Tighter pledging norms hit promoters’ borrowing plans

A major source of raising funds for promoters has dried up with lenders tightening the terms of borrowing against shares as collateral. Promoters are finding it unviable to take loans from mutual funds against pledged shares after the Securities and Exchange Board of India (Sebi) recently tightened norms, while non-banking finance companies have become choosy about lending against shares as tight liquidity conditions and an uncertain market outlook have heightened concerns over defaults. Mutual funds and NBFCs have been the biggest lenders to promoters in recent years.

Promoters of most mid- and small-sized companies have been impacted the most. Proposals of at least five companies including a steel manufacturer and an auto component maker to raise funds against shares in the last one month have found no buyers, said at least two people privy to the development.

Mutual funds have been forced to drastically cut their lending to promoters after Sebi increased the equity cover that mutual funds take as collateral to four times. Earlier, mutual funds collected cover worth 1.6-1.7 times the loan amount. Analysts estimate the market for promoter funding by debt mutual funds used be around Rs 25,000 crore a year ago which is about 1.5-2 per cent of the Rs 12 lakh crore debt fund industry. The figure has fallen to as low as Rs 5,000 crore currently, said industry officials.

“Loan against Shares by mutual funds have clearly shrunk after the increase in equity cover to four times. Sebi has also tightened the disclosure norms for pledge transactions, which has made this route more difficult at this point,” said Bhushan Kedar, director, funds research at rating agency Crisil.

Most of the lending against shares as collateral by mutual funds is happening to promoters of large companies. “After series of crisis in the debt markets, the funding for promoters came to a halt for two quarters. Funds have recently resumed lending to promoters but only large promoters who can afford to pledge sufficient shares are getting funding now,” said a debt fund manager.

Sebi’s decision to tighten rules for mutual funds’ loan against shares came after Subhash Chandra’s Essel Group failed to bring in more shares as collateral top-up following the crash in share prices of Zee Enterprises and Dish TV in late January. The regulator was worried that such lending posed risks to the wider financial system.

NBFCs too are sticking to larger business groups and multinationals, say debt market investment bankers. “Even in cases where the smaller players are getting loans, the interest rate is exorbitantly high. Before the debt markets went soft, such promoters used to prefer MFs since they used to offer loans at lower interest rates and the collateral needed was also lower,” said an investment banker.

As per the Reserve Bank of India (RBI) rules, NBFCs can lend to promoters if the pledged shares are at least two times the loan amount. While MFs had ability to lend at lower rates around 11-12 per cent, NBFCs can only lend at higher rates since they must factor the cost of borrowing.

“The risk involved in promoter pledging has gone up significantly in the last one year and hence NBFCs want higher returns on their loans. However, paying 17-18 per cent interest will not be viable for lot of promoters,” said another investment banker. Once the crisis in the debt market subsides, NBFCs could be the preferred choice of fund raising through this route but mutual could also try to stay relevant in the game. For instance, mutual funds could offer promoters lower rates and bigger amounts, which will make up for the higher equity cover.

“Since an NBFC can lend with two times collateral, the first choice will be an NBFC. Only if a mutual fund lends at a rate, which is lower by at least 200 basis points and the promoter could come to mutual funds,” said a fund manager at a domestic fund house.