Following dissertation is strictly for infomation purpose and any action or inaction because of it should be performed under close supervision of competent authority in field of investment management. :)
Till start of this fateful year Manappurum Finance (MF) stock was flying high and was a rather spoild favourite of FII’s and retail investers. Then came the almighty RBI with its Elder wand (aka audits and further scrutiny and LTV guidelines), whispered ‘Assio Manappurum’, the stock came crashing down to its book value. Now any lending institution quoting at or below its book value isn’t particularly shocking, given that almost all the government bank are quoted at substantial discounts to their book values even though, GOI is behind their back, to pour in more equity as the wave of defaults would come; almost ensuring that the business won’t go bust in reasonably pessimist scenarios.
So the astute reader would ask why am I babbling about MF?
To answer this, let me point to the most dangerous trap that some people on street are concerned with, that RBI asking MF to deposit loans above hundred thousand rupees in an account and not disburse cash. This would have grave repercussion on the firm and would most surely precipitate the worst case scenario. But happening of this is remote, as would be explained later. This scenario also ushers new schemes where same borrower takes multiple loans rather than single large loan, though its feasibility in terms of segregation of modal jewelry value is something I don’t have information on.
Also recent article in national daily news paper cited that Manappurum is giving loan to buy gold, loans are long term, to duration of 5 years, gold bought would be with Jewelers and is in form of coins and bars. This defeats the whole purpose of investing in this firm as short loan backed by easily sellable collateral with high profitability and scalability are the points why one would choose gold finance companies over other lenders. There has been no mention of this product in con calls or research reports and we don’t have data on what percentage of the portfolio comes from lending to buy gold. Though I assume that the quantum is really small compared to the firms assets or it would certainly have been highlighted somewhere. Never the less this is one of major concerns that this blogger has, as he looks for safety first.
Also this firm has large FII holding (35%) in its capital structure, another major drawback or (upside) depending on how you look at it. If FII’s sell and one has opinion that MF is worth investing in, it could create some really exciting buying opportunities for patient investor.
This industry doesn’t have particularly strong lobby representing its interests from the look of it, though they have association constituted under leadership of Muthoot promoters.
Now the gold finance firms came under limelight because of their blinding growth, for example starting from 100 Cr balance sheet to 11,000 Cr one in span of six years in case of MF. Add to that they were immensely productive with ROE in range of 25% and more, ROA above 3.5% on sustained basis.
Gold loan originators typically cater to people who need money on short notice. People come to take loan as they are going for routine purchases and need immediate cash. (as told by management and confirmed first hand)
People ask for sum and are not looking for LTV or interest rates.
They also mention that people take large loan in excess of 1 Lac frequently, while these loans if taken for duration longer than 12 months have to be renewed and re collateralized at appropriate rates at - end of 12 months which abets some of the collateral insufficiency risk.
Now MF has a rather stringent audit system, which is not well known in the equity analyst circle, as it is not mentioned in any reports I have gone through. These people check particular loans disbursed day before almost each day. For example loans given to person on repeated basis, large corpus advances are scrutinized almost every day. This includes collateral checks and other inputs. As person looking for safety this blogger is more interested in collateral than anything else and at what Loan to value of the ornament (LTV) its been given, to this end the system at MF is reassuring.
Earlier these firms valued the Jwellery for their gold content alone but because of the 60% LTV cap imposed by RBI, they have started adding 20% markup to the price of gold and started to lend at 60% of 120% of gold content, effectively lending at about 72% LTV. This translates for us that if the gold value decreases by 28%, the collateral that I have would take care of the loan in case of default.
Cynic like this blogger would assume that gold prices would reduce by 50% from this point, what then, answer to this lies in the loan period which is on average 4 months, ( this may be a bit longer say about 6 months, as management told in con call that the securitization portfolio would be depleted by September { recent securitization guidelines prohibit these companies from Securitizing their portfolios, closing a large finance source for MF} and their securitization portfolio swelled in Jan-March quarter, so the loans securitized in this year would be repaid by September. I am also assuming that the decrease would be gradual with sharp decline in next quarterly filing. If it is not so then managements claim to short loan duration would be in question, seriously undermining my argument towards safety of MF equity.)
If the loan duration is really short one to tune of say 6 months, then each successive new loan would be given at lower amount for each gram of gold pledged when gold prices are decreasing so that the collateral would more than enough to take care of defaults. Now if gold prices decrease by say 25% in a month, then this can cause problem but the history of gold price movement over century has not been that severely volatile. So I am assuming that change in gold prices would be a bit lenient than mentioned earlier. This assumption forms another weak link in my argument that MF equity is reasonable if bought at book level.
The company auctions 2% of its portfolio each year, which is higher than its peer but as long as it fetches sum enough to cover advances this blogger is happy with it. Though this blogger has not taken part in any auction but looks forward to do so.
Easy liquidity of collateral is major positive from this bloggers perspective and is major reason for assuming that MF book value is tangible and differs qualitatively from other lending institutions.
