The term “Pledging of Shares” is looked upon with a needle of suspicion by Investors. This is one kind of LOAN against SHARES to raise Finance. Mostly, Investor/Promoter have pledged their shares as collateral to raise working capital or a term loan, to increase their holding or to fund an acquisition as a multinational had done to buy an Indian company. Investors pledging their shares for getting working capital either to trade or invest.
In a scenario of rising stock prices, there is no concern, but if the price of the shares declines to a certain level, the Investors are required to make some payment or pledge more shares. If the Investor defaults or is not able to provide further shares as margin, then the lender has a right to sell the shares in the open market.
To understand the process, we may discuss the same in a vast wary especially for a Promoter/Company who arises their funds by pledging their shares in a particular company to invest/trade and/or for growth of the Company.
Promoters resort to various modes of raising finance to meet their business and personal needs. Loan against shares is one such method of raising finance. Under this method, promoters pledge the shares held by them with lenders to get the required financing. These loans typically have tenure of one to three years, and carry a margin requirement of two-three times. Simply put, it means that the value of the promoters shares pledged is two-three times of the amount of loan.
The method appears beneficial for promoters as well as the lenders. The promoters get access to quick short term financing, whereas lenders charge premium rates for this short term financing arrangement and also have about twice the value of the loan as pledge of shares, with a right to sell the shares if the promoter defaults in repayment or if the value of pledged securities goes down.
The risks associated with pledging of shares are quite significant particularly from the promoter’s perspective. In case of default, lender can sell the shares in open market to recover their dues, which could result in fall in stock price and erosion of market capitalisation. Also, promoter’s run the risk of losing management control if significant portion of their holding is pledged.
Usually the quantity of shares sold by lenders is large resulting in erosion of stock price. Companies with low interest coverage and high proportion of pledged promoter holding are susceptible to such erosion in stock prices. Investors tend to be wary of investing in such companies.
In the last seven quarters from the data available on pledged shares, we have been able to decipher that promoters have utilised pledging of shares to get loans on a regular basis. On an average, 8-9% of the promoters holding has been pledged during the period March 2009 to September 2010. The last seven quarters have seen the sensex on constant up move due to which pledging would not cause alarm bells to ring as the value of shares would not have seen much of erosion in value. But, recently the markets have been weak and the sensex has corrected by more than 10%, resulting in erosion of market capitalisation of stocks and thereby the value of shares pledged for securing loans. In such a scenario, companies which have taken loans against shares have to provide further margin in cash or pledge more securities to maintain the margin requirement. The companies that default may face the situation of selling of pledged shares by the lenders resulting in decline in stock prices and reduction in promoter holding.
ONE CAN GET ALL THE DETAILS OF A PARTICULAR COMPANY'S PLEDGING FROM NSE WEBSITE.
Recently, there was a news that Unitech is warding off lenders trying to sell the promoters pledged shares.
Unitech, had to rush to the Delhi High Court over the weekend to get an injunction against lenders selling the promoters pledged shares.
Rs 178 crore had been raised via debentures last year, with repayment due this May. But with the stock falling below Rs 60 (now its trading at 43; experts expect it to go for 36-38 level), the lenders wanted to sell the pledged shares.
Unitech promoters told the Delhi high court that the lenders were going against the agreement as ample notice for such a move is a pre -requirement.
Sources say promoters are now breaking into their treasury investments in mutual funds and fixed deposits to settle the demands. The promoters will be paying 50% of the Rs 178 crore to lenders this week and the rest by next week. It'll be interesting to see if Unitech faces similar margin call pressures from other lenders. Their exposure to such debentures is worth Rs 250 crore.
I WOULD LIKE TO REQUEST YOU ALL INVESTORS NOT TO GO FOR PLEDGING YOUR SHARES UNTIL OR UNLESS YOU NEED IT BADLY. YOUR VIEWS ARE WELCOME.......
