Pledged Shares

Why promoter’s pledged shares must be watched closely

As India celebrates a plethora of good news like low inflation, falling deficits and corporate profitability; there is a silent problem that is lurking in the shadows. Promoters pledging shares with financers to raise money for their business is nothing new. The problem arises in two basket cases. Firstly, when promoters have pledged almost their entire holdings with the financers! Secondly, when the pledged shares belong to a company that is susceptible to bouts of volatility! Unfortunately, both these cases are visible in abundance in India currently.

Pledging too much shares…

A recent study by SEBI has revealed that out of the 5000+ listed companies on the BSE, almost 82% of the companies’ promoters had pledged shares with financers. In 6-7% of the cases, the proportion of promoters’ stake pledged was in excess of 50%. Typically, promoters who pledge a large chunk of their shares tend to belong to the small cap and mid cap space. These stocks anyways tend to be more vulnerable to any news on pledge of shares, which is now publicly available.

Why is pledging a concern…

Banks and NBFCs offer financing to promoters against their shareholdings. The typical haircut on such shares may be around 50%. This means that on pledged shares with a market value of Rs.100/-, the promoter is entitled to a funding to the extent of Rs.50. This clause substantially protects the financer in case of fall in markets.

But the real problem happens during a free fall. As stock prices plummet, banks call for additional shares or margins or impose stricter haircuts. Most small cap and mid-cap promoters will have neither shares nor cash and hence banks will be forced to offload shares in the market. We have seen this happen in case of Orchid Pharma, Wockhardt and Global Tele; where price damage was huge.

What to watch out for…

Firstly, be cautious where more than 90% of promoter holding is pledged. It is a recipe for trouble. IL&FS Transport, Essar Ports, Jaiprakash Power, Gokaldas Exports and Gammon Infra have close to 100% of promoter stake pledged. Secondly, look at the quarterly trend in promoters’ stake being pledged. If you see a sudden and sharp increase in the proportion of shares pledged, be cautious. In the last 1 quarter, Impex Ferro saw pledged share go up from 0.4% to 99.9%. Unity Projects, 20 Microns and MCF; all saw a sharp rise in promoter pledge. This is again a cause for caution. Lastly, a combination of high pledged shares, weak cash flows, high fixed expenses and low market cap/debt is a cocktail for trouble. And if they are mid-cap or small cap companies; more reasons to worry! ©

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