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Most Of Rated Debt Against Pledged Shares Lacks RBI-Prescribed Cover

Nearly all the rated debt against pledged shares doesn’t meet the minimum collateral level prescribed by the banking regulator, Crisil said, underscoring the risk involved in such lending.

While the borrowing against shares is an easy way of monetising promoter holding, it may have implications for lenders as debt is backed by collateral of equity shares, rather than cash flows, the rating agency said in a report ‘Covering the Pledge’. More than 60 percent of this is rated in the ‘AA’ category or above, and almost 90 percent is in the ‘A’ category or above. But pledged shares are exposed to high market risk and transaction-level cover agreed to is also often inadequate.

Of the Rs 38,000-crore rated pledged debt in the market, about 90 percent had a transaction cover less than the Reserve Bank of India-mandated two times, and in some cases, as low as 1.2-1.3 times the value of debt, the report said.

The troubles of Essel Group and the Reliance Group brought the practice of promoters raising debt against shares into the spotlight. Lenders were forced to agree to a standstill after a steep fall in the share prices over debt-related concerns.

According to Crisil, liquidity in the Indian equity market is insufficient to provide an orderly exit. In case of a breach of covenants, lenders usually have less than a month to liquidate shares, the rating agency said. The domestic equity markets may not have the depth and liquidity to absorb the flood of promoter shares within that time frame in case of a liquidation, it said. “It would take more than 30 days to sell Rs 500 crore worth of shares of 50 percent of the companies in the Nifty 500 Index, and more than 90 days for 30 percent of the companies.”

Overall Cover Key Indicator

Invoking pledged shares has faced both legal and practical challenges in the past, Crisil said, adding that such transactions should be assessed on the basis of overall cover available on the entire promoter debt.

Such debt can work if it is assessed based on overall cover available through promoter holdings (both pledged and unencumbered) on the overall debt that the promoter has raised in various holding or investment companies, the report said. The overall cover should be the determinant of the credit profile of the promoter debt, rather than the pledged shares and the structure of a specific transaction alone, it said.

“The overall cover acts as the first line of defence,” Gurpreet Chhatwal, president at Crisil Ratings, said. It helps in determining refinancing ability, provides flexibility to pledge additional unencumbered shares to maintain the minimum cover requirement and prevents breach of covenants in any specific transaction.

The higher the overall cover, the higher the availability of shares that can be used for topping up the pledge, enabling the transaction to withstand higher share price drops before covenants are breached and pledge is invoked by the lenders.
Crisil Report