CRISIL has assigned its 'CRISIL PP-MLD AAr/Positive' rating to Rs.200 crore Proposed Issuance of Long Term Principal Protected Market Linked Debentures of Muthoot Finance Limited (Muthoot Finance). The ratings on existing debt instruments have been reaffirmed at 'CRISIL AA/CRISIL PP-MLD AAr/Positive/CRISIL A1+'.
 
The ratings continue to factor in the established track record of Muthoot Finance's promoters in the gold financing business, strong capitalization and healthy profitability. The aforementioned strengths are partially offset by high geographical concentration of loan portfolio and operations in South India ' which accounted for 49% of the Assets under Management and housed 60% of the branches, as of March 31, 2020 and; inherent challenges in profitably scaling up the non-gold loan segments.
 
The outlook remains driven by Muthoot Finance's demonstrated ability to sustain its strong financial risk profile while profitably scaling its core gold loan business and maintaining asset quality. Having registered a 3 year CAGR of 17.8% - to achieve a consolidated assets under management (AUM) of Rs 46,871 crore as of March 31, 2020, the company continues to retain its leadership position among non-banking financial companies (NBFCs) in the gold financing business. The gold loan book grew at 14.4%% CAGR over last 3 years while the non-gold segments registered a growth of over 300% over similar period, albeit on a smaller base. Asset quality as measured by annualised credit costs has also been under control, despite non-performing asset (NPA) levels exhibiting a rise in Q4 of fiscal 2018, though it has since moderated. Stage III assets stood at 2.2% as on March 31, 2020 as compared to 4.4% (gross NPA of 7%) on March 31, 2018.
 
Profitability has remained healthy over the years and, has improved further in the last 2-3 fiscals, evidenced by a consolidated return on managed assets (RoMA) of 6.6% for fiscal 2020, against a RoMA of 3% for fiscal 2016. The improvement has been supported by high margins and low credit costs (particularly after implementation of IndAS) and, further bolstered by increased collection of interest.
 
The company has strengthened its capital position alongside ramp up in scale of operations, maintaining adequate networth and a comfortable gearing during the course of it. Capitalisation remains strong as reflected in the reported networth of Rs 11,829 crore (consolidated), tier I capital adequacy of 24.3% (standalone) and a low gearing of 3.6 times at a consolidated level, on March 31, 2020. Over the last 5 fiscals, gearing (standalone) has remained below 4 times whereas Tier I capital (standalone) adequacy has remained above 20%.
 
Apart from strengthening its standalone capital position, CRISIL believes that strong internal cash generation from gold finance business will also help Muthoot Finance to prudently capitalise its subsidiaries as they diversify into other asset classes including microfinance, vehicle finance and housing finance. Non-gold segments now constitute about 13% of the total loan portfolio.
 
In terms of funding, while a larger proportion of borrowing has been sourced as funding lines from banks and financial institutions (39%), the company's resource profile remains diversified across avenues like non-convertible debentures and subordinated debt (28%), commercial paper (10%), External commercial borrowing (20%) and other sources (3%) ' as of March 31, 2020
 
The lockdown (presently effective till the end of July 2020 in most parts of the country) declared by the Government of India to contain the spread of the Novel Coronavirus (Covid-19) will have a near-term impact on disbursements and collections of financial institutions. With the lockdown being in its sixth stage now, the relaxations have been granted in a phased manner - varying across geographies. Eventual lifting of restrictions is also expected to be in a staggered manner. Any delay in return to normalcy will put further pressure on collections and asset quality metrics of companies. Additionally, any change in the behavior of borrowers on payment discipline can affect delinquency levels. However, for Muthoot Finance, around 87% of the consolidated loan book is in the gold segment. And within the gold segment, the portfolio loan to value (LTV) is comfortable due to the sharp increase in the gold prices. Hence, timely auction will ensure that credit losses are minimal, even if the company faces delinquencies. For the balance 13% of the portfolio, asset quality risks are likely to manifest, especially in the microfinance segment.
 
On the liability side, the Reserve Bank of India (RBI) announced regulatory measures under 'Covid-19 - Regulatory Package'Ã'Â?, whereby lenders were permitted to grant moratorium on bank loans for a period of 3 months ending May 31, 2020, which - as per RBI announcement dated May 22, 2020 - was allowed to be extended by another 3 months till August 31, 2020. However, Muthoot Finance has not availed moratorium on its borrowings.
 
