Care Ratings Webinar on Gold Loan NBFCs

Please find our summary of excellent webinar conducted by Care Ratings on structure of Gold Loan Industry. (Emphasis Ours)

Industry Overview

The major differences between Unorganised and Organised Players are classified under: Safe Custody of Gold, Interest Rate, Regulations, LTV (Loan to Value Norms)

The Advantages outlined by the speaker for organised players are listed above. The infrastructure in the organised sector is secured whereas in the unorganised sector it is not the case. Most of the companies under the umbrella of organised sector come under the regulation of either Ministry of corporate affairs or Reserve Bank of India.

Aggregate Growth of loan Portfolio

Gold Loan NBFCs created a stronger base with significant expansion during the period FY08-FY12 mainly driven by branch expansion. High Volatility in gold loan prices in 2012 has adversely impacted the profitability and even recovery of ultimate principal in some cases. This coupled with major regulatory intervention by RBI had set the base for new phase of growth with low credit cost and healthy profitability.

Regulatory Change-Leading to stronger asset quality

GNPA (Gross Net performing assets) levels are generally low for Gold loan NBFCs. The reason for that is the collateral is Gold which can be easily sold and recovered if the borrower fails to pay the loan amount.

NPA is termed as a bad debt of the lender when it is not returned after 90 days. Usually, 90-day period is a standard period; however, the time can be longer or shorter as mentioned in the terms and conditions of the lending.)

(The difference between gross NPA and Net NPA is that Gross NPA is the non performing asset that includes both the principal and the interest amount while Net NPA is the asset obtained after subtracting provisions from the Gross NPA)

Also the auction losses have also been controlled with regulator bringing in restrictions on LTV. Generally, the loan to value ratio is bought under control to minimise losses if the gold is not sold at a requisite amount.

Further the companies have also mitigated the price risk of gold by focusing on shorter tenure loans and lower LTVs for longer tenure loans.

Impact of Covid-19 on Gold Loan NBFCs

Because of the covid-19 there was a huge lockdown. Due to Lockdown there was a restriction on opening of new branches. With the sentiment going south people stopped borrowing in a way leading to shortage of funds. The repayments became smaller and thus leading to some losses. In the last few years there has been a rising trend of online gold loans.

AUM growth comparison

Loan against gold ornaments had become one of the easily available sources of fund for households and small businesses when economic activity resumed post lifting of lockdown.

Growth rate of gold loan NBFCs started showing improvement immediately post the lockdown in Q2FY21 as compared to credit growth of banks and NBFCs.

AUM in relation to Gold price and Gold Holdings

AUM is derived based on Gold prices and Gold Tonnage with the gold loan company.

AUM = Gold Price * Gold Tonnage * LTV

Competitive Position of Gold Loan NBFCs

Profitability – Interest spreads- Likely to remain high

Yield on advances of larger gold loan NBFCs are high and almost comparable to some of the unsecured asset classes. But smaller Gold loan NBFCs provide loans at lower rates to attract borrowers from competition.

High yields arising from relatively smaller ticket size of loans wherein ROI has not been the major decision making factor- convenience/ease of raising loan is the major factor.

Larger size coupled with stronger credit profile command lower cost of borrowings resulting in higher spreads. Also, majority of the borrowings of the gold loan players are mostly of short term in nature.

Higher yields likely to sustain- as convenience outweighs cost for this segment of borrowers cost of funds-likely to remain stable given stronger credit profile of larger gold loan NBFCs.

Profitability - Operational expense- High in relation to other NBFCs

Operating expense always remains relatively high for gold loan NBFCs due to factors such as requirement of physical infrastructure, high employee base, security costs, etc.

With use of technology in the security aspects, the requirement of a physical security guard is reducing significantly.

However, Opex ratio (Operating ratio shows the efficiency of a company’s management by comparing the total operating expense (OPEX) of a company to net sales) improves as the AUM per branch improves significantly.

Profitability -Credit Cost- Low

Gold loan NBFCs has physical possession of the underlying collateral i.e. gold ornaments. Entities have a right to auction the gold once the loans become overdue.

