IPO Grading

Muthoot Finance Limited

CRISIL IPO Grade 4/5 (above average)

Elizabeth John Analyst, CRISIL Equities Chetan Majithia Head, CRISIL Equities

April 2011

Disclaimer A CRISIL IPO Grading is a one-time assessment and reflects CRISIL's current opinion on the fundamentals of the graded equity issue in relation to other listed equity securities in India. A CRISIL IPO Grading is neither an audit of the issuer by CRISIL nor is it a credit rating. Every CRISIL IPO Grading is based on the information provided by the issuer or obtained by CRISIL from sources it considers reliable. CRISIL does not guarantee the completeness or accuracy of the information on which the grading is based. A CRISIL IPO Grading is not a recommendation to buy / sell or hold the graded instrument; it does not comment on the issue price, future market price or suitability for a particular investor. CRISIL is not responsible for any errors and especially states that it has no financial liability whatsoever to the subscribers / users / transmitters / distributors of CRISIL IPO Gradings. For information on any IPO grading assigned by CRISIL, please contact 'Client Servicing' at +91-22-33423561, or via e-mail: [email protected]. For more information on CRISIL IPO Gradings, please visit http://www.crisil.com/ipo-gradings

Grade
CRISIL IPO Grade 4/5: This grade indicates that the fundamentals of the issue are above average, relative to other listed equity securities in India. However, this grade is not an opinion on whether the issue price is appropriate to the issues fundamentals

Issue details
Shares offered to public As per cent of post issue equity Object of the issue 51,500,000 13.85% Amount proposed to be raised Price band Lead managers To augment the companys capital base to meet the future capital requirements for funding of loans to customers General corporate purposes

Not available at the time of grading Not available at the time of grading ICICI Securities, Kotak Mahindra Capital Company Ltd, HDFC Bank

About the company

Headquartered in the southern Indian state of Kerala, Muthoot Finance Ltd is a non-deposit taking systemically important non-banking finance company (NBFC) incorporated in 1997. It is primarily in the business of lending against household used gold jewellery to individuals. Muthoot Finances operating history has evolved over a period of 70 years since Mr M George Muthoot (the father of the present promoters) founded a gold loan business in 1939 under the heritage of a trading business (under partnership firm) established by his father, Ninan Mathai Muthoot in 1887. In 2001, it received the NBFC licence from the RBI. Muthoot Finance has the largest branch network among gold loan providers in India with 1,605 branches and a strong presence in under-served rural and semi-urban markets in India. It reported AUM of Rs 74 bn in FY10. During 2010, the company received fund infusion amounting to Rs 2.5 bn from private equity players like Baring India Private Equity, Matrix Partners India, Kotak India Private Equity Fund and Wellcome Trust for a 6% stake in the company. Further, in 2011 Wellcome Trust picked up additional 1% stake from the promoters, taking the total stake of private equity investors to 7% in the company. Current promoters Mr M. G. George Muthoot, Mr George Thomas Muthoot, Mr George Jacob Muthoot and Mr George Alexander Muthoot (all brothers) are collectively operating the company under the brand The Muthoot Group. The group has diversified interests in financial services, hospitality, healthcare, education, plantations, real estate, foreign exchange, information technology and insurance distribution.
1

Detailed Grading Rationale

A. Business Prospects

Under-penetration in domestic LAG industry indicates huge untapped potential

The annual consumption of gold in India estimated at 65 tonnes in 1982 increased to ~700 tonnes in FY10, out of which 80% is for jewellery fabrication (source: Bureau of Indian Standards). India accounts for ~10% of the global gold stock. The overall gold pledged in India accounts for hardly 4.7%; 75% is pledged with local moneylenders and pawnbrokers who constitute the unorganised market. Fast growth recorded by organised players increased their market share to more than 25% in FY10. Huge untapped potential of loan against gold (LAG) along with a high share of unorganised players augur well for the organised LAG industry in India.

Figure 1: Organised LAG in India grew at a CAGR of 40%

(Rs bn) 400 350 300 250 200 150 100 50 0 25 FY02 120 FY07 250 FY09 375 FY10

Figure 2: Under-penetration in LAG industry

Value (Rs bn) Estimated gold stock in India Organised gold loans % of estimated gold stock Unorganised gold loans % of estimated gold stock Total pledged gold loans % of estimated gold stock Source: DRHP 32,000 375 1.2% 1,125 3.5% 1,500 4.7%

Volume (tonnes) 18,000 211

633

844

Source: DRHP

The strong growth in the organised LAG industry is supported by increasing inflation, secular bull run in gold prices (appreciated 268% during FY02-10) and an increase in the number of branches.

