August 01, 2013

Mumbai

Muthoot Fincorp Limited

Ratings downgraded to ‘CRISIL A/Negative/CRISIL A1’; Negative outlook continues

(Refer to Annexure 1 for details on facilities)

CRISIL has downgraded its ratings on the bank facilities and debt instruments of Muthoot Fincorp Ltd (MFL) to ‘CRISIL A/Negative/CRISIL A1’ from ‘CRISIL A+/Negative/CRISIL A1+’. The downgrade reflects the expected weakening in the MFL – Muthoot Capital Services Ltd (MCSL) combine’s (together referred to as MFL-MCSL combine) profitability on account of elevated level of delinquencies along with gold price volatility and increased operating cost. The downgrade also reflects the likely funding constraints due to recent Reserve Bank of India (RBI) guidelines restricting the issuance of privately placed non-convertible debentures (NCDs) by NBFCs.

For arriving at its ratings on the bank facilities and debt instruments, CRISIL has combined the business and financial risk profiles of MFL and MCSL. This is because MFL and MCSL are controlled by the Muthoot Pappachan group and have significant financial and operating linkages with each other.

CRISIL expects significant weakening in MFL-MCSL combine’s profitability during 2013-14 (refers to financial year, April 1 to March 31) with return on assets (RoA) likely to decline to just above 1 per cent from 2.2 per cent in 2012-13, and 4.5 per cent in 2011-12. The RoA could further decline by about 75 basis points in case gold price declines further by 5 per cent from the present levels.

A part of high loan-to-value (LTV) disbursements made during several months in 2011-12 have turned delinquent in 2012-13; with decline in gold prices the value of collateral of these delinquent loans was lower than the aggregate principal and interest dues. Consequently, on auction of collateral, the MFL-MCSL combine suffered under-recovery of interest, which was partly accounted in 2012-13; the balance will be accounted during 2013-14 as the auction of such jewellery gets completed during 2013-14. Similarly, part of high LTV loans disbursed during several months in 2012-13 are likely to turn delinquent during 2013-14 resulting in further material under-recovery of interest. The below-average cumulative collections witnessed in the immediate six months after these disbursements (in 2012-13) is likely to result in higher delinquencies at the end of contracted maturity, especially in light of recent fall in gold prices. This is expected to lead to under-recovery of interest on a significant proportion of these loans and consequently, lower-than-expected profitability.

Furthermore, the MFL-MCSL combine has opened over 1200 branches in 2012-13 and plans to add over 400 branches during 2013-14. In the absence of strong advances growth over the medium term, the elevated level of operational expenses is also likely to adversely impact profitability. MFL-MCSL combine’s operating cost has increased by more than 60 per cent for 2012-13 over that of 2011-12 mainly on account of larger branch network, increased marketing expenses for the launch of new loan scheme, revision in staff salary, and change in the depreciation policy. However, the MFL-MCSL combine may report profits higher than estimated by CRISIL for 2013-14 on account of its liberal interest recognition policy that recognises interest on delinquent loans even after contracted maturity and without reference to realisable collateral value. Such accrued interest is reversed in subsequent accounting periods to the extent of under-recovery on auction of jewellery.

Furthermore, MFL-MCSL combine’s funding profile is expected to be under pressure with the recent RBI guidelines restricting NBFCs raising funds through private placement of NCDs. About 24 per cent of the total borrowing, as on March 31, 2013, was from privately placed NCDs. The MFL-MCSL combine is required to find an alternate funding source for these NCDs. Although, the combine is planning to raise funds through public issue of NCDs, the efficacy of this route to garner funds, on an ongoing basis with frequent public issues, is yet to be demonstrated and has not been attempted so far in the Indian capital markets. In addition, incremental funding from other sources, including banks, may slow down due to uncertainties in the sector including gold price volatility.

