Pledging of shares is a financial arrangement where a shareholder offers their shares as collateral for a loan or to secure a financial obligation. This means that the lender has a claim on the shares if the borrower defaults on the loan.
Let us learn about pledging of shares and the nitty gritty associated with it in detail.
How Does It Work?
1. Loan Agreement
The shareholder takes out a loan and agrees to pledge a certain number of shares as collateral. The value of pledged shares is determined by both the lender and the promoter, based on the current market value of the shares. They formalize this arrangement in a written agreement. When obtaining a loan against these shares, a haircut is applied, meaning the loan amount will be less than the full market value. According to the Reserve Bank of India (RBI), a loan-to-value (LTV) ratio of 50% must be maintained, ensuring that the loan amount does not exceed half the value of the pledged shares.
Pledging of shares is favourable in bull markets when the market is moving upwards. In the bear market, if the value of shares drops, it can be a loss for the promoters.
2. Pledge Registration
The pledge is usually registered with the relevant authorities or recorded in the company’s books to protect the lender’s rights.
3. Ownership Rights
The shareholder retains ownership rights such as voting rights and dividends unless they default on the loan.
4. Default
Once the loan is repaid, the pledged shares are returned to the promoter. However, if the promoter defaults on the loan, the lender has the right to sell the pledged shares to recover the outstanding debt.
Is Pledging Good or Bad?
It depends on the specific circumstances and context. Pledging shares can be a useful financial strategy but it carries inherent risks. It is essential to weigh the below listed factors carefully and consider market conditions, financial stability and individual risk tolerance before proceeding to pledge the shares.
Pros
- Access to Capital: It allows shareholders to access funds without selling their shares which can be beneficial for investment or liquidity needs.
- Retained Ownership: The shareholder maintains ownership rights such as dividends and voting rights unless they default.
- Potential for Investment: The funds obtained can be used for investment opportunities that may yield higher returns than the cost of the loan.
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Cons
- Risk of Default: If the borrower fails to repay the loan, they may lose their shares which can be particularly detrimental if the shares are a significant part of their portfolio.
- Market Volatility: A decline in share value can increase the risk of margin calls or forced sales to cover the loan.
- Limited Flexibility: Pledged shares may limit the shareholder’s ability to sell or transfer those shares until the loan is repaid.
- Impact on Credit: If the pledged shares are related to a personal or corporate guarantee, defaulting could affect credit ratings.
How To Check Pledged Shares?
Checking pledged shares typically involves a combination of reviewing company filings, stock exchange disclosures and financial databases. It is important to ensure that reliable and up-to-date sources are referred for the most accurate information. This information is crucial for assessing financial health and risk associated with the stock. Let’s explore the different methods to check the pledging of shares for InterGlobe Aviation (IndiGo).
1. Stock Exchange Filings
- Method: Companies are required to disclose pledged shares in their regulatory filings.
- How to Check: Visit the NSE or BSE websites and look for InterGlobe Aviation’s filings under the “Corporate Announcements” or “Investor Relations” section.
2. Annual Reports or Quarterly Results
- Method: Annual reports contain information on shareholding patterns including pledged shares.
- How to Check: Download the latest annual report from the company’s investor relations page. In IndiGo’s annual report, there is a section on shareholding that specifies how many shares are pledged by promoters.
3. Registrar of Companies (RoC) Filings
- Method: Companies must report details about pledged shares to the RoC.
- How to Check: Access the Ministry of Corporate Affairs (MCA) website and search for InterGlobe Aviation’s filings. Specific documents such as Form CHG-1, which pertains to the creation of charges disclose the pledge details. This information can be accessed through their online services or by filing a request.
4. Financial News and Analysis Platforms
- Method: Financial news websites and market analysis platforms often report on significant pledges by company insiders or major shareholders.
- How to Check: Use platforms like Moneycontrol, ET Markets or Bloomberg. A news article might state that a certain percentage of promoters’ shares in IndiGo are pledged as collateral for loans.
5. Investor Relations Contact
- Method: If detailed or specific information is required, contacting the investor relations department directly can be helpful.
- How to Check: Use the contact details provided on the company’s website and reach out via email or phone to inquire about the latest pledged shares status.
6. Other methods
- Third-Party Databases: Some financial data providers offer insights into pledged shares and other shareholder information for a fee.
- Online Brokerage Platforms: They may provide information on share pledges as part of their stock analysis tools if one has an account with them.
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Impact of Pledging Shares on Stock Valuation
While pledging shares can provide short-term financing for promoters, it often raises concerns among investors that can negatively influence stock valuation. Therefore, monitoring the levels of pledged shares is crucial for assessing a company’s financial health and stock performance.
1. Perceived Risk
High levels of pledged shares may signal to investors that promoters are facing financial difficulties, increasing perceived risk and potentially leading to a decline in stock price.
2. Market Sentiment
If investors believe that pledged shares indicate instability or a lack of confidence from promoters, it can result in negative market sentiment, further driving down the stock’s valuation. Continuous pledging of shares may also lead to a loss of investor confidence, making it harder for the company to attract new investments, impacting overall valuation.
3. Liquidity Concerns
If a significant portion of shares is pledged, it might raise concerns about liquidity. Investors may worry that a forced sale of shares (due to default) could flood the market and depress prices.
4. Loan-to-Value (LTV) Ratios
Lenders typically apply a haircut when calculating the LTV ratio. A lower LTV ratio can restrict the amount of financing available, potentially impacting the company’s growth prospects and subsequently, its stock valuation.
5. Influence on Corporate Actions
Companies with heavily pledged shares might be less flexible in pursuing strategic initiatives such as mergers or expansions, which can affect long-term growth prospects and stock value.
Wrapping Up
To conclude, pledging shares is a prevalent practice in the corporate world, allowing promoters to secure financing while still maintaining ownership of their shares. While it can provide liquidity and support growth initiatives, it also introduces certain risks. For investors, understanding the nuances of share pledging is crucial, it is important to weigh the benefits against the potential risks. Staying informed about the levels of pledged shares can help investors make more informed decisions and better assess the overall health of a company.
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