In terms of liquidity, the company has been able to roll over existing working capital lines and also raise incremental funds over the first quarter of fiscal 2021 thus far, which has aided its liquidity cover. In terms of interest collections in the gold loan portfolio, after a dip in April 2020, collections have started to revive at a healthy pace to restore to pre-covid-19 levels. However, CRISIL will continue to monitor this trend closely.

To arrive at the rating, CRISIL has evaluated the consolidated business and financial risk profile of Muthoot Finance and its subsidiaries, including Muthoot Homefin India Limited, Belstar Microfinance Limited and Muthoot Money Private Limited.

Please refer Annexure - List of entities consolidated, which captures the list of entities considered and their analytical treatment of consolidation.

Strengths
* Established track record and brand name in gold financing industry
Muthoot Finance has sustained its leadership position in the gold financing segment, supported by the long and established track record of 80 years of its promoter family. The company has a large operational base of over 4,500 branches ' spanning across India, which has continued to support its market share of >45% within the universe of NBFCs carrying out gold loan business over the years. Despite modest volume growth, the company's gold AUM grew by 21.4% in fiscal 2020 to reach Rs 40,772 crore at the end of March 2020. The company's operating efficiency ' indicated in terms of gold AUM per branch ' remains high at Rs 8.9 crore as of March 31, 2020, higher than Rs 7.5 crore ' a year ago.
 
Muthoot Finance's extensive branch network and client base, which is relatively more diverse in terms of geographies and is gradually improving further, will improve its competitive position over the medium term. While the company has started to diversify into non-gold segments, its primary focus would remain on gold.
 
* Strong capitalisation
Muthoot Finance's capital position remains strong in relation to its scale and nature of operations, supported its demonstrated ability to raise capital frequently and large accretions to networth. As of March 31, 2020, the company reported a consolidated networth of Rs 11,829 crore and gearing remained comfortable at 3.6 times. Tier I and overall capital adequacy ratios on a standalone basis have also remained comfortably >20% over the last few years owing to moderated growth in business, and stood at 24.3% and 25.5% respectively on March 31, 2020. Over the medium term, the AUM in the gold loan segment is not expected to grow sharply and the share of non-gold segments (affordable housing finance, and microfinance) would remain relatively small scale, therefore ' capitalisation is expected to remain adequate. Even after factoring in leverage in the key subsidiaries, CRISIL believes that consolidated gearing will remain below 5 times over the medium term.
 
* Profitability to remain healthy
Profitability continues to improve reflected in standalone return on assets (RoA) of 6.8% for fiscal 2020 which was higher than 5.7% for the preceding fiscal. This improvement can be attributed to dedicated recovery efforts, favourable movement in gold prices and reduction in provisioning requirements after implementation of IndAS. Despite charging yields which are lower than industry average, the company has been able to sustain margins on account of its high operating efficiency.
 
Over fiscal 2019 and 2020, increased focus on collection of interest on a regular basis along with revision in its interest rates on different schemes, has resulted in sustenance of margins. Additionally, operating expenses remained low and credit costs reduced after implementation of IndAS. Asset quality as measured by annualised credit costs has also been under control, despite non-performing asset (NPA) levels exhibiting a rise in Q4 of fiscal 2018, though it has since moderated. Stage III assets stood at 2.2% as March 31, 2020, as compared to 4.4% (GNPA of 7%) on March 31, 2018.  Lower asset-side risk (security of gold, which is liquid and is in the lender's possession) helps in controlling credit costs in the gold finance business. Over the last three years, credit costs have remained sub 1% of total assets and for the current fiscal 2021, despite the expectation of a marginal uptick in consolidated credit costs due to Covid-19 disruption, profitability is expected to remain healthy in the normal course of business - supported by sustained margins and low operating expenses. As the group is diversifying into other segments, asset quality within non-gold businesses would remain a monitorable.
 
Weaknesses
* Geographical and segmental concentration in operations
Despite gradual increase in diversification over time, Muthoot Finance's operations have a high degree of geographical concentration in operations. South India accounted for 49% of the company's AUM and 60% of its branches as on March 31, 2020. Significant regional concentration exposes the company vulnerabilities of economic, social, and political disruptions in the region. Furthermore, implementation of the Kerala Money Lenders Act, 1958, for NBFCs could affect Muthoot Finance's lending rates and operational expenditure as the compliance requirements under the act would be rigorous and cumbersome. This will remain a key rating monitorable.
 