Early-mover advantage, established track record and strong brand name

Muthoot Finance has been in the gold loan financing business for nearly seven decades. An early entry in this business, not only in South India but also in other regions, has helped the company develop a strong brand image, wide distribution network (1,605 branches as of FY10) and AUM. The promoters rich experience in the LAG business coupled with their execution capabilities enabled the company to scale up its operations significantly in recent years - AUM has grown at a four-year CAGR of 74% to Rs 74 bn in FY10.

Niche and largest player in gold financing

Muthoot Finance has emerged as the largest player in the niche business of gold financing, both in terms of AUM and distribution network. The company has grown its market share by 9 percentage points during FY07FY10 (relatively largest increase, where other players have even lost market share) on account of its recognisable brand name, particularly in South India. Its growth was on the back of offering innovative schemes to cater to the needs of various customers.

Major players with AUM

Estimated gold loans portfolio (Rs bn) Gold Loans Provider FY07 FY09 FY10 FY07-FY10 Absolute growth Muthoot Finance# Muthoot Fincorp Manappuram# Indian Bank Indian Overseas Bank Federal Bank South Indian Bank State Bank of Travancore Andhra Bank 15 5 5 17 17 6 6 11 4 33 12 12 33 31 11 15 16 9 73 22 26 39 52 9 24 19 14 59 17 21 22 35 3 18 8 10 Growth (%) 417% 368% 433% 131% 209% 43% 292% 69% 250% 11% 4% 4% 13% 13% 5% 5% 9% 3% 13% 5% 5% 13% 13% 4% 6% 6% 4% 20% 6% 7% 10% 14% 2% 6% 5% 4% Gold loans market share (%) FY07 FY09 FY10 FY07-FY10 % change 9% 2% 3% -3% 1% -2% 2% -4% 1%

# includes assignments
Source: DRHP

Strong systems and processes, quick disbursement

Over the years, Muthoot Finance has developed specialised credit processes to appraise loans against gold, assess gold purity and monitor loans. The management has instilled strong processes and systems, and hired experienced personnel who understand the gold loan business because although a vast proportion of the processes are automated, faster and efficient distribution of loan depends on human assessment of gold. It employs in-house staff to appraise the gold and every employee acts as an appraiser which entails quick disbursement of loans. All branches are audited either weekly or monthly, and quality of gold pledged is verified randomly for fraud and negligence by employees. The end-to-end process from appraisal to disbursement is completed swiftly, which provides an edge over banks. The internal systems and processes have minimised the number of frauds and errors by employees.
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Strong asset quality; NPA around 0.46%

Muthoot Finance has maintained strong asset quality supported by its comfortable loan-to-value (LTV) ratio at origination, robust systems and processes, and the highly secured nature of the LAG business. Strong underwriting standards have resulted in very low gross non-performing assets (NPA) of 0.46% for the company. Sentiment attached to the household ornament also support low NPA. Also, the ultimate losses have been lower; it has incurred credit losses lower than Rs 30 mn over the past seven years, out of cumulative disbursement of more than Rs 590 bn. Gold loan is provided on the basis of weight of the gold ornaments excluding cost of studded stones and making charges for the ornament which further lowers the LTV of the loan. Such factors along with sentiment attached to ornaments discourage customers from defaulting.

Enjoys diverse resource profile

Muthoot Finance has access to a diversified resource profile. As of FY10, it had a total debt outstanding of Rs 52 bn. Its established track record helps to mobilise funds from retail investors by issuing non convertible debentures (NCD) through its branches offering interest rates of 11-11.5%. As of FY10, NCD contributed 51% to its reported total borrowing.

Growing and managing branch network outside the South

Muthoot Finance is aggressively expanding its footprint outside the South, especially in northern and western India where it sees strong business opportunities. Over the past two-three years, its branch concentration in the southern market has reduced from 85% to around 70% in FY10. Overall, AUM per branch is slightly lower in the North. However, the same is expected to improve as awareness about LAG increases.

Figure 3: Loan concentration in South India slowly reducing

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% North 13% FY08 South 14% FY09 West 15% FY10 East 82% 80% 75% 1% 4% 1% 5% 2% 8%

Figure 4: Branch concentration in South India down

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 8% FY08 Northern India 10% FY09 Southern India 17% FY10 Western India 17% 5m FY11 Eastern India 85% 81% 70% 69% 1% 6% 2% 7% 3% 10% 3% 10%

Source: DRHP

Source: DRHP

Dependence on single line of business; concentration in southern India

Muthoot Finance derives 98% of revenues from the gold loan business. Also, it is expected to remain concentrated in South India, which accounts for 75% of AUM for the short to medium term despite aggressive growth plans in the northern and western states.

