For George Alexander Muthoot, gold loans are a business driven by sentiment. It may sound soft-hearted, even soft-headed to the cynical, but the gold-loan NBFC has been doing exceptionally well. Between FY19 and FY20, the company’s net income grew 28% from Rs.68.8 billion to Rs.97 billion, and its net profit went up 51% from Rs.19.72 billion to Rs.31.69 billion. Amid the lockdown, loan moratoriums and shrinking economy, its stock price rose 120%, from Rs.508 on March 23 to Rs.1,098 on September 9, on the back of 40% rise in gold loan demand.

Alpesh Mehta, deputy head of research at MOFS, says the NBFC’s biggest strength is its robust network of branches — over 4,500 in FY20. This is the highest for any NBFC; even the largest private bank has about 5,300 branches across the country. Yes, it’s capex-heavy, but it’s necessary for a gold-loan business. The NBFC also offers a wide range of loans, which start as small as Rs.1,000 and have no upper limit, and for anywhere between 7 days to 12 months. 

Besides its reach, the company has also worked on its customer service. Loans are processed in hours, where banks could take up to two weeks. Therefore, even when Muthoot Finance charges rates upwards of 11.99%, it gets more business compared to PSU banks who charge 8-9%. As all lending is based on highly liquid collateral, MOFS’ Mehta says, “It’s the safest business to be in... You have to do something really foolish to get this wrong.” 

A second-generation entrepreneur and MD of the country’s largest gold-loan NBFC, Muthoot tells Outlook Business how they have managed to keep growing over the past 80 years, and why gold loans flourish in a good and bad economy.

With the economic environment turning uncertain, other banks and non-banks are looking at gold loans, too. What is Muthoot’s competitive strength in this space?

We have been in the gold-loan business for ages and it forms nearly 90% of our total business. We know every aspect of it and have built a strong retail franchise. We also have a team of 25,000 employees dedicated to this vertical, can process loans in 10 minutes and have various schemes that charge interest rate between 11.99% and 23%. Our clients keep coming back to us, more than 75% of our clientele are repeat customers. There is increased competition, but we have faced this before, in 2011. Suddenly, gold loans were in the limelight, and many banks and non-banks were trying to enter this space. But, even then, gold loans were just one of the many products they were offering. They were not focused, and we maintained our lead.

In terms of cost of funds as well as cost-to-income ratio, and even branch network, Muthoot will be way less competitive than banks. How do you stay competitive?

We don’t see banks as serious competition because it does not make sense for them to issue gold loans on a large scale. The cost of operations is high, and the average ticket size is too small at Rs.60,000. Therefore, for banks, gold loans form only 1-2% of their total businesses. Anyway, funding costs have started to come down in the past 30-40 days as commercial paper rates have come down. Cost of other modes of borrowing has also fallen by 100-200 basis points.

Does digital lending work for gold loans?

These loans are of small ticket size and customers are more comfortable coming to a branch with their ornaments. In gold loans, digitisation has been only for payment of loans, collection of interest and so on. This has had minimal impact on our operations or costs because, as I have said, these are small loans and most borrowers don’t have to service EMIs. They return the principal amount within one to two months. That said, people have been doing more digital transactions after demonetisation and lockdown. They used to be less than 20% of the total pre-COVID but now form 40%. Noticing this change, from March end through April, we started mapping and linking our customers’ bank accounts to our loan accounts to make payments easier.

To deposit gold, we started a ‘Loan at home’ programme, for customers opting for loans more than Rs.200,000. Through this programme, we verify the borrower’s credentials through the KYC process before sending our team to check and collect the gold. Once the collection is done, the loan is released immediately. This has helped customers who are comfortable transacting online, especially HNI clients, who otherwise are reluctant to carry their gold to our branches. 

How secure is the gold-vetting mechanism?

We only accept gold ornaments and not bullion, and we are not purchasing the ornaments, only holding them. Also, the ornaments pledged with us have sentimental value and the families want them back. Only when one is purchasing, we melt them and check for purity. That said, over the years, we have evolved methods to ensure quality. Each of our employees is trained to check the quality of the gold ornaments. We also have a dedicated team of 1,000 employees who visit each branch to check the quality of the collateral. If there is a sharp fall in price and the people don’t take their gold back, we send a notice and auction the gold within 30-45 days.

