Tuesday, February 17, 2009

Just how much money is at stake in shares pledged by promoters?

SEBI in its recent directive in January mandated disclosures regarding pledge of shares by the promoter and persons forming part of the promoter group to the company and by the company to the stock exchanges where shares of the company are listed, post Satyam fiasco.

Ever since the companies started disclosing this information, market learned the degree of this financial engineering, which looks like and Indian version of western word’s CDO/MBS.

Majority of Indian companies have been pledging shares for more than two decades, if not longer. There are 114 companies where promoters have pledged more than 50% of their stake, and about 22 companies (about 5% of disclosing companies) have pledged more than 50% of their paid up shares. Promoters of 467 companies have pledged with lenders an average 23% of their holdings so far. At current market prices, the total value of pledged stocks is over Rs 62,000 crore. This is over 2% of Indian stock market’s market-cap of Rs 30.33 lakh crore.

Promoter’s pledged shares represents, on average 17.07% of paid up shares. As per the data available for 3,483 listed companies, Indian promoters hold 49.85% of paid-up shares of these companies as on Dec’08. Generalization of this to all listed entities, suggests whopping 258,107 crore[1]. Assuming 50% margin, the bank credit to these promoters could be pegged at Rs. 129,000 crore (about 5% of credit by entire banking system in the economy)!

What would happen if the equity prices continue in its downward trend, eventually forcing promoters (those who have pledged their almost entire stake in the company) to default leaving financial institutions no other choice than to off-load all the equity in the market? And if they choose to off-load these pledged shares in the market, its bound to cause havoc on the equity prices, set to crash by at least 20-30%, and eventually the losses financial institutions may have to bear could be well about 100,000 crore (about 25% of Scheduled commercial banks capital, reserves and surplus as on March’08).

The question in every investor’s mind is whether it is just a corporate governance issue or a much deeper financial problem looming its head? Is our banking system strong enough, as argued by almost everyone in past, to whether out such blow on their balance sheets? Are they capitalized well to survive?

[1] SEBI directive doesn’t ask mutual funds to disclose their pledged shareholding. Mutual funds are also expected to have pledged shares to the tune of Rs. 3,000 crore.