CRISIL has assigned its ‘AA-/Stable’ rating to the long-term debt programmes of Muthoot Finance Ltd (MFL), while reaffirming the rating on the short-term debt programme at ‘P1+’.

The ratings reflect MFL’s established track record in financing against gold jewellery, its strong and stable asset quality, and healthy earnings profile. These rating strengths are partially offset by MFL’s lack of diversity in financing business, significant dependence on banks for funding, and susceptibility to a changing regulatory and legislative framework.

MFL’s promoter family has been in the business of financing against gold jewellery for almost seven decades. MFL’s specialised end-to-end credit processes, from appraisal to disbursement, the experience of the promoters’ in the business of financing against gold jewellery, the company’s strong brand image, particularly in South India, and wide network have enabled the company to significantly scale up its operations between 2006-07 (refers to financial year, April 1 to March 31) and 2008-09. The company’s assets under management (AUM) increased to Rs.115.50 billion as on September 30, 2010 from Rs.74.38 billion as on March 31, 2010 (Rs.33.69 billion as on March 31, 2009). MFL has a network of around 2038 branches as on September 30, 2010; steady expansion of branches, particularly in northern and western India, will enable the company to improve its competitive position in the business of financing against gold.

MFL has maintained a strong and stable asset quality, supported by its highly secure gold loan financing business, robust systems and processes, and strong credit underwriting norms including conservative loan to value (LTV) levels. The company’s LTV ratio at origination was around 75 per cent as on September 30, 2010. Furthermore, to mitigate operational risks, the company conducts regular risk audits, such as cash verification and valuation of collateral, to ensure adherence to processes. The gross non-performing asset (NPA) ratio in MFL’s gold loan financing portfolio was 0.4 per cent as on September 30, 2010 (0.5 per cent as on March 31, 2010 and 0.5 per cent as on March 31, 2009).

MFL has a healthy earnings profile, supported by its high interest spreads and low credit costs. The company reported a profit after tax (PAT) of Rs.2.0 billion for the first six months ended September 30, 2010, against Rs.2.3 billion for 2009-10. For 2009-10, MFL’s net profitability margin (NPM; based on quarterly average) was 5.2 per cent. However, with the removal priority sector lending (PSL) benefits and increasing interest rates, the cost of bank funding for the company is expected to increase. CRISIL believes that the impact of increase in cost of bank funding on MFL will be offset by the company’s improving ability to access to funds from capital markets, high yields, improvement in operating efficiencies, and low credit costs. NPM is expected to remain comfortable at around 4 per cent, as the company is likely to pass on most of the increase in cost of borrowing to its customers. CRISIL does not expect MFL’s ability to source funds from banks for financing growth or for meeting refinancing requirements to be significantly affected by the removal of priority sector benefits. Nevertheless, given MFL’s significant dependence on banks for funding (working capital or through loan assignment), its ability to source funds from banks and its liquidity will be rating sensitivity factors.

Although MFL has increased its disbursements and assets under management (AUM) significantly at a compound annual growth rate of 68 per cent and 76 per cent respectively over the past four years, its scale of operations remain modest compared to the large asset-financing non-banking financial companies (NBFCs). Furthermore, MFL’s operations continue to be mainly confined to financing against gold/gold ornaments; this business accounted for more than 95 per cent of the company’s overall revenues in the period April to September 2010.

CRISIL believes that MFL’s ability to scale up operations and maintain its robust systems and processes will be critical for maintaining sustainable profitability. Recently, the Reserve Bank of India (RBI) announced the removal of PSL benefits available to commercial banks, under the agriculture classification, for loans to (and assignment portfolios from) gold-loan companies. CRISIL also expects competition for gold-loan players from banks and other lenders to intensify. Therefore, CRISIL believes that although MFL will continue to demonstrate strong growth, its compound annual growth rate will moderate to less than 50 per cent over the medium term, from nearly 70 per cent witnessed over the past four years.

MFL is also exposed to regulatory risks and risks related to a changing legislative framework, especially at the state level. The recent notification by the RBI with respect to priority sector lending benefit for portfolios originated by gold financing companies could result in lower growth and profitability and lower funding flexibility for MFL. The impact of the State Money Lenders Act for NBFCs, the decision on which is awaited from the Supreme Court, could not only adversely affect MFL’s lending rates but also increase its operational expenditure, given the requirements (under the act) of registering all establishments with state authorities and complying with state regulations. The decision of the Supreme Court regarding this issue and future developments in the regulatory environment remains a rating sensitivity factor for the company.

Outlook: Stable
CRISIL believes that MFL will maintain its growth, strong asset quality and earnings profile over the long term. The outlook may be revised to ‘Positive’ if the company improves its market competitiveness significantly without weakening its capitalisation, asset quality, or earnings profile. Conversely, the outlook may be revised to ‘Negative’ in case of a steep decline in the company’s asset quality or capitalisation.

About the Company
MFL, an NBFC, was established in 1997 as a private limited company and reconstituted as a public limited company in November 2008. MFL is in the business of financing against gold jewellery; the promoters’ family has been in this business for almost seven decades. MFL is the flagship company of The Muthoot Group-A Muthoot M George Enterprise, which is also into hospitality, healthcare, media, education, information technology, foreign exchange, insurance distribution, and money transfer services. MFL operates through a nationwide network of more than 2000 branches.

For 2009-10, MFL reported a PAT of Rs.2.30 billion on a total income of Rs.10.90 billion, against a PAT of Rs.0.98 billion on a total income of Rs.6.20 billion for the preceding year. For the six months ended September 30, 2010, the company reported a PAT of Rs.2.00 billion on a total income of Rs.9.00 billion, against a PAT of Rs.0.74 billion on a total income of Rs.4.20 billion for the corresponding period of the previous year.