What kind of loan book growth do you expect over the next one to three years?

As long as there is economic growth, people will look for quick and easy money, and gold loan will be the go-to option. Last year, we grew 22% and this year we are expecting to grow 15%. Since the economy is not doing well and there are moratoriums on loan repayment, banks are hesitant to issue new loans. Therefore, gold loans remain an easy option for both individuals and institutions. Moreover, gold rates going up gives an added benefit.

From past customer behaviour, what is the sensitivity of gold price increase to prepayments? Is there any penalty on prepayment?

To begin with, there are no prepayment penalties on our gold loans. Second, on sensitivity to gold price rise, when the prices rise, some of our customers avail an additional loan on the gold that has been already pledged. Some other customers use it as an opportunity to take back some of the ornaments that were pledged. For example, if five bangles were pledged, the customer might take back one bangle. The maximum loan amount we give is 75% of the gold content value, with a margin of 25%. However, as on June 30, the average LTV (loan-to-value) of our loan portfolio was only 55%, effectively giving us a margin of 45% on the overall portfolio. Additionally, there is cover of about 20-25%, which is the making charge for the gold jewellery, which essentially is the replacement cost for the borrower. This effectively increases our margin even further.

We always safeguard 100% of our principal amount. If the gold price is low, we might lose on the interest amount, which might fall to 14-15% down from our normal realisation rates of 18-19%. Otherwise, we do not lose any money. 

How do you see the macro trend in terms of gold buying and what does this mean for your business?

We are not concerned about fresh buying. We only lease the gold that is stored at homes. In India, around 25,000 tonne of gold is present across households. Of this, only 3,000 tonne has been in the system for gold loans. More than 20,000 tonne of gold is still locked up, so we do not need anyone to make new gold purchases. Instead, we have to make people more comfortable with mortgaging their jewellery, and therefore we have had marketing campaigns such as ‘Gold Loan is Good’ and ‘Sunheri Soch’. We connect to different markets through different strategies. 

What kind of loan-to-value has Muthoot been maintaining for loans disbursed in the past quarter?

As per regulations, we cannot give more than 75% of what we hold in value. On average, people do not take more than 68%. With gold rates rising, it has come down to 55-60%, and that increases our margin. Also, there is making charges on all of these ornaments which the customer would lose if they don’t take it back. It’s not just loan-to-value that is important in our business, it is the sentimental value of that ornament. We have little left to auction from loan defaults. Last year, we had lent around Rs.800 billion in loans and had to auction only Rs.5 billion.

When it comes to margin calls, how quickly can you liquidate the gold? 

If there is a sharp fall in price and borrowers do not take their gold back, we send a notice and auction the gold within 30-45 days. But, the percentage of default is low. People usually pay one-year loans within four to five months. Within six months, 60% of the loans are closed and, by 12 months, 95% is closed.

How much liquidity do you want to maintain over the next one to three years? What kind of compromise do you see in terms of yields and return-on-asset because of increased liquidity?

Return on assets will be lower although I wouldn’t like to put an exact number. As an NBFC, it is always better to maintain higher liquidity. For instance, two years ago we witnessed the IL&FS issue and the Yes Bank problem. Our investors, too, like to see some liquidity in the books. It is a cost but it is a part of the business. I don’t need liquidity since all my loans are short term but my lenders would like to see us maintain some. Last quarter, we had about Rs.90 billion liquidity with us. Although it might be seen as bit high, we would always like to maintain that.

As of Q1FY21, what amount of loans has gone under moratorium across the subsidiaries? What kind of loan loss do you see in non-gold loan portfolio overall?

Gold loans, which constitute 90% of the business, aren’t covered under the moratorium. For import finance, 20% customers have opted for moratorium and we are offering special provisions for housing and vehicle financing. Overall, subsidiaries comprise Rs.50 billion-worth of our portfolio.