Gold loan companies don't relish a fall in the price of the yellow metal. It hurts them in more ways than one.

First, it can increase defaults, and second, the loan size will come down in sync with the value of the metal. This will decelerate the business growth of these companies, almost all based in Kerala.

Since January, the retail price of gold has dropped by about five per cent.

India's second largest gold loan company, Manappuram Finance Limited, has caused a mild storm by announcing that it is expecting an under-recovery in some gold loan portfolios. It goes without saying that the risk is more in respect of loans issued prior to the Reserve Bank of India modifying lending guidelines in March 2012, capping the loan size at 60 per cent of the metal's value. This is called loan to value or LTV. The gold loan firms had lent up to 85 per cent of the value before the new norms came in place. If industry sources are to be believed, even after the new rule, where possible the firms tweaked the valuation methods to qualify a piece of gold ornament for higher loans. For gold loan companies, growth comes from lending more.

The gold loan companies, interestingly, lend only against jewellery as they believe a borrower has a sentimental association with his or her jewellery, and would want to clear the loan soon in order to take it back.

According to a report that the rating agency ICRA Limited released on March 21, in Manappuram's case, the weighted average LTV stood at around 70 per cent. "While ICRA had expected some deterioration in asset quality on account of lower refinancing capacity, the quantum of delinquencies is higher than ICRA's expectations. Further, the portfolio originated in October 2011-February 2012 would be most vulnerable to the transition when it completes 12-18 months," the report notes.

In the first nine months of financial year 2012/13, Manappuram reported profits of Rs 84 crore as against Rs 161 crore in the same period last year. As of December 31, 2012, it had a gross non-performing asset of 1.02 per cent.

"The negative news was specific to Manappuram, and the markets have discounted the stock," says Alex Mathews, Head of Research at Geojit BNP Paribas Financial Services Limited. "I am cautiously optimistic about the future of Manappuram." The Manappuram scrip closed flat at Rs 24 on the National Stock Exchange on Thursday.

The fall in the price of the yellow metal, in any case, has not dramatically improved buying at jewellers. "The buying has been stable although gold prices have been volatile in the past six months," says Ganesh Narayan, Joint Managing Director at C. Krishniah Chetty & Sons, a jewellery retailer in Bangalore.

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Keywords:Gold loan companies, yellow metal,gold, Manappuram Finance Limited, gold ornament , jewellery , sentimental association, agency ICRA Limited, Manappuram's case,ICRA, Research, Geojit BNP ,Paribas Financial Services Limited, National Stock Exchange , jewellery retailer,Business news