Pledging of shares is common in companies where promoter holding is high. While pledging shares, ownership is retained by promoters. In a rising interest rate scenario, promoters often use shares owned by then as collateral for loans. In India out of the over 5000 listed companies, promoters of 4274 companies had pledged all or some of their shares, according to an analysis by Securities and Exchange Board of India. This was quoted in the recent RBI Financial Stability report. Of these, promoters of 286 companies had pledged more than 50% of their shareholding. Nearly 90% of these companies belong to the small-cap category.
The concept of pledging of shares by promoters is not new to India but it caught the attention of investors only after the Satyam Debacle and also due to companies going bankrupt. Promoters, in order to raise funds for either personal or company needs, pledge their holding shares to any financial institution. Non-banking financial institutions are more active than banks in providing such loans.
Sometimes promoters collateralize their shares for converting warrants into shares. For example, KS Oil borrowed Rs. 50 crore to raise money required for conversion of warrants into shares. Also, they might find share prices in the secondary market quite lucrative for fresh purchase and adopt this route for garnering funds for the consideration to be paid for open market purchase.
In developed countries like the US, not just promoters but directors too are required to disclose their pledged shares. In UK this is considered under insider trading regulation. But in India, until recently when securities and Exchange board of India made it compulsory for promoters to disclose their pledged shares, there were no disclosure norms.
However post satyam debacle, SEBI has made it mandatory for promoters and promoter groups to disclose the details of pledging shares of their listed entities. Under this guideline, apart from disclosing whenever shares are pledged, promoters are also supposed to disclose it periodically. Respective stock exchanges are to be informed about the details of share pledging.
RISK TO PROMOTERS:
- Bankers or financers give loan taking the shares as collateral. Hence, whenever the prices of shares comes down to a certain level in the secondary market, the promoters is required to either make some payment or pledge more shares. If the promoter cannot do either, the lender keeps the right to sell pledged shares in the market. Apart from this, promoters always have the risk of a hostile takeover.
SIGNALS TO THE INVESTORS:
- If promoters raise the money for the betterment of the business, investors should take it positively but if the money is raised for any personal needs, it imparts negative signal. Even if the funds are raised for improving the business it indicates a liquidity problem.
HOW INVESTORS SHOULD DEAL WITH SUCH STOCKS:
- One way is to stay away from such stocks especially where, the promoter pledge is more than 50%. There are so many other good stocks in the market.
- There are technical factors also working against these counters. The promoter pledging only makes the counter more volatile. “Even when the fundamental is good, the corrections in these counters, whenever happens, will be more. Investors need to be extra careful when the promoter pledging is high.
- Risk takers, however, can still investing them provided they do proper research. Our advice to such investors is to study following factors before buying such stocks.
- CHECK THE REASONS BEHIND THE SHARE PLEDGING:
- It is fine if the pledging has been done in the interest of the company. Sometimes, banks ask promoters to pledge their holding in the company to get project or working capital funding for the company. This only shows the commitment by the promoters to the company. And since it is treated only as additional collaterals, there is very little chance of banks selling these shares if the share price comes down in the open market.
- CHECK THE REASONS BEHIND THE SHARE PLEDGING:
WHEN INVESTORS SHOULD AVOID THE COMPANY:
- If the pledge is for the promoters personal use, for example to invest in other businesses. Investors also need to take a closer look to find out who is pledging the shares – core promoters or someone in the distant family, who is also clubbed as promoters due to regulatory reasons. If it is not the core promoter, there won’t be any strategic incentive to retain the holdings and if the price continues to fall, the same share may come to the market for sale.
- The following data shows that companies with high pledging of promoter holding tend to witness volatility. Most companies in which promoters have pledged 100% holding are trading in red since the beginning of 2016.
- FOR EXAMPLE: Shares of Paramount Communications slid 46.22% on a Year-to-date basis till April 7, whereas shares of IVRCL and Suryajyothi Spinning Mills tanked 44.97% and 42% during the same period. As on December 2015, promoters of Reliance capital had pledged 33.49% of their stake in the company. Similarly, COX & Kings (49.71%), Future Retail (76.23%), JSW Energy (47.10%) and Gati (72.55%).