Tuesday, November 29, 2011

>PLEDGED SHARES (ICICI DIRECT)

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 or three times. Simply put, it means that the value of the promoter’s shares pledged is two to three times the amount of loan. The method appears beneficial for promoters as well as 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, a lender can sell the shares in the open market to recover their dues, which could result in a fall in stock price and erosion of market capitalisation. Also, promoters run the risk of losing management control if a significant portion of their
holding is pledged.

The term “pledging of shares” is looked upon with a needle of suspicion by investors. In a scenario of rising stock prices, there is no concern but if the price of the shares declines to a certain level, the promoters are required to make some payment or pledge more shares. If the promoter defaults or is unable to provide further shares as margin, then the lender has a right to sell the shares in the open market. Usually the quantity of shares sold by lenders is large resulting in an erosion of stock price. Companies with a 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 10 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 promoter’s holding has been pledged during June 2009-September 2011. In the quarter ended September 2011, the percentage of promoter holding pledged has increased from 9.1% in June 2011 to 9.5%, whereas the percentage of total equity pledged has increased from 5.0% in June 2011 to 5.1% in September 2011. From June 2009 to December 2010, the Sensex was on a constant up move due to which pledging would not have caused alarm bells to ring as the value of shares would not have seen much of erosion in value. However, recently the markets have been weak. The Sensex has corrected by ~ 20% in the last three quarters, resulting in an erosion of market capitalisation of stocks and, hence, the value of shares pledged for securing loans. In such a scenario, companies that 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 lenders resulting in a decline in stock prices and reduction in promoter holding.


RISH TRADER

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