What sparked the sell-off in midcap companies' shares today
Talk in the market is that a couple of brokers who are facing a liquidity crisis have sold pledged shares of companies, triggering a sell-off in the shares of nearly a dozen mid-cap companies.
July 27, 2012 / 08:42 IST
Santosh Nair
Moneycontrol.com
Last year in November, stocks of many mid-cap companies fell as much as 50% as many non-banking finance companies dumped shares pledged by promoters with them. The promoters had raised money from these NBFCs by pledging* their shares, and when the promoters failed to put up the additional margin because of a decline in their stock price, the NBFCs sold the shares in the market to recover their dues, aggravating the slide.Also read: Carnage in midcaps as financiers pull out; stocks down 10-30%A few promoters nearly lost control of their firms because of their holdings decreasing. And even though the NBFCs dumped the shares at the first sign of trouble, some of them could not recover their entire principal because of the precipitous fall in the share price. After this unpleasant experience, NBFCs tightened their lending norms and would not easily give loans to promoters of mid-cap companies against shares.This put many promoters in a fix. Their antecedents were such that traditional routes of funding were closed to them, and they would have to pay ruinous rates to borrow from unofficial channels. This situation presented a good business opportunity to some dubious brokers who are resourceful when it comes to raising funds at reasonable rates.Promoters starved of funds would form a group and approach such broker X, adept at fixing deals. Broker X would ask all the promoters of this group to pledge a portion of their shares, and would then approach an NBFC, offering this basket of shares as collateral. The logic was simple: even if the stock price of one company in the basket declined, the NBFC would not have to resort to a fire sale, because the other stocks would provide the cushion. The NBFC would lend the money to this broker, who would pass the funds to the promoters after taking his cut. In theory, this model should have worked well for everybody concerned. But when there are too many doubtful characters involved, even the best of plans fail.The syndicate of promoters approached more than one broker, pledged their shares and borrowed money. Some of the promoters were in dire need of funds as their foreign currency convertible bonds were coming up for redemption, and they had to maintain their stock price above the conversion price so that the lenders would convert their loan into shares. Else, the lenders would demand repayment of the loans, which most companies were not in a position to do so. And the brokers had their own positions, against which they had borrowed from the NBFC. So it goes something like this. Broker X has borrowed Rs 100 against his own name and Rs 100 of behalf of the syndicate of corporates. If X runs into trouble for some reason, and is unable to meet the margin requirements on his positions, the NBFC will sell whatever collateral it can, to recover its dues. And if the NBFC is unable to sell broker X’s personal collateral, it will start selling the collateral of the corporate syndicate that X had pledged with the NBFC. This, then triggers a domino effect, as other lenders (with whom the syndicate had pledged shares) too start dumping the shares when they see the prices falling. Talk in the market is that a couple of brokers who arrange such deals for corporates, are facing a liquidity crisis, and this is what triggered the sell-off in the shares of nearly a dozen mid-cap companies, causing a 10-25% decline in stock price. One of the names doing the round is of a leading Kolkatta-based broker, who was implicated for his role in the stock market scam of 2001.* Here is how the pledged share mechanism works.Assume a promoter wants to raise money by pledging his shares, and the NBFC is willing to give him 50% of the value of the shares. If the promoter wants to raise Rs 50, he has to pledge Rs 100 worth of shares. The amount loaned against the collateral depends on the liquidity in the stock, the company’s financials and the promoters track record, and could vary from 40-70% of the collateral.In this case, the promoter borrows Rs 50 by pledging Rs 100 worth of shares. If the share value falls to Rs 90, the promoter has to either return Rs 5 (so that the loan to value stays at 50%) or put up another Rs 10 worth of shares as collateral. If the promoter fails to deposit the additional margin, the NBFC will dump Rs 10 worth of shares to maintain the loan to value at 50%. Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