Intensifying competition to lower gold loan yields, thereby putting margin pressure
With low entry barriers in the LAG industry, many players have entered this segment. With competition heating up in the LAG industry, CRISIL Equities expects the gold loan yields to reduce, especially of NBFC players, who charge relatively high interest rates compared to banks. This will result in pressure on NBFCs net interest margins, thereby impacting their profitability.

Sharp downside in gold prices a key monitorable

A significant rise in gold prices along with the increase in loan requirement by customers has boosted Muthoot Finances AUM. Any sharp fall in gold prices could pose challenges. However, Muthoot Finance has a comfortable LTV ratio in line with other gold financing NBFCs ranging from 70-80%, which helps it to combat the downside in gold prices. Also, the shorter tenure of gold loans (usually ranging from three to six months) offers flexibility of resetting the LTVs. The maximum three-month and six-month downside risk based on the past 38 years gold price movement is only 10% and 20% respectively, which provides a cushion based on the LTVs (70-80%). Our study based on the historical gold movement concludes that the probability of gold prices falling for more than 10% for the continuous three-month and six-month period is only 2% and 4%, respectively.

Figure 5: Maximum downside risk on 3-month basis is ~10%

25% 20% 15% 10% 5% 0% -5% -10%
Mar-72 Mar-74 Mar-76 Mar-78 Mar-80 Mar-82 Mar-84 Mar-86 Mar-88 Mar-90 Mar-92 Mar-94 Mar-96 Mar-98 Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10

Figure 6: Maximum downside risk on 6-month basis is ~20%

125% 100% 75% 50% 25% 0% -25%

3-month movement in gold prices

6-month movement in gold prices

Mar-72

Mar-74

Mar-76

Mar-78

Mar-80

Mar-82

Mar-84

Mar-86

Mar-88

Mar-90

Mar-92

Mar-94

Mar-96

Mar-98

Mar-00

Mar-02

Mar-04

Mar-06

Mar-08

Source: World G old Council, CRISIL Equities

Source: World Gold Council, CRISIL Equities

Regulatory hitches can be a bottleneck

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 Muthoot Finances 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 remains a sensitive factor for the company. In addition, extension of regulatory restrictions on securitization to bilateral direct assignments being adopted by the company can be a hurdle. Also, any cap on interest rates can adversely affect the companys performance. We believe that RBIs recent directive for removal of priority sector lending (PSL) benefit available to commercial banks, under agriculture classification, for gold loans to (and assignment portfolios from) gold loan companies would adversely affect the company leading to an increase in borrowing cost and a moderation in return ratios.
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Potential risk of brand dilution

Although Muthoot Finance is a strongly entrenched brand name in gold loan financing, the use of the moniker Muthoot by other gold loan financiers, like Muthoot Fincorp, could create some confusion in the market and pose a risk for Muthoot Finance. However, both these companies, till date have been able to maintain their distinct brand identities.

Mar-10

B. Financial Performance
Muthoot Finances AUM increased at a CAGR of 74% from Rs 8 bn in FY06 to Rs 74 bn in FY10 driven by a rise in pledged gold and a significant spurt in gold prices.
Figure 7 : AUM up with gold prices and rise in pledged gold
Rs bn 80 70 60 50 40 30 20 22 10 8 0 FY06 FY07 FY08 FY09 FY10 Gold prices (RHS) 15 4,000 2,000 0 8,730 10,179 13,780 16,716 74 17,874 Rs per 10 gm 20,000 18,000 16,000 14,000 12,000 10,000 8,000 34 6,000

Muthoot Finance AUMs (LHS)