Another point to note is that the borrowers repay interest only and give principal at end of period, which increases yield on the loan as a whole by a small margin. J
Banks that give loan against loan apparently don’t have much risk weightage to gold loans when calculating their capital adequacy ratios, which puts Gold loan institutions at disadvantage as such, but there is no reason to fret over this.
Now the source of funds for FM come from bank borrowing, secured bonds issued to public and securatizatio ( this is going to seize to be an option going forward.) its peer Muthoot actually aggressively markets secured debentures, which MF has started emulating. At about 13% interest rate, the cost of borrowing can go a bit higher as the CP have dried up and they are chasing banks for further funding. But there are many banks with almost no exposure to gold loan originators and as the general advance growth in system dries up ( as is happening now) MF might as well get loans it is seeking from the banks.
MF has about 18% equity of its total assets, far above mandatory requirement of 12% , is rather conveniently placed for growth without much dilution, which is also a reason why its ROE is almost half of Muthoot.
MF has almost two loans per unique customer, has about 40gm of Gold per customer in its vault.
Also remarkable point is that many jewelers are its customers, because of the know your customer guidelines many small borrowers cant approach MF, and they go to jewelers who in turn go to MF, acting as intermediary and eating the spread. As long as collateral is ample this blogger doesn’t see any major pit fall in this though regulator is miffed about this.
Also land developers of small sizes form sizable portion of their clientele, but as mentioned earlier collateral given by such borrowers is scrutinized by more than one auditor, so this is not major concern.
One can hear of company actions that are compliant with new RBI guidelines and a lot of proactive steps being taken at branch levels which does give you good impression of the management as a whole.
Back of the envelop calculations for a tire 2 city branch of MF showed that its operating expenses ( not accounting for interest) come to about 2%-3% of assets of the branch (in inflated assumptions on my part, after authoritative inputs). Currently the figure hovers around 5.75% of total assets on aggregate level, and is possibly because they added about 25 branches for 100 branches at start of year, implying that a large amount of operating expenditure for branches that have not earned much in this year. Also there is talk of consolidation and it appears that they would be amalgamating branches ( rationalization) in almost all the places. This blogger thinks that this would lead to considerable savings in operating expenditure (it’s a rare occasion when blogger agrees with popular sell side analysts).
Now under new policies MF is giving loan based on what amount you want and then decides LTV and interest rate charged. Smaller the amount you want lesser would be LTV and greater collateral needed (in relative terms) from you but interest rate would be lower. This means that company is relying on larger loan sums to drive profitability, which is a worrying sign for this blogger coupled with higher LTV, though at reasonable discounts. We would have greater clarity on the repercussions of this strategy in coming quarter.
There has been some bad press about the company with say promoters or people related to them selling their equity in open market before share price correction, company taking deposits from citizens and some affiliated concern of MF doing business from same premises. This does point to deficient management practices but the business itself is sound and according to what is happening at ground level there has been major shift in policies regarding this in all good ways one would like to see.
What about average yield on the loans disbursed, currently they charge as high as 26% on yearly term, and their average borrower would at least have to pay 18%, from the structure of loans offered.
It appears that unorganized players may take this opportunity to regain the market but as pointed out earlier it may as well happen that they would route the loans to these organized players for safe keeping , earning the spread in between.
Another worry of apex regulator is that gold imports are being influenced by ascend of organized players, to which this blogger has no remark to offer. Though what MF promoter said has some weight age that firms holding in total sat 1.5% of total gold assets in country really cant affect the dynamics of gold import as such.
With worst case scene of say cost of funds at 14% and operating cost at 6% and asset yield of 20% the company would not earn a dime in this year. But slight decrease in cost of funds say (0.5%) coupled with small saving in operating expense (0.5%) and greater advances yield ( 0.5%) which is not too much to ask in this bloggers perspective they might earn say 3 to 3.5 Rupees per equity share that you hold suggesting that you buying each equity share at 21 rupees appear a bargain, when what you are paying is backed by liquidable gold asset worth 21 rupees.
This scenario is clearly not an example of extreme discount issue but starting to score some shares and then accumulating them as prices nose dive from current prices might prove to be wise strategy if the gods seating in regulatory citadel show even slightest sign of contentment over latest development.
Major risk is of further policy actions making accounts at bank compulsory for loan takers and then depositing the loan amounts in the accounts rather than in cash form. If this happens these organized lenders stand to loose major chunk of their business, making 20 Rs cost of equity share rather a blatant overvaluation in retrospect 1 year down the line. But the argument goes like, these lenders like microfinance people cater to under banked population and thus need not be subjected to the said clause. Apparently prominent analyst in Banking space are gung-ho on this possibility and rightly so. But from the bloggers perspective it’s the risk one can take given adequate diversification of portfolio, staggered buying strategy and plentitude of upside if things go even slightly in favor of MF.
