Mid Day : 2019-02-11

The Guide : 24 : 22

The Guide

22 mid-day Monday 11.02.2019 Pledge Shares - Hanging Sword on the Promoters and Investors at Large Pledge of Promoter Shares - One of the most significant aspects investors should look at FINANCE KA FUNDA call and the value of the collateral has also eroded. In order to meet up the difference in the collateral value, the promoters have to cover the shortfall by either giving additional cash or pledging more shares to the lender. As an illustration if a share is trading at INR 1,000 and the promoter has taken a loan to an extent of INR 25 crores as a loan against shares by pledging the shares; the lender will assign a margin that is required to be maintained say in this case at 30%. Hence in order to maintain the margin for the loan of INR 25 crores, now the per share value will be taken at INR 70. Hence number of shares pledged would be 250,000,000/ 70 which is around 35.71 lakh shares. If the value of the shares goes down from INR 100 to say 80 the lender will keep the margin on the current market price of 30% i.e. 56, hence value to raise the same amount of INR 25 crores now shares that would be required would be 250,000,000/ 56 which is approx. 44.64 lakh shares. In practice, the lender will not wait for the price to fall as the price is going down from 100. He will ask the promoter either to pledge more shares or pay up some part of the money else sell the shares at the current market to maintain the margin requirement as per the original agreement. Hence the moment the share drops to an extent by 5%, the exercise of top-up or selling of shares is triggered by the lender. In most cases this is automated by the trading system hence even if the share drops in price for sometime it triggers a margin call and the trading system sells the shares. While investing in these political uncertain times investors should be extra cautious and pledge of shares is one aspect that the investor should look at. As a thumb rule, pledging of shares above 50% can be risky for the promoters. This is because pledging of shares is a sign of poor cash flow, low-creditability, high-debt company and inability to meet the short-term requirements. A decreasing pledging of shares over time is a good sign for the investors. On the other hand, an increasing pledging of shares can be dangerous for both promoters and shareholders. Even quality companies can become a victim if the pledging of shares is not reduced over time. Farzan Ghadially INVESTING in equity markets in these political turbulent times is a challenge in itself. When an outsider is looking at the market, the view appears very rosy and healthy as the Nifty is around the 11,000 levels and looks at touching its lifetime high. However the reality of the investors at large is very different. The mid-cap and to some extent even the largecap stocks have been beaten down and are anywhere down 20 to 50% from their all-time high levels. Hence there is a big paradox that investors face as the headline Index of Nifty and Sensex show a very good picture but at a portfolio level the reality is very different. With the General Elections less than 90 days the biggest question that investors have is should they invest further capital in the market; should they just wait and watch or should they exit the market and be a fence sitter till the major event of elections is out of the way. The key lies in moving to quality companies which have a proven track record, established well know management and not too dependent upon government contracts as awarding of such contracts would stop due to code of conduct and payment linked to such contracts would be delayed due to the possible change in Government. The stock market would continue to be volatile in the next three months and the volatility would peak as we move closer to the elections and would be at its highest on the results counting day which could well result the stock market settling 10% higher or lower depending on how the results pan out. Post the initial immediate reaction of the markets, things would settle and would be dependent more on fundamental factors of the companies rather than political outcomes. In this volatile phase one of the selling in panic would be from retail investors, HNI (High Networth Individual) investors and in certain cases Foreign Portfolio Investors if they see a very adverse outcome of the elections at large. Along with these factors one of the most important factors that may cause a further sell-off in the stock markets is the margin call of pledged shares of the promoters and HNI investors at large. Over the last few weeks’ stocks like ZEE Entertainment, DHFL have been sold to a very large extent and resulted in value destruction for the investors. A large part of the selling was a result of margin calls or the promoters against their pledge shares. Bad In turbulent market conditions, Pledge of Promoter Shares is one of the most important aspects the investors should look at when investing in a company. High debt on the books of the company along with high levels of pledge of promoter shares should be considered as red flags for investors news, lack of faith in the current promoter and management along with the excessive debt on the books of the company altogether along with the margin calls results in the share price falling to a large extent. In layman’s term, pledging of shares means taking loans against the shares that one holds. This is a way for the promoters of a company to get loans to meet their business or personal requirements by keeping their shares as collateral to lenders. Promoters usually pledge shares to borrow money in personal capacity. This money could be used for the company for working capital or fresh investment and can be brought into the company via unsecured loans by the promoter. If a large part of the promoter holding is pledged, as an investor one should also look at the money infused by the promoter by unsecured loans. Generally, pledging of shares is the last option for the promoters to raise fund. It is comparatively safer to raise fund through equity or debt for the promoter. However, if the promoters are looking forward to pledging their shares, then it means that all the other options of raising funds have been closed. While pledging of shares, the promoters use their stake as collateral to get the secured loans. During a bull market, pledging of shares may not create many issues as the market is moving upwards and the investors are optimistic. However, the problem arises in the bear market or when the sentiment for the stock has turned negative. As the price of stock keeps fluctuating, the value of the collateral [against the secured loan] also changes with the change in the share price. However, the promoters are required to maintain the value of that collateral. If the price of the share falls, it triggers what is known as a margin Farzan Ghadially is an Investment Banker by profession and a management faculty Send your feedback to [email protected] The views expressed in this column are the individual’s and don’t represent those of the paper.

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