Credit cost is basically interest and other related expenses. When we say the credit cost as a percentage of Average total cost (ATA) is low, it means that the interest component in the overall average component is coming low which is a good sign.

The major risk that gold loan NBFCs are exposed to is under-recovery in the auction which may result in principle/interest losses in case of fall in gold prices and inadequate asset coverage. However, the same has been mitigated by measures such as shorter tenure loans, Lower LTVs for longer tenure loans and periodical interest collection.

Lower credit cost is one of the competitive advantages of gold loan NBFCs;

Credit cost is likely to remain low; as long as present cap on LTV is maintained and recovery steps initiated in early stages

Global Loan Industry Overview

According to World Gold Council (WGC), India and China account for nearly half of the global demand. In 2019, India accounted for the 16% of the global gold demand.

Over the past 2 decades, gold demand in India has been range bound between 700-900 tons per year.

Roughly two-thirds of gold holdings are primarily concentrated in the rural pockets of the country.

According to a KPMG analysis report, the total gold loan outstanding in the organized sector was less than 5% of the total household gold holdings in India, indicating significantly low penetration in the industry.

Unorganized gold financiers comprise 65% of the total gold loan market.

Demand Driver for Gold Loans

Also, as income levels go up, the value that people attribute to their time goes up, and this increases the demand for gold loans (which is available instantaneously with minimum hassles) for meeting short term, small ticket needs. (Opportunity cost of alternative loans—involving multiple visits to branches, time consuming documentation etc—increases.

Some relevant Macroeconomic trends

Low penetration: Notwithstanding rapid growth achieved by organized players in gold loans, the market penetration is still quite low. Most private gold remains locked up in safes and vaults. This indicates a potentially large untapped market.

Unorganised players dominate:

Gold loan sector continues to be dominated by unorganised players who still command an estimated 65% market share.

Demonetisation, GST, pandemic impact and digitization trends are hastening pace of formalisation of India’s economy. This presents organized sector gold loan players with better opportunity to grow business by taking market share away from unorganised players.

International Gold Price holding relatively firm:

Gold prices may fluctuate in the medium term; they have been on a steady uptrend in the long term. Over the past 5/10/15 years, gold prices have delivered 14%/10%/14% CAGR.

Advantage Gold Loan NBFCs over Banks

Depth of reach: Compared to Banks, the focussed non-banks are better placed here because their low cost model in terms of employee strength & other infrastructure makes it easier to open new branches in rural and semi-urban areas. (A critical factor as the bulk of India’s private gold resides with the rural population.)

Operating cost: Banks have much higher operating cost, they would hesitate to venture in these parts given limited potential for other business.

Availability of Valuers and specialised infrastructure at branches for specialised NBFCs as compared to banks.

Documentation: Banks have to ensure complete KYC compliance when disbursing loans, while NBFCs can do with simplified KYC compliance as a general practice.

Quicker (TAT) Turn Around Time: Specialised NBFCs disburse loans within – minutes while banks take few hours or even days to disburse loans. Certain NBFCs also started digital disbursements.

Repayment flexibility: Normally NBFCs granting bullet payment loans with pre-payment facility while banks are generally grants EMI-based loans and changing penalties for pre-payments.

Working hours: NBFC branches are open beyond banking hours, unlike bank branches. It ensures that daily wage earners don’t lose a day’s work in their quest to avail the loan.

Niche Customer Base, easy accessibility of a large branch network focused only on gold loans.

Given high margins and negligible credit costs, specialised gold NBFCs generate return ratios superior to NBFCs peers. Even during past years of turmoil, these companies delivered an average 25% ROE, which highlights the strength of their business model.

Advantage over NBFCs in other product segments:

a) Less competition from banks given the niche expertise required,

b) Low asset quality risk due to the 75% LTV cap and highly liquid collateral,

c) Strong ALM (Asset Liability mismatch) position with short loan tenures, and d) low balance sheet leverage.