Yellow fever

Vazhappully Padmanabhan Nandakumar, the unlikely poster boy of the gold loan business, started off as an officer with Nedungadi Bank and took over the reins of his family’s money-lending business after the untimely demise of his father in 1986. In the years that followed, Nandakumar managed to persuade investors of the gilt-edged opportunities in a business that was till then the preserve of pawnbrokers and largely confined to the South.

Though listed since 1995, Manappuram Finance caught the Street’s attention when private equity player Sequoia invested $14 million in it at ₹142 a share, in 2007. That investors continued to eat out of the company’s hands was evident when it managed to raise ₹1,245 crore through two qualified institutional placements (QIPs), in 2010. Sequoia’s returns did multiply five times over by the time it exited in 2010 at ₹740 a share, but for investors who invested in the QIP later that year at ₹168 a share (pre-split), the story turned out to be far from alluring. The share price has since halved to ₹46.50. What’s going wrong with Manappuram? To know that, we first need to understand what went right for the Kerala-based non-banking finance enterprise. 

How It All Began

Manappuram ventured into the business of gold financing in 1998 but the business gained traction only around 2006, when gold prices shot up by 36% from $445 per troy ounce (one troy ounce = 31.103 gm) in 2005 to nearly $605 per troy ounce in 2006. Since then, gold prices have gone up by 185% to $1,725 levels. Over this period, Manappuram managed to make a mark for itself by catering to a large section of the population — especially in South India, which accounts for 85% of the gold loan market — which was not considered ‘credit-worthy’ but did own gold jewellery.

Since Reserve Bank of India (RBI) norms mandate that banks must provide small loans (up to a credit limit of ₹2 lakh) at an interest rate not higher than the benchmark prime lending rate, NBFCs such as Manappuram went for the kill. Banks, on the other hand, preferred to participate in the gold loan rush through the securitisation route, or by extending loans to gold-financing NBFCs. And thanks to buoyant equity markets and bank funding, Manappuram’s loan book ballooned from ₹63 crore in FY06 to ₹9,000 crore by FY11. Over the same period, revenues surged from ₹20 crore to ₹1,181 crore and profits zoomed from ₹4 crore to ₹283 crore. 

And now Manappuram is looking beyond its core south market, home to 76% of its 2,738 branches, with the objective of monetising a large part of the gold stock in the country, estimated at around 18,000 tonne. Though not well documented, estimates peg gold loan penetration in the country at under 1%. But what has got the market hooked to the gold loan story is the prospect of high yields on advances. Lending rates of 24-30% and loans of a shorter duration (average tenure of only three months) have allowed Manappuram to report higher net interest margins (NIM) of 13-15% on its loan portfolio and return on equity (RoE) of 30% in the past.

A large part of that is also because of how the company sanctions loans. It estimates loan-to-value (LTV) by taking into account only the scrap value, that is, the value of gold excluding making charges, VAT and so forth. The maximum LTV could be around 85% of the scrap value. “Whenever you buy gold, you pay for making charges but since we don’t take into account making charges when we estimate LTV, we have a minimum cushion of 15% and a maximum of 25%,” says the company’s managing director, I Unnikrishnan, adding, “The cushion protects us from any decline in gold prices.”

As a result, NPA levels stand at an insignificant 0.19% of the total loan book. Says Pankaj Agarwal, analyst, Ambit, “Since the average duration of  the loan is 100 days and since 65% of the loans are repaid within 90 days, the sector is insulated to a large extent from a decrease in gold prices, provided it is gradual.” 

Though Manappuram’s business has been growing at a healthy clip, increasing regulatory headwinds since late 2010 have taken the wind off the stock. 

Mint Street Blues

To begin with, the RBI has removed gold financing from the priority sector ambit, dealing a blow to NBFCs such as Manappuram, which rely on banks for 55-60% of their funding needs. Agarwal of Ambit believes that since the cost of funds under the priority sector was 150-200 bps cheaper than bank borrowings, the cost of funds for Manappuram will go up by 110 bps. Also, capital adequacy norms have been raised for deposit-taking NBFCs from 12% to 15%.

So, for every ₹100 advance, Manappuram has to set aside ₹15 as core capital. Analysts feel the high capital adequacy ratio will restrict the company’s ability to leverage, resulting in lower RoE growth. Earlier, Manappuram could have leveraged its books up to 8.33 times as the company was required to set aside 15% capital adequacy only for 80% of the loans that were on the books.

Now it has to set aside capital adequacy of 15% for the entire portfolio of ₹100. “Regulatory arbitrage is tilted in favour of banks, because for a loan of  ₹1 lakh, the risk weight for banks is 50%, whereas for us it is double that,” rues Unnikrishnan. For now, Manappuram is comfortable with a capital adequacy ratio of 20%. “An increase in capital adequacy ratio has been recommended but it’s not been implemented,” says Santhosh Singh, an analyst with Execution Noble. “It is still a recommendation. Whenever it comes in, it can reduce leverage for Manappuram.”

That’s not all. If the bad loan provisioning norm of 90 days is made mandatory for NBFCs, that will spell more trouble. “This could hurt growth and margins,” writes Kashyap Jhaveri of Emkay. 

The odds are rising

If the buzz in the market is anything to go by, then the road ahead for Manappuram is going to be a difficult one. According to media reports, the RBI may put limits on gold loans as a percentage of scrap value and also restrict the maximum interest on gold loans. However, Unnikrishnan is unfazed. “I have been hearing about this for a year. It’s all hypothetical,” he says. For now, Manappuram is happy about its numbers. Net interest income grew by 84.3% y-o-y to ₹430 crore. The company’s cost of borrowing stood at 12.34% as of December quarter.

Going ahead, it expects an RoE of 22-25% and NIM of 13%. However, some analysts are seeing stress points. Jhaveri of Emkay points out that despite the addition of 1,345 branches in the past five quarters, gold stock additions have consistently declined from 9.4 MT/quarter to 4.3 MT/quarter. Unnikrishnan attributes this to borrowers pledging lesser quantity for the same loan amount following the rise in gold prices but analysts think otherwise. They see it as an indication of a genuine decline in growth and rising competition from other players.

Compounding the weak sentiment around the stock are instances of poor corporate governance. Recently, the RBI barred a promoter entity from using the listed entity’s network to raise deposits from the public. The other issue was that of an independent director selling 13.63 lakh shares just before RBI’s diktat was made public, after which the stock crashed.

Though the management quickly decided to separate the company’s resources from its promoters and formed an independent committee, the damage was already done. So, while valuations may look attractive now with the stock quoting at 1.6 times estimated FY13 book value, the regulatory headwinds mean that Manappuram could well lose its Midas touch.