In terms of concentration across segments, Muthoot Finance has steadily diversified its product suite across housing finance (Muthoot Homefin), microfinance (Belstar Microfinance), vehicle finance (Muthoot Money) and a few other segments. This expansion into non- gold segments and growth of these businesses has resulted in their share in the consolidated AUM, going up to almost 13% as of March 31, 2020. However, it still remains low ' reflecting high segmental concentration in AUM and revenue profile as majority income flows through the gold loan business.
 
* Challenges associated with non-gold loan segments
Given the low track record and seasoning in the non-gold loan segments, the growth, asset quality and profitability in those segments are yet to stabilise. Within the housing finance segment, Muthoot Homefin operates in the affordable housing finance segment, catering to self-employed customers engaged in small business activities and thus, have a relatively weak credit risk profile because of the volatile nature of their income and employment in un-organised segments. Therefore, the delinquencies from this book may increase as the portfolio achieves more seasoning. Similarly, microfinance loans, through which the company intends to cater to weaker sections of the society, are unsecured in nature and are rendered to borrowers with a weak credit risk profile. This segment also exhibits high subjectivity to local socio-political issues. The vehicle finance business, which is relatively new, deals with lending against commercial vehicles and equipment ' majority of which are old vehicles.
 
With respect to impact of covid-19, most of the smaller segments wherein the company operates - micro, small and medium enterprise (MSME) finance, home loans and micro finance, could still witness challenges, especially in the cash salaried and self-employed segment, wherein income streams of borrowers is likely to be affected given the challenging macro environment. Collections across most of these segments have dropped during April and May. However, the group is taking steps to improve its collections in the non-gold businesses by engaging and reaching out to the borrowers.
 
From a longer term perspective, as the growth within these segments has remained limited as yet, the asset quality and profitability in these businesses will be a key monitorable.

The lockdown (presently effective till the end of July 2020 in most parts of the country) declared by the Government of India to contain the spread of the Novel Coronavirus (Covid-19) will have a near-term impact on disbursements and collections of financial institutions. With the lockdown being in its sixth stage now, the relaxations have been granted in a phased manner - varying across geographies. Eventual lifting of restrictions is also expected to be in a staggered manner. Any delay in return to normalcy will put further pressure on collections and asset quality metrics of companies. Additionally, any change in the behavior of borrowers on payment discipline can affect delinquency levels.  On the liability side, the Reserve Bank of India (RBI) announced regulatory measures under 'Covid-19 - Regulatory Package'Ã'Â?, whereby lenders were permitted to grant moratorium on bank loans for a period of 3 months ending May 2020, which ' as per RBI announcement dated May 22, 2020 ' was allowed to be extended by another 3 months on the lenders' discretion. Muthoot Finance has not availed moratorium on its borrowings.
 
The company's liquidity position remains adequate with cash and equivalents balance of Rs 8288 crore as on June 30, 2020 (excluding un-utilized portion of existing term loans, Cash Credit and Working Capital Demand Loans). Liquidity cover for debt and operating expense obligations arising over July and August 2020, without factoring in any roll over or incremental collections, was at 1.3 times. Additionally, the company has been able to roll over/ issue facilities and has also received other sanctions over the last 3 months.

CRISIL believes the company will sustain its strong capitalisation and healthy profitability. Asset quality within the gold business, which accounts for a significant majority proportion of the AUM, would remain stable ' supported by increased frequency of interest collections and the highly liquid nature of the underlying security ' gold ' which should keep credit losses very low. For non-gold segments, maintenance of asset quality and profitability alongside growth, remains a monitorable.

Upward Factors
* Maintaining its strong market position in the gold finance business while increasing diversity in AUM mix
* Sustenance in profitability with RoMA at above 5% on a steady state basis, while improving asset quality

Downward Factors
* Significant and sustained deterioration in asset quality and profitability, leading to moderation in capital position ' reflected in the tier I CAR declining to below 15%.
* Inability to maintain momentum of growth in the gold loan business, resulting in a significant decline in market share.

Muthoot Finance, an NBFC, was originally set up as a private limited company in 1997; this was reconstituted as a public limited company in November 2008. It provides finance against used household gold jewelry; the promoters' family has been in this business for over seven decades, during the initial days ' the business was carried out under the name 'Muthoot Bankers'Ã'Â? which was a partnership firm. Muthoot Finance is the flagship company of the Muthoot group (promoters of Muthoot Finance), which is also in the hospitality, healthcare, media, education, information technology, foreign exchange, insurance distribution, and money transfer businesses.

Any other information: Not applicable