Gold Loans NBFCs: Auctions to Stabilize; Intensifying Competition from Banks to Lead to Adoption of Aggressive Growth Strategies

23 Feb 2022 , 08:27 AM

India Ratings and Research (Ind-Ra) believes that auctions by gold loan non-bank finance companies (NBFCs) would normalize in 4QFY22, as gold prices have stabilized since October 2021, after periods of corrections seen since December 2020, along with normalcy returning in business activities. However, facing intense competition from banks, and absence of any similar spikes in gold prices, NBFCs, especially the ones with a large portfolio, are likely to adopt aggressive strategies to maintain and expand their gold loan franchise. Some of this would reflect in compromising on margins while offering lower yield loans, especially large ticket size loans, to retain customers, incurring higher operating expenditure, and probably driving flexible loan terms, thus impacting operating performance.

The gold loan auctions by NBFCs rose in 9MFY22, perhaps highest since FY14 when gold saw larger volatility in its prices. NBFCs offering gold loans faced higher auction pressures in 9MFY22, largely due to the COVID-19 impact on borrowers’ cash flows and gold price correcting by around 10% during mid-June to 30 September 2021. A similar fall was seen in 4QFY21 adding further pressure in 1QFY22. Figure 1 reflects a sizeable proportion of loans turning delinquent, leading to auctions in the range of 4% to 13% of gold AUM in 9MFY22 across lenders with subsequent build up in gross stage-3 assets. The total stress would be even higher than the summation of these data as not all delinquencies are auctions with some managing to arrange payments. As gold loan borrowers, especially small ticket ones, are generally among the financially weaker segments, the auction data also indicates the high stress among these borrowers largely due to pandemic. This is corroborated by the high delinquencies observed in microfinance loans in 9MFY22.

The sharp rise in delinquencies and auctions are a reminder that the asset class performance remains vulnerable to sharp volatility in gold loan prices and income volatility among weak borrowers.

While NBFCs have seen a sharp rise in loan auctions, the situation at banks have been less intensive as the regulations ensure that the loan-to-value (LTV) ratio remains lower throughout the tenor of the loans, increasing the incentive for borrowers to arrange for the redemption of gold loans from lenders.

Ind-Ra notes that the general practice among NBFCs financing gold loans is to limit the LTV ratio at 75% at disbursal and this buffer could reduce on a build-up of interest. However, banks are required to maintain LTV of 75% during the entire tenor of loans. As per the respective internal risk policies, NBFCs largely send auction notices to borrowers if the accrued interest + principal dues lead to a rise in LTV to 90%-95%, thereby necessitating borrowers to either top-up the collateral or close the loan. In case of a shortfall in both the cases, the borrower collateral goes for an auction.

As gold prices seem to have stabilized and price holding current levels, Ind-Ra opines that the auctions would stabilize towards long-term average, in the absence of sharp corrections. Furthermore, a large portion of auction could mean that some weak borrowers would have filtered out. Also, the high liquidity in collateral and fast liquidation ensure modest loss given default for lenders. In most of the cases, losses are limited to part of interest. if any. However, the larger implication is on loan portfolio expansion.

Many banks both private and public have become fairly active in the gold loan space, enticed by high yield and liquid security. For e.g. gold loan portfolio across banks has jumped by more than 89% yoy to INR607 billion in FY21 and INR709 billion in 9MFY22.

These banks have large distributed presence and have strong pricing power. Furthermore, since these loans are to be distributed from mostly existing infrastructure, the incremental operating expenditure is moderate. The gold loans across banks which are classified as agricultural gold loans where there is LTV relaxation available, providing banks with the ability to offer similar terms as that of NBFCs.

The higher competition from banks could result in NBFCs pursuing aggressive strategies to maintain and expand their gold loan franchise. This could result in an increasing proportion of lower yield loans especially in higher ticket size loans and expansion in operating costs impacting profitability. Furthermore, there could be a temptation to make loan terms more flexible.