Source: World G old Council, CRISIL Equities

On the back of growth in AUM, interest income increased at a CAGR of 66% from Rs 1.4 bn in FY06 to Rs 10.8 bn in FY10. Profit after tax (PAT) improved from Rs 271 mn to Rs 2,276 mn in FY10. The adjusted EPS and adjusted book value of the company increased at a CAGR of 53% and 43% respectively over FY06-10. Gross NPAs have been contained to less than 0.5% in the past three years.
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Muthoot Finance enjoys a strong capital to risk adjusted ratio (CRAR) of 15% which is in excess of the RBIs requirement of 12%. The company frequently sells its portfolio under bilateral direct assignments which also helps it keep its capital ratio strong. In 2010, the company raised Rs 2.5 bn from private equity players, which will help it shore up capital base and fund its growth.
Financial performance snapshot
FY08 Gold AUM (including assignments) Gold volume pledged Interest income Interest expense Net interest income Other income Net profit Adjusted EPS Adjusted equity shares Net worth Adjusted book value RoE RoA Gross NPA CRAR Tier I capital Source: DRHP Rs mn tons Rs mn Rs mn Rs mn Rs mn Rs mn Rs mn Rs mn Rs % % % % % 21,790 30 3,579 1,798 1,781 107 636 2.6 246 2131 8.7 34% 3% 0.42% 12.6% 10.6% FY09 33,001 39 6,062 3,098 2,965 142 977 3.5 280 3614 12.0 34% 3% 0.48% 16.3% 12.5% FY10 73,417 66 10,775 4,737 6,037 119 2,276 7.6 301 5842 19.4 48% 5% 0.46% 14.8% 9.9%

C. Management Capabilities and Corporate Governance

Strong capability of promoters

Muthoot Finance is largely a promoter-driven company where the promoters belong to the same family. The current management is headed by third generation entrepreneurs. Several decades of experience of the promoters in the gold loan financing business, coupled with the companys strong processes and systems, has enabled it to scale up its operations significantly with AUM growing at a CAGR of 74% during FY06-10 and distribution network growing to 1,605 branches in FY10. Aged between 55-60 years, the promoters are fast approaching retirement. Hence, succession, especially from within the family, would be a key monitorable.

Strong internal processes and systems

Loan against gold is largely a process-driven industry. Employees mostly deal with gold and cash. The management has built in a robust internal system and processes by virtue of their years of experience in the loan against gold business. The focus has minimised number of frauds and errors by employees over the years.

Fairly experienced second line of management

The top management team is well supported by the second line of management who possess adequate qualifications and experience. Mr. K P Padmakumar, who is an executive director in the company, has more than 35 years of experience in the banking industry and is associated with the company for the past five years. Mr. K. R. Bijimon (chief general manager) has been with company since its inception.

Experienced and reputed independent directors

Muthoot Finances board consists of eight members- four of them are the promoters and the rest are independent directors, as per the minimum requirements stipulated in the Securities and Exchange Board of Indias (SEBIs) listing guidelines. The independent directors are professionals and industrialists with in-depth experience and knowledge. Out of the four independent directors, two have been associated with the company for three years while two have been appointed in July 2010.
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Compensation level of key management personnel is low

The compensation level disclosed for key management personnel (KMP) appears low which can result in attrition. However, most of the senior people in the management have been associated with the company for a long time thereby minimising this risk.

Annexure I
Business Profile
Business overview Muthoot Finance is in the business of lending against household used jewellery. It is the largest gold financing company in terms of AUM as well as branch network with highest concentration in South India. Muthoot Finances target audience consists of small businessmen, vendors, traders, farmers and salaried individuals, who for reasons of convenience, accessibility or necessity, avail credit facilities by pledging their gold jewellery rather than by taking loans from banks and other financial institutions. It meets its funding requirement by issuing non-convertible debentures (NCD) called Muthoot Gold Bonds, bank loans, subordinate debt and assignments. The gold loans offerings are usually of shorter tenure ranging from three to six months with a maximum term of 12 months.
Figure 8: Branch network grew at a 3-year CAGR of 40%
2,000 1,750 1,500 1,250 1,000 750 500 985 1,605 1,921

Figure 9: 69% of branches are located in South

1% 6% 2% 7%

100% 90% 80% 70% 60% 50% 40% 30%

707

3% 10%

3% 10%

85%

81%

70%

69%

20% 10% 0% 8% FY08 Northern India 10% FY09 Southern India 17% FY10 Western India 17% 5m FY11 Eastern India

250 0

FY08

FY09

FY10

5m FY11

Source: DRHP

Source: DRHP

Figure 10: Gold AUM expands at a 3-year CAGR of 73%

(Rs bn) 80 70 60 50 40 30 20 10 0 FY07 FY08 FY09 FY10 14 22 33 73

Figure 11: Volume of gold held by Muthoot Finance

(tonnes) 70 60 50 40 30 20 10 0 FY08 FY09 FY10 39 66

30

Source: DRHP

Source: DRHP

Revenues from gold loan constituted 98% of the total income. Additionally, it provides money transfer services through its branches as a sub-agent for various registered money transfer agencies and recently commenced providing collection agency services. It also operates three windmills of 1.25 MW in Tamil Nadu.
Key operational Data
Parameters Ticket Size Yield Gross NPAs Source: DRHP Range : Rs 2,000 to Rs 1,00,000 (Average Rs 26,183 in FY10) Range: 12% to 30% p.a. (Average 19.94% p.a. in FY10) Less than 0.5%

