personal finance

A pledge for investors and regulators


By S SRINIWASAN


The perils of investments by mutual funds investing in debt paper collateralised by listed equity shares came home to roost recently. In this instance mutual funds have acted prudently and agreed to a controlled liquidation with some possible additional returns for investors. This brings to focus the “loan against shares” market in India. Traditionally this has been the domain of non-banking finance companies (NBFCs) and other non-bank financiers. It’s an important source of risk capital for promoters of companies which has had its share of accidents in the past as well when data was not easily available about the levels of pledge.

Now it is a different world and information is readily available. According to Bombay Stock Exchange data for February 2019, the total value of shares pledged by promoters is more than Rs 2 lakh crore, involving 800 companies and Rs 1-1.3 lakh crore of pledge debt, not all of it from mutual funds, I must add.

A CRISIL report estimates that Rs 38,000 crore of rated debt (accounting for 30-40 per cent of total pledge debt of promoters), backed by pledge of shares, has been raised from the market to date. More than 60 per cent of this is rated in the ‘AA’ category or above, and almost 90 per cent is in the ‘A’ category or above.

Many of these market borrowings will hit maturity over the next 3- 8 quarters. In a functioning market with ample liquidity, this amount will likely get rolled over or refinanced. However, we are in unchartered territory due to the woes of the NBFC market and with this experience, mutual funds would turn extremely cautious. Investors in these funds are already asking probing questions about such exposures and turning risk averse. Two important sources of rollover/ refinancing market are likely to be very tight fisted.

So what could be in store? How could this turn out? In the absence of a liquid credit market, the pledge may have to be invoked and shares sold by lenders to recover their debt. CRISIL’s study of data over 15 years points out some key challenges.

The study found that it would take more than 30 days to sell Rs 500 crore worth of shares of 50 per cent of companies in the Nifty 500 index and more than 90 days for 30 per cent of companies in the index, if shares worth the average daily turnover of 2018 were liquidated every day.

With most pledge invocation having a 10 day or 30 day notice period, this is clearly insufficient.

Further, the study states that during the same period, there were market developments in which half of the companies having such transactions witnessed market capitalisation fall of more than 45 per cent, i.e., even a cover of 1.8 times could have been fully depleted within a month in the case of 50 per cent of companies.

This means the selection of the companies and their susceptibility to volatility become critical for lending against their shares. Of course there will be investors with risk appetite and a mandate to take higher risk. Obviously commensurate rewards for the risk would be expected. Enter credit funds!

As they say, every adversity offers an opportunity. While the overall regulatory changes for creditor protection has been a positive, this situation will likely accelerate the development of a high yield market in India and will get priced better. So some of the rollovers may find a home here. Some others will simply have to bite the bullet; or worse, the promoters may lose control of the company! Buyout funds are likely rolling up their sleeves at this prospect.

How can the system benefit? Never waste a crisis! We have a history, as a nation of being spurred into action only when a crisis hits us. Regulators and policy makers must pledge (pun intended!) to implement the long-pending bond market reforms which has had several committees pontificating. A deeper, healthier and liquid credit market is imperative for the economy to attain the $5-trillion size goal quickly.

(Author is managing director of Kotak Investment Advisors. Views expressed are personal )





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