MUMBAI (NewsRise) -- As liquidity tightens, investors in India are grappling with the growing risk posed by founder-led companies that are laden with debt and have a high proportion of shares pledged as collateral for loans.
The latest case to unsettle the market concerns Reliance Anil Dhirubhai Ambani Group, which is led by Anil Ambani, younger brother of Asia's richest man, Mukesh. Over the course of four trading sessions early in February, the group's companies lost nearly 55% of their collective market capitalization as lenders L&T Finance and Edelweiss Group dumped pledged shares worth 4 billion rupees ($56 million).
The selling came after group company Reliance Communications, which has $7 billion in debt, filed for insolvency. That set off a chain reaction, weakening share prices across the group and eroding the value of the pledged shares. According to the lenders, the company did not heed calls to top up collateral.
The concern now is that more companies may find it difficult to repay debt leading to a vicious cycle of falling share prices and collateral values and further selling of pledged stock by creditors. Since founders tend to hold at least 51% of a company, the impact of such forced sales can be profound, extending to ownership changes. Other factors such as a slowing economy, an equities market struggling for direction and heightened risk aversion ahead of general elections could amplify the knock-on effects.
Market watchers find many similarities with China in the recent developments. Late last year, the massive amounts of shares pledged for loans by small and medium Chinese companies in a credit-short economy roiled markets on the mainland, triggering calls for state help.
In India, the extent of such borrowing, which allows creditors to sell the shares if the company is unable to meet minimum requirements, is much smaller. Excluding government-owned companies, about 4% of founders' stock worth $26 billion is pledged, according to a recent CLSA report. This compares with 50% of Chinese small and medium stocks pledged at the peak in March 2018.
However, the Indian companies hit by talk of default and lenders invoking their pledges have been major ones so far. The ensuing developments and media reports have not only underscored the need for more due diligence by investors but also raised questions about transparency and governance especially as many large groups contain a complex web of listed and unlisted companies with varying standards.
In January, a report alleging fraud at Essel Group led to a more than 26% fall in the stock of unit Zee Entertainment Enterprises, India's largest media company, as lenders sold pledged shares. Sister concern Dish TV India, a cable operator, lost 33%. Zee Entertainment later said its creditors had agreed that they would not sell any more shares until September, no matter the price, as it tried to find a strategic investor.
Meanwhile, India's fraud investigators are probing Nityank Infrapower, an obscure firm which the media report identified as linked to Essel Group, for the large deposits it made soon after New Delhi withdrew high-value cash from the market in 2016. Essel Group has denied any connection to the company.
The practice of share pledging is common globally and does not pose a systemic risk, say analysts.
Anil Gupta, head of the finance sector at ratings agency ICRA, said the recent problems are because founders are unable to roll over their loans against securities as lenders have become wary.
Credit has tightened partly because of the lending curbs imposed on banks in a bid to reduce their bad loans. The crisis last August at leading shadow bank Infrastructure Leasing & Financial Services, which missed payments on many debt obligations, has aggravated the issue by causing a liquidity crunch and raising short-term borrowing costs.
Although the Reserve Bank of India recently cut rates and announced some relaxation of curbs on banks, more needs to be done to improve liquidity, say observers.
Pranav Haldea, chief executive of PRIME Data Base, pointed out that in some instances, founders have pledged as much as their entire stake, increasing the company's vulnerability. "There should be a cap on the proportion of shares a founder can pledge," he said.
According to PRIME, founders of 214 companies on the National Stock Exchange have pledged more than 50% of their holdings. Big names top the list by the value of shares pledged, including Adani Ports, led by tycoon Gautam Adani who founded the Adani Group, Tata Consultancy Services, the country's largest outsourcing company controlled by the Tata Group, and JSW Steel, a leading steel maker run by the Jindal family.
Over at Suzlon Energy, a renewable power firm whose stock slumped 28% last week amid rumors of a debt default, founders had pledged 77% of their shares at the end of last year. The company has denied any debt default.
On Monday, shares of Apollo Hospitals Enterprise dropped 11% even after the company reported better-than-expected results, as investors fretted over its move last month to increase the proportion of pledged shares by 4% to 75%.
In a conference call with analysts, the company tried to allay investor concerns saying it would cut the proportion of pledged shares by 60% over the next six months by selling a stake in its insurance unit and another asset.
--Dhanya Ann Thoppil