As at 12th April, 2019, Indian Inc saw INR 2.25 lakh crores worth shares pledged of 2,928 companies with lenders and other financial institutions.
Share pledging – Defined
Dictionary meaning of pledge stands at “a solemn promise or undertaking”. Whereas, in legal terms pledge means “a thing that is given as security for the fulfilment of a contract or the payment of a debt and is liable to forfeiture in the event of failure”.
Thus, share pledging is the act of raising money by keeping the shares of the company as a collateral. However, ownership of the pledged shares remains with the promoters.
Reasons for share pledging – Explained
Share pledging is common with the companies having substantial promoter holding. In tight liquidity and volatile market conditions promoters often pledge their share as a collateral to raise easy and cheap finance. Further, high interest rate environment often promulgate share pledging.
Look at the proportion of share pledged before buying any stock.
It has empirically been observed that share price of companies with significant portion of pledged shares tends to be volatile. If the share prices of the company fall, the value of pledged shares (collateral) also falls putting pressure on the promoters to pledge more shares as a collateral to the lender. Subsequently, if the company’s financial health worsens, the lender may be succumbed to sell the company’s share leading to further fall in the scrip.
Generally, companies having greater than 50% of the total shares pledged is considered to in high risk category.
Real life example – Illustrated
The fiasco of Reliance Communication hasn’t been hidden in the markets. The Company has been reeling under a debt of around INR 47,000 crores and had a opted for share pledging for borrowing purposes. Since February 2019, entire ADAG (Anil Dhirubhai Ambani Group) Companies came under intense pressure of sale of pledged share. It started with L&T finance selling around INR 234 crores shares of the Group, followed by Edelweiss and STCI finance selling pledged shares woth INR 37 crores. Lately, on 13th March, 2019 lenders sold 12 crore shares of the telecom company accounting for 4.34% stake of promoters. Currently, the stock is trading at throw away price of INR 2.55 (12th April, 2019).
Higher promoter shareholding may be a poison if coupled with higher pledging.