Pledging of Shares –A boon or a curse???

Author: Pratik Jain

Pledging of share is a simple mechanism where promoters, in order to raise funds for either personal or company needs, pledge their holding shares to any financial institution, it is a phenomenon in which the promoter of an entity keeps his own stake as collateral for the borrowed funds; the debt can be for personal purposes or for the companies’ sake.

Generally the loans provided is about 25-40 % of the collateral value depending upon the liquidity in the market and the profile of the company and the promoter. Due to restriction on the part of banks to provide such funding, the Non Banking Financial Institutions (NBFC’s) are more active in providing such kind of loans.

So what does it mean for retail investors?

If an entity has raised funds by pledging their shares it means that the company has exhausted all other options of raising capital from the markets. Usually, pledging is used by the promoters as a last resort to raise capital.

If the promoters have raised the capital for the betterment for the business, investors need not worry, but if it has been raised for personal needs it sends a negative signal to the investor. 

The risk for the promoters

The real problems begin when the share prices tumble for any reason, shares worth 200 crores are suddenly worth only 120cr. The lenders would as for ask for more shares as collateral. If the promoter cannot provide more shares than the lender has the right to sell these shares in the market.

The risk for retail investors.

After the SATYAM fiasco, where it was found that most of the shares held by the promoters were pledged, SEBI has made it mandatory to disclose details about pledging of shares. Unfortunately, some of the critical information as to why the shares have been pledged (for personal or corporate reasons) which can change your view about the stock have still not been made mandatory.

The Indian Angle

As discussed above pledging can be risky for a promoter and can even make him lose his stake in the company. Yet more than 800 companies have taken this route to raise capital. As discussed above it is generally the last resort for funding. But promoters still prefer it because it does not lead to dilution of their holdings.

Another pitfall is that financiers have hardly taken a stern view against defaulting promoters. Often imprudent lending leads to the promoter going bust and the retail investors witnesses a loss of wealth.

List of Indian companies as that have pledged shares as a percentage of their holding

% of Promoters holding pledged	Number of Companies	Major Companies
90%+	More than 60	Ansal Properties, United Spirits, Gujarat Pipapav Port
75-90 %	Around 70	Wockhardt, Essar Oil, Orchid Chemicals, S Kumar Nations
More than 50 %	More than 100	Alok Industries, Suzlon, JP Power, Everonn
Less than 50 %	More than 500	Network 18, Tata Tele, Hero MotoCorp

Margin Call - Triggers

In the week ending July 27^th 2012, there was a lot of selling pressures on mid-cap stock like Tulip Telecom, Pipapav Defence, Parsvnath Developers etc. These companies had a very high level of promoters holding being pledged. Shares of Tulip Telecom plunged up to 40 % on a intraday basis on fears that margin calls had been triggered and a large operator was selling these shares before rising and closing at 25 % down. Pipapav Defence was down 12.5 % and 10% on consecutive days .

The companies eventually gave press releases that no margin calls had been triggered and it was business as usual at these companies. So as you can see, even rumors of margin call triggers by finance companies can send the stock tumbling down as everybody presses the panic button and sells. After the events of this week SEBI has swung into action asked BSE and NSE to put these stocks in 5 % circuit filter bracket.

 

 PIC: Drop In price of Tulip Telecom on July 26th, 2012 due to fear of margin call triggers 

Course of Actions for Retail Investors

Pledging of shares by companies’ promoters does not necessarily mean that the company should be avoided totally, but certain prudence should be shown while investing in such companies. Companies with large debt on their books and a large percentage of pledged shares should be avoided. A few exceptions to this can be some large cap companies like Hero MotorCorp. But as Warren Buffett number one rule says “Never Lose Money” one should approach these stocks with a certain level of caution and investors with relatively low risk appetite should certainly avoid them.