What would you do when you need urgent cash and your bank balance is 0? you generally ask money from your parents, relatives or friends. In case they also don’t have cash then?
Then you pledge!
If you have gold then you pledge the gold and then get the cash. So, pledging is always the last option. Let’s come back to your portfolio.
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. Pledging of shares can be used to meet different needs like working capital requirements, funding other ventures, to carry out new acquisitions, personal obligations and more.
In India, promoters are the majority shareholder group that manages the day-to-day affairs of a company. When they need money, very often, promoters of listed companies pledge all or some of their shares with lenders. It means that these shares are offered as collateral to banks in exchange for loans. This is one of the many sources of borrowing money, especially in a volatile market with tight liquidity conditions. If the promoters are looking forward to pledging their shares, then it means that all the other options of raising fund have been closed.
These situations occur during the economic slowdown. As shares are also considered as assets, hence it can be used as a security to take loans from the banks.
Why is pledging of shares risky for the shareholders?
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.
As the price of stocks 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 shares falls, the value of the collateral will also erode. 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.
In the worst case, if the promoters fail to make up for the difference, the lender can sell the pledged shares in the open market to recover their money. This minimum collateral value is agreed in the contract between the lenders and the promoters. Hence, it gives the right to the lender to sell the pledged shares in the if the value falls below the minimum value.
What is the risk for the retail investors?
In general, the stock price can fall heavily on the news that lenders are selling shares in the open market that are pledged by the company’s promoters. This may result in a further decline in the collateral value because of the panic selling by the public.
In addition, selling of the pledged shares by the lenders may also result in the change of the shareholding pattern of the company. This may affect the voting power of the promoters as they are holding fewer shares now and their ability to make crucial decisions.
Moreover, pledging of shares can create a disaster if the share price continues to fall. This is because the promoters have to consistently pledge more shares to cover up the difference in the collateral value.
How to find the pledging of shares for Indian companies?
The best source to find the pledging of Indian shares would be the BSE or NSE website.
- Go to BSE India website →
- Search the company name in the top search bar →
- Click on the ‘shareholding pattern’ tab on the left sidebar of the company page→
- Open the latest quarter report of the shareholding pattern →
- You can find the summary statement holding of specified securities.
For example- Here is the shareholding pattern of Suzlon Energy for the quarter of June 2018. Please notice the current pledging of shares (31.58%) by the promoters.
Pledging of shares is generally seen in the companies where the shareholding of the promoters is high. As a thumb rule, pledging of shares above 50% can risky for the promoters. In short, ignore companies with high pledging of shares to avoid unnecessary troubles.
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. (If the promoters have pledged a high percentage of shares, then it’s always worthwhile to find out the reason.) 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.
Nevertheless, pledging of shares is not always bad for the companies. You can understand this by relating to your personal loans. For example, taking an educational loan, car loan, house loan is not a big issue if you have a steady income or an amazing future earning prospects.
Similarly, if the company has increasing operating cash flow and good future prospects, then pledging of shares is not a big concern for them. Many times, pledging of shares helps in the expansion of the company or to carry out new projects which result in increased revenue in the future. Moreover, 5–10% pledging of shares in fundamentally healthy companies should not be considered as a problem.
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.
Pledging of promoter shares witnessed its highest quarterly jump in three years in June 2013 quarter. During an economic slowdown and rising interest rates, banks could put strict conditions on borrowing.