasons like their past experience, well-oiled collection machinery, conservative lending standards, etc, the most important reason seems to their cost leadership. Let’s delve a little deeper.

The virtuous cycle of cost leadership: Like most corporates, Muthoot Finance too likes to maintain its margins & profitability. In the early years (2010-13), competition was low, operating costs were very high and charging higher interest rates (16-24%) were vital for NBFCs to maintain profitability.

But as years passed, the branches become more productive, operating costs started reducing. The management was quick to pass the benefits to customers in form of lower interest rates. This in turn helped the company to get access to better quality customers and higher loan growth. This further increased their branch productivity and reduced operating costs again. The virtuous cycle continues till day.

Competing with banks, yet profitable like an NBFC: Thanks to its cost leadership, Muthoot has products that allow it to lend across the spectrum of banks as well as NBFCs (10-21%). As such, it is able to access prime customers compared to its NBFC counter parts and that has been one of reasons why the customer stress was so low during the current storm. Another thing to note is that the reduction in lending rates hasn’t resulted in reduction of profitability. In-fact profitability is at its best ever. Profitability built on basis of cost leadership is the most sustainable kind of profitability.

One explanation for its ability to generate 21% yield at the portfolio level despite lending at lower
rates is the high levels of activity at its branches (lot of loans are originated & settled within the quarter, which improves the yield on quarter ending loan book).

Is this the Titan moment for Muthoot Finance?

Somewhere in 2015-17, it became clear that Titan’s jewellery business was “breaking out” of the pack i.e. it had become significantly stronger than its closest competitors. The stock got re-rated significantly because market participants realized that over next 10 years, Tanishq will capture very large part of the profit pool of the jewelry industry in India. We have seen similar trends happen with Hatsun in Dairy space in 2016-19, Cholamandalam in CV space in 2016-18, AU Bank in the small finance bank space in 2017-19.

Is this a similar moment in gold loan space? Time will be the best judge but the stars are aligned. Manappuram has a long road ahead, as it has to change its strategy of high yield lending. IIFL Finance has got its strategy around gold loans absolutely right (selecting operating leverage over higher ending rates), but is has to deal with high borrowing costs, other problematic areas like MFI, developer, LAP, and has a much smaller branch network. And valuations of Muthoot Finance are amongst the lowest for leaders.

Trivia – How tech savvy is the gold loan business?

India’s most valued Fintech company i.e. Bajaj Finance too has joined the gold loan bandwagon.Even more enlightening is the fact that it is taking the old brick & mortar route i.e. opening 25 new physical branches (12 in Jaipur & 13 in Vaizag) exclusively for gold loans! May be that’s as much tech as gold loan business needs! Should investors not be bullish on the best player in this space, where everyone else is seeing so much merit in this business?