If you have taken a loan against physical gold, now that gold prices are down more than 15% from a year ago, you may be wondering what to do? Should you continue with your loan or repay and get your gold back or just junk it, the last option being the most tempting.
Default is tempting...
It may be tempting to walk away from the loan. Sample this: if you had taken a loan against 10g of gold in December 2011 when the price was about Rs. 29,000 per 10g, you would have got around Rs. 24,000 (about 85%) or so. Now at an interest rate of, say, 24% per annum, that works out to an annual repayment (including principal) of around Rs. 30,500, 11% higher than gold’s current value which is at Rs. 27,191 (approx) per 10g. Companies give the option of repaying the entire principal and interetst in one go at the end of a specified period, known as the bullet repayment structure. In you are on this structure, it would be cheaper to simply buy 10g of gold from the market rather than getting the collateral released by repaying.
...but don’t do it
But remember that defaulting on the loan will impact your credit score. “Default on loan payments negatively affects the borrower’s credit score and hampers chances of getting a loan in the future,” said Harshala Chandorkar, senior vice-president, consumer relations, Credit Information Bureau (India) Ltd. This temptation will get only stronger if gold prices were to fall further. “On average, customers pay back loans within 4 months. In the past, we have seen around 2% people defaulting and with lower gold prices this may increase by another 1-2%,” said I Unnikrishnan, managing director, Manappuram Finance Ltd. He added that the consumer psyche was to buy more gold when prices fall.
What should you do?
If you had taken the loan simply to monetize your asset, it may make sense to repay the amount with only the proportionate interest, rather than wait for the full term. If, on the other hand, there was a financial gap you needed to fill with the loan, then continue it and repay the loan on schedule. Lastly, if you were considering taking a fresh gold loan, then it may be wise to hurry and take advantage of a declining price trend.
NCDs: stay put for now
With major rating agencies putting out a negative outlook on non-banking finance companies (NBFCs) that give loans against gold, non-convertible debentures (NCDs) issued by them are effectively on watch.
In FY’12, these NCDs were quite a hit with retail investors as annual coupon rates were high at 12-13% and the tenor of 24-60 months wasn’t too long.
Stress on financials
If gold prices fall sharply, while the amount that NBFCs lent would remain high, the value of the collateral would fall. In case of a default, even the auction of gold will fetch less value. Companies like Manappuram Finance Ltd have already guided that the losses (thanks to lower gold prices) on the loans given between August 11-12 will be about R40-50 crore in the fourth quarter of FY’13. As explained in the accompanying story, the bullet repayment structure is susceptible to defaults if the value of gold falls sharply.
Lower realisations in auctions aside, the issue is the method of accounting for interest. Instead of reporting it when it is received, the amount is divided and spread across the four quarters. Later, if the actual interest received is lower because of defaults, then the amount already accounted for will have to be reversed and that can lead to losses for the company. In a report, Icra Ltd has revised its outlook on Manappuram Finance to “negative” from stable. The report says that the increase in defaults may necessitate more auctions, which in turn means that the company loses out on interest income.
What it means for you?
Despite uncertainties, gold NBFCs are financially stable as of now. “The ratings of all the three gold loan companies rated by Crisil continue to remain unchanged, although we have recently revised the outlook to negative,” said Pawan Agarwal, senior director, Crisil Rating. “The companies continue to be well-capitalised and have enough cushion in their networth to absorb any potential losses. Their liquidity position also remains good.”
NCD holders need not worry right now. Interest payments are on track, thanks to existing liquidity. But be aware of the risks. If you are getting a good price on a secondary sale via the exchange, it’s worth considering.