The MFL-MCSL combine’s business may be adversely impacted by the regulatory issues around Muthoot Estate Investments (MEI), a group entity, continuing to hold public deposits. While unincorporated bodies such as partnership firms and proprietorships are outside the jurisdiction of the RBI (acceptance of deposits by these entities is regulated by state government bodies), CRISIL believes that the RBI perceives significant level of systemic risks associated with acceptance of deposits by such bodies, particularly in cases where large public funds are involved. The size of public deposits held by MEI is substantial and is a little lower than the net worth of MFL, the flagship company of the group. MFL has stated that MEI, in the normal course, can repay these deposits only over a period of eight to ten years as the funds have been invested in long-term real estate projects and a material amount of deposits has been repaid since April 2012. MFL and its group companies’ credit risk profiles will be adversely affected in case MEI is required either by RBI or any other authority to repay the public deposits over a shorter period.

CRISIL’s ratings continue to reflect the extensive experience of the MFL-MCSL combine’s promoters in financing against gold, and its adequate capitalisation. These rating strengths are partially offset by the MFL-MCSL combine’s weakening profitability, its exposure to risks relating to adverse changes in regulatory and legislative framework, geographical and product concentration in revenue, and to significant dependence on banks for funding.

Outlook: Negative

The ‘Negative’ outlook reflects the potential stress on the MFL-MCSL combine’s profitability owing to high delinquencies and gold price volatility. The outlook also reflects the potential uncertainties that may arise on account of regulatory discomfort on unincorporated bodies such as MEI continuing to raise/hold public deposits. The ratings will be downgraded if profitability deteriorates more than expected, or if the combine is unable to raise sufficient debt to replace the existing privately placed NCDs. The rating may also be downgraded if MEI is required to repay the public deposits over a shorter-than-expected timeframe, or if adverse regulatory or legislative developments impact the MFL-MCSL combine’s business risk profile. Conversely, the outlook may be revised to ‘Stable’ if profitability, over the next few quarters, is better than the expected, if MFL-MCSL combine adequately demonstrates a track record of raising debt to replace the privately placed NCDs without disrupting normal business and the legal and regulatory issues concerning the public deposits held by MEI are resolved.

About the Company

MFL, set up in 1997, is a non-deposit-taking, systemically important NBFC engaged in lending against gold. MFL is the flagship company of the Muthoot Pappachan group, which is also into hospitality, real estate, and power generation. MFL also distributes mutual funds, and general and life insurance products, and is also in the money-transfer business. The MFL-MCSL combine had 3453 branches as on March 31, 2013. MFL had an advance book of Rs.86.8 billion with a net worth of Rs.12.9 billion and gearing of 7.2 times as on March 31, 2013.

Set up in 1994, MCSL is a deposit-taking systemically important NBFC. MCSL started with financing two-wheelers; later it offered business loans. In the late 1990s, on account of intense competition, the company exited these businesses and shifted to gold loans. Subsequently, as the group scaled up its gold financing business in MFL, MCSL entered two-wheeler financing once again in 2007-08 and, gradually, exited the gold loan business. MCSL has no public deposits, but plans to raise public deposits. MCSL is listed on the Bombay Stock Exchange and is the only listed company in the group. MCSL has also invested in wind power plants primarily to avail of incentives provided by the Government of India for investments in renewable energy. As on March 31, 2013, the advances portfolio comprised of 65 per cent of two-wheelers and 35 per cent of three-wheelers.

For 2012-13, MFL earned a profit after tax (PAT) of Rs.2.1 billion on a total income of Rs.20.8 billion, against a PAT of Rs.3.0 billion on a total income of Rs.15.1 billion for 2011-12.

For 2012-13, MCSL earned a PAT of Rs.0.22 billion on a total income of Rs.1.07 billion, against a PAT of Rs.0.15 billion on a total income of Rs.0.67 billion for 2010-11.

For 2012-13, the MFL-MCSL combine reported a PAT of Rs.2.3 billion on a total income of Rs.21.9 billion, against a PAT of Rs.3.2 billion on a total income of Rs.15.7 billion for 2011-12.

Annexure 1 - Details of Bank Facilities