Recent market events have put the practice of lending against shares pledged by promoters under the scanner and sent market participants on a frantic search for ways to gauge the risks in such deals.
“What are the risks in these transactions?
What should be the cover commensurate with the risks?”
Such are the questions flying thick and fast.
To be sure, borrowing based on the value of the underlying listed shares is an easy way of monetising a promoter’s ownership without ceding control. According to Bombay Stock Exchange data, the total value of shares pledged by promoters is more than Rs 2 lakh crore, involving 800 companies1 and Rs 1-1.3 lakh crore of pledge debt.
This has implications for the lending community, for such debt is backed by collateral of equity shares, which are inherently volatile, rather than by cash flows. Hence, pledge debt is exposed to high levels of equity risk, and the cover through pledged shares is usually small to absorb these risks.
The typical transaction cover for ~Rs 38,000 crore of rated debt in the market analysed by CRISIL2 – accounting for 30-40% of the total pledge debt of promoters – is less than 2 times.
In case of a breach of covenants, lenders usually have less than a month to liquidate the shares. However, the domestic equity markets may not have the depth and liquidity to absorb the flood of promoter shares dumped by multiple lenders. Therefore, ensuring an orderly exit without a drastic impact on share prices is easier said than done.
Besides, enforceability of pledge has been called into question in the past because of legal and practical challenges.
CRISIL believes debt raised through pledge of promoter shares should be assessed based on the overall cover available through promoter holdings – both pledged and unencumbered – on the overall debt that the promoter has raised in various holding/ investment companies, and not on the pledge and structure of a specific transaction alone.
The overall cover acts as the first line of defence, determines refinancing ability, and provides the flexibility to pledge additional unencumbered shares to maintain the minimum pledge cover requirements and prevent a breach of covenants in any specific transaction.
CRISIL’s overall cover requirement for assessing debt of a promoter’s holding companies depends on the rating category, an auto-correcting factor that adjusts based on the state of the market and sensitivity of the specific stock to overall market movement. CRISIL also factors centrally the credit profile of the company whose shares are pledged and the management quality.
1 As on February 27, 2019
2 Data related to rated ‘pledge’ debt as of January 15, 2019. CRISIL has not rated any of these transactions.