Pre-issue shareholding pattern#

Pre-IPO Placement , 7%

Post-issue shareholding pattern

Public, 14%

Pre-IPO Placement , 6%

Promoter group , 93%

Promoter group , 80%

Source: Company, DRHP

Source: Company, DRHP

#In 2011, Wellcome Trust bought further 3.2 mn equity shares from the promoters

Annexure II: Profile of the Directors

Name M. G. George Muthoot Designation Age Qualification Promoter, Whole-time Director & Chairman 61 Engineering degree and businessman by profession Date of Joining Since Experience & previous employments National executive committee member of the Federation of Indian Chamber of Commerce & current chairman of FICCIKerala State Council. Conferred the Mahatma Gandhi National Award for social service for 2001 George Thomas Muthoot Promoter, Whole-time Director 59 Businessman by profession Since Inception Muthoot Vehicle & Asset Finance Ltd, Muthoot General Finance, Muthoot Insurance Advisory Services, Muthoot Properties and Investments, etc George Jacob Promoter, Muthoot Whole-time Director 58 Civil engineering degree from Manipal University and businessman by profession. Member of the Trivandrum Management Association, the Since Inception Muthoot Securities Ltd, Muthoot Commodities Ltd, Muthoot Vehicle & Asset Finance Ltd, Muthoot Investments, etc Directorships / partnership in other entities Muthoot Gold Funds Ltd, MGM Muthoot Medical Centre Private Ltd, Muthoot Vehicle & Asset Finance Ltd, Muthoot Securities Ltd, Muthoot Commodities Ltd, Muthoot General Finance, etc

from Manipal University Inception

10

Confederation of Real Estate Developers Association of India (Trivandrum) and the Trivandrum Agenda Task Force George Alexander Muthoot Promoter, Managing Director 55 Chartered Accountant Since Inception Chairman of the Kerala Nonbanking Finance Companies Welfare Association from 2004 to 2007 and is currently its vice committee member of the Equipment Leasing Association, Chennai. He is also MD of Equipment Leasing Association. Founder member of the Indus Entrepreneurs International, Kochi Chapter P. George Varghese Nonexecutive Independent Director 62 Graduate in mechanical engineering from Kerala University Jan 2008 MD of FCI OEN Connectors Limited and FCI Technology Services Ltd, VP of the Kerala 2006 to 2007 Indo American and has been on managing committee of Chamber of Commerce from 1992 to 1999 FCI OEN Connectors Ltd, FCI Technology Services Ltd, Geomaths Stocks & Ltd, Prime Business Private Ltd, Prima Components Ltd, Yoj-Ujar Stocks & Shares Trading Private Ltd. Muthoot Vehicle & Asset Finance Ltd, Muthoot Securities Ltd, Muthoot Commodities Ltd, Muthoot General Finance, etc

Management Association from Shares Trading Private

Name

Designation Age Qualification

Date of Joining

Experience & previous employments

Directorships / partnership in other entities

K. John Mathew

Nonexecutive Independent Director

78

Graduate in law from the Government Law College, Ernakulam. Retired judge of the High Court of Kerala. President of the Peoples Council for Social Justice, Kerala.

Jan 2008

Served as the Chairman of the Nil Cochin Stock Exchange and was a SEBI nominee director of the Cochin Stock Exchange from 2002 to 2007

John K. Paul

Nonexecutive Independent Director

57

Graduate in engineering from the Regional Engineering College, Kozhikode and a businessman by profession.

Jul 2010

Director of Popular Automobiles Ltd, Popular Vehicles & Services Ltd, the first Maruti dealer in Kerala and of Popular Mega Motors (India) Limited., the dealer for TATA Commercial Vehicles. President of the Kerala Chamber of Commerce and Industry from 2005 to 2006. President of both the Kerala Hockey Association from 2005 onwards and the Ernakulum District Hockey Association from 2004 onwards

Popular Vehicles and Service Ltd, Popular Kuttukaran Cars Private Ltd, Kuttukaran Machine Tools, etc

George Joseph

Nonexecutive Independent Director

61

A commerce graduate from Kerala University

Jul 2010

Former chairman & MD of Syndicate Bank. Before joining the Syndicate Bank, he was employed with Canara Bank for over 36 years.

Nil

11

Source: Company, DRHP

Notes

Notes

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