Gold prices are falling: According to Reserve Bank of India regulation, gold loan companies can lend up to 60 per cent of the value of jewellery. Manappuram offers loans at 75 per cent of the scrap value of jewellery. At 24 per cent per annum interest, the principal and accrued interest will become 93 per cent of the value of jewellery in one year's time. This scenario leads to an incentive for borrowers to default. So, companies are forced to reverse interest income to prevent defaults.
Profit hit: Manappuram Finance revised its January - March guidance from a profit of Rs 90 crore to a loss of Rs 50 crore due to interest reversals of Rs 250 crore. According to Espirito Santo Securities, Manappuram management explained that this has occurred on Rs 1,500 crore of loans which were disbursed between September 2011 and January 2012 and expected accrued interest of Rs 500 crore up to March 2013. The management said that there may be further losses if the gold price declines from current levels.
Risk management practices: There is a perception that the gold loan business is secure as the underlying asset is highly liquid and the borrower has emotional attachment to the asset. However, the recent episode highlights that slippages are very high (15 per cent of September-December 2011 disbursements turning bad) and even in a stable gold price scenario the company may incur losses, Espirito Santo says.
Bank of America-Merrill Lynch downgraded Manappuram Finance to "underperform" from "buy", and reduced its target price to Rs 20 from Rs 48, citing higher-than-expected under recoveries.
Corporate governance issues: Espirito Santo says Manappuram management had selectively disclosed the revision in the quantum of interest reversals before making it public. This is the second instance of miscommunication with investors. Management committed similar mistakes during Q3 FY13 results. We downgrade our corporate governance rating to Red from Amber, the brokerage added.