In assessing LAS transactions, Ind-Ra evaluates two parameters, the probability of liquidation and the quantum of loss on liquidation.
A widespread sell-off in the equity markets due to the outbreak of novel coronavirus is likely to deplete the share cover available to investors in loan against shares (LAS) transactions, says India Ratings & Research (Ind-Ra).
According to the rating agency, 21 BSE 500 companies would have to pledge more than 100% of promoter holding to maintain minimum 2.5 times share cover. this analysts is based on the assumption that the loan against shares transactions quantum basis disclosures available till 31 December 2019. These companies would be required to pledge an additional collateral or deposit cash to maintain the original security cover.
In such scenario, the investors in these LAS transactions could either be required to restructure these exposures, liquidate the collateral or in some cases also recall the loans. While the rating agency believes that adjusted base case assumes a gradual recovery from the novel coronavirus outbreak, the recovery in the equity prices could also be protracted.
In case there is a further build-up of risk aversion in the capital markets, equity prices could fall further, thereby necessitating additional share pledges to maintain the security cover. Sectors such as power, construction and metals, which have historically been most exposed to cyclical risks and have recently been under stress, are likely to see a high proportion of their promoter holdings pledged.
“Equity prices bear a strong correlation with the earnings quality of an entity. Thus, the weakening share price in this case is accompanied by a similar erosion of the liquidity buffers of the underlying borrower. This could affect the entity’s ability to meet any unprecedented cash outflows emanating from an untimely recall of LAS or even pledge additional liquid collateral,” said Ind-Ra.
In assessing LAS transactions, Ind-Ra evaluates two parameters, the probability of liquidation and the quantum of loss on liquidation. The rating agency believes that in the current market conditions not only the probability of liquidation has increased on account of an increase in encumbrances, but also the loss on liquidation is expected to be higher than what would have been initially factored in by lenders, owing to the sharp correction in equity prices.
The companies already classified as Elevated Risk of Refinancing as per Ind-Ra’s asset funding & refinancing risk study are likely to be most affected indicates Ind-Ra’s analysis. “A large number of these companies already have a significant proportion of their promoter holdings pledged. Of the 58 companies likely to have more than 50% of their promoter holdings pledged, 19 are already in default while another 19 are classified as Elevated Risk of Refinancing,” said the rating agency.
As on 31 March 2019, the total debt outstanding with the 58 companies stood at Rs 5.35 lakh crore while Ind-Ra estimates LAS transactions to account for Rs 34,300 crore (at 3x share cover) to Rs 41,100 crore (at 2.5x share cover). “It is imperative to note that the entire quantum of LAS transactions may not be outstanding on the books of these companies; rather promoters often pledge the shares of operating entities to meet the liquidity requirements of other group companies,” said the rating agency.