June 25, 2012

Mumbai

Muthoot Capital Services Limited

Ratings Remains on ‘Watch Negative’

(Refer to Annexure 1 for details on facilities)

CRISIL’s rating on the debt programmes of Muthoot Capital Services Ltd (MCSL; MCSL; part of the Muthoot Fincorp Ltd [Muthoot Fincorp]-MCSL combine, which is controlled by the Muthoot Pappachan group) remains on ‘Rating Watch with Negative Implications’.

For arriving at its ratings, CRISIL has combined the business and financial risk profiles of Muthoot Fincorp and MCSL together referred to as the Muthoot Fincorp-MCSL combine. This is because Muthoot Fincorp and MCSL are controlled by the Muthoot Pappachan group and have significant financial and operational linkages with each other.

CRISIL placed its ratings on the debt programmes on watch on March 30, 2012, following the Reserve Bank of India’s (RBI’s) press release, issued on March 29, 2012, cautioning the public against placing deposits in Muthoot Estate Investments (MEI), a partnership firm in which the promoters of Muthoot Fincorp are the partners. RBI, in its press release, had stated that MEI, being a partnership firm, is prohibited from accepting deposits from public. Furthermore, RBI had cited that these deposits are collected through Muthoot Fincorp’s branches at different locations in Kerala. Consequently, RBI had directed Muthoot Fincorp to stop allowing the use of its premises/branches or officials, in any manner by MEI for accepting deposits from public.

CRISIL’s rating action reflects the potential uncertainties arising out of the regulatory and governance issues highlighted by RBI. In addition, the quantum of deposits raised by MEI is material, in relation to the asset base of the Muthoot Pappachan group. CRISIL is in discussions with Muthoot Fincorp’s management to assess the impact of these developments on the company’s credit risk profile. Muthoot Fincorp has stopped its deposit-taking activities in MEI. The company has also made a representation to RBI (accompanied by a legal opinion) that contends that MEI is permitted to take public deposits and that there has been no violation of the RBI Act. However, full clarity on the legal and regulatory treatment of these deposits is yet to emerge. With respect to the use of Muthoot Fincorp’s branches for collecting deposits on behalf of MEI, the company has also started separating the branches, employees and other infrastructure of Muthoot Fincorp and MEI; but full compliance may take two to three quarters, considering that the majority of Muthoot Fincorp’s branches in Kerala were carrying out this activity.

CRISIL will continue to closely monitor the manner in which Muthoot Fincorp systematically addresses the regulatory, governance and process issues highlighted in the RBI release. Furthermore, the response of various stakeholders, including Muthoot Fincorp’s bankers and retail debenture holders, to this development will continue to be monitored by CRISIL.

The ratings continue to reflect the extensive experience of the Muthoot Pappachan group’s promoters in financing against gold, and the Muthoot Fincorp -MCSL combine’s strong and stable asset quality, and healthy earnings profile. These rating strengths are partially offset by the combine’s susceptibility to changing regulatory and to legislative framework, geographic and product concentration, and significant dependence on banks for funding.

CRISIL believes that a series of recent regulatory pronouncements on the gold loan non-banking financial company (NBFC) sector will benefit sector over the medium term. The cap on loan-to-value (LTV) ratio at 60 per cent will further strengthen asset quality of the gold loan NBFCs. Business growth of these entities will decline significantly in the short term, but is expected to stabilise at a sustainable level of around 20 per cent in the medium term. On account of the high fixed-cost structure and heightened competition from banks and the unorganised sector, profitability of the sector is expected to halve to around 2.5 per cent return on assets (RoA), but remain healthy and sustainable over the medium to long term.

However, the gold loan NBFC sector is likely to face challenges in the near term, as it transitions into the new regulatory regime. Disbursements for the overall sector, including the Muthoot Fincorp-MCSL combine, have declined sharply in the past couple of months and this trend is likely to continue for a few more months. Although resource raising capability of the Muthoot Fincorp-MCSL combine is currently stable, funding-related challenges may emerge if fast-paced regulatory changes (both for the combine and for the sector) make the lenders, particularly banks, more cautious. Despite these near-term challenges, CRISIL’s ratings on MCSL continue to reflect Muthoot Fincorp-MCSL combine’s good asset quality, liquidity, and potentially lower, albeit relatively healthy profitability. CRISIL will closely monitor the growth (the level of fresh disbursements), profitability and funding situation as well as the impact of any additional regulations on the Muthoot Fincorp-MCSL combine.

About the Combine

Established in 1994, MCSL commenced operations with financing against gold and two-wheelers. Muthoot Fincorp, set up in 1997, is a non-deposit-taking, systemically important non-banking financial company. Muthoot Fincorp is the flagship company of the Muthoot Pappachan group, which is also into hospitality, real estate, and power generation. Muthoot Fincorp distributes mutual funds, and general and life insurance products, and is also in the money-transfer business. The Muthoot Fincorp-MCSL combine had 1645 branches as on December 31, 2011, most of which are in South India.

For 2011-12, the Muthoot Fincorp-MCSL combine reported a PAT of Rs.3.1 billion on total income of Rs.15.7 billion, against a PAT of Rs.2.2 billion on total income of Rs.8.0 billion for the preceding year. The combine had assets under management (AUM) of Rs.74.5 billion as on March 31, 2012, compared with Rs.39.4 billion a year ago.

Annexure 1 - Details of various Bank Facilities