thecorporatetreasurer.com38 corporate treasurer December 2014 / January 2015

Following higher corporate defaults and subsequent tighter lending rules, treasurers are resorting to pledging company shares and assets to lock in investors. India’s central bank is not overly fond of the practice, however. Emma Bi reports

the shares or other pledged assets are delivered to the investors.

“I saw many more corporates use promoter financing [in 2014], as borrowing is more difficult,” said Manoj Lodha, CFO of Jain Irrigation Systems, a micro-irrigation systems maker based in India and a user of promoter financing.

Long nights India has recently set up 39 debt recovery tribunals to help state-owned banks recover debt by selling defaulters’ assets more efficiently. The nation also allowed banks to label corporates’ directors and debt guarantors as “wilful defaulters” – a tag that makes loans to violators practically impossible. Even for corporates that are not wilful defaulters, financing has become more challenging.

Jain Irrigation was no exception. Short of funds at a time when the company was trying to grow to benefit from government initiatives to improve agricultural efficiency, Lodha was struggling to secure the necessary capital. With a market capitalisation of Rs37.61

H undreds of Indian companies have been surrendering their own shares and company property as a means to

help raise funds this year. Although not unheard of, the recent spate has been driven largely by a regulator-led clampdown on lending standards that have forced treasurers outside of the traditional bank markets.

As of November 7, 19% of the 4,380 corporates listed on Indian stock exchanges have pledged shares to raise funds, according to Bloomberg data. Tata Consultancy Services, Sun Pharma, Tata Motors, Mahindra & Mahindra, Bajaj Auto, and Asian Paints – companies all with a market capitalisation of more than $10 billion – have committed their stock for this purpose.

Broadly put, this is called promoter financing – where the stock, or other assets or securities, are used as collateral via a third party “promoter” to convince investors to stump up cash in the form of a loan. If the loan is not paid back,

billion ($607 million), Jain Irrigation sells systems to more than 3,000 dealers who distribute equipment to farmers in India. Jain Irrigation also sells to Coca-Cola, Nestlé, Unilever, and Amari Plastics.

“We needed financing to meet our growth needs, as some Indian state governments have mandated the use of drip-irrigation systems for grow-for-sale crops,” explained Lodha.

Having failed to lock in a suitable lender, in March this year, Lodha turned to Religare Credit Advisors (RCA), a subsidiary of Indian financial services firm Religare, and used promoter financing.

“I tried for months, but couldn’t get anything from traditional [financing] channels, and I had a very limited time left [to raise funds],” said Lodha. “I remember sitting with [RCA] for meetings until 12 midnight, and it turned out to be the first time in my 20-year professional career that we could have a transaction done within about 15 days.”

Jain Irrigation and RCA thrashed out an agreement whereby the latter would

Pledging fundingsecure shares to

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provide a loan through a non-operating promoter-owned investment holding company, Jalgaon Investments Private Limited. Jalgaon Investments holds Jain Irrigation shares, which it pledged, together with its properties, to a fund that is managed by RCA called the Religare Credit Opportunities Fund.

“A quarter of the fund is from Religare Group’s balance sheet, and 75% of the fund is from investors arranged by [RCA],” explained Kanchan Jain, CEO and principal managing partner of RCA. “These investors include high network individuals, rich families, and corporates.”

Through this structure, Jain Irrigation raised a three-year loan worth Rs500 million at an annual interest rate of 15.5% (75 basis points over India’s present prime lending rate). The total collateral pledged is worth approximately Rs1 billion. The funds were moved over to Jain Irrigation on March 24.

RCA and investors in the fund have full recourse to the shares and property in the event Jain Irrigation defaults on its debt. The debt is repaid back to RCA via Jalgaon Investments. Operating companies in India cannot hold their own shares; a third party promoter is necessary in this arrangement.

RCA subjected Jain Irrigation and Jalgaon Investments to due diligence, with a focus on assessing business models, performance records, and the need for funds. Religare also analysed Jain Irrigation’s existing debt profile, along with the repayment track records, said Sandeep Adukia, managing partner of RCA.

no magic buLLetAlthough promoter financing has worked for Jain Irrigation, lawyers are generally warning CFOs against using the strategy for loans with long tenors.

“[Pledging shares to finance] may be an attractive route, with a short duration of less than two years, but it’s better not to use it for long-term debt,” said Dipankar Bandyopadhyay, a partner at Indian law firm Verus, who is concerned that stock market volatility could force companies to pledge more shares.

“Besides, bank loans may still be cheaper, despite the many restrictions on whether and how a bank can lend to a corporate,” he said.

Beyond just losing shares in the event of a default, a company could potentially lose control if the company fails to pay its debt. “Our investors have the right to invoke the pledge on shares and liquidate to recover and, in the case of Jain Irrigation, also take possession of the property if Jalgaon Investments fails to pay back the funds,” said Adukia.

“Pledging shares may be an attractive route… but it’s better not to use it for long-term debt”

reguLatory worriesThe increasing volume of the corporates’ borrowing against pledged shares has also attracted the attention of the Reserve Bank of India (RBI), India’s central bank. “This has been a very less regulated area, but the central bank is now trying to improve the transparency and avoid stock market volatility from the promoter financing transactions,” said Bandyopadhyay.

When borrowers default on their borrowings, the lenders, who are non-banking financial companies (NBFCs), have in the past offloaded shares in the market, creating stock volatility, said the RBI.

As a transparency requirement, the RBI issued new rules on August 21 to requesting all NBFCs with assets of more than Rs1 billion to report the information about pledging shares to stock exchanges. Two online reporting websites have been established to protect shareholders’ interests.

The central bank also requires NBFCs to maintain a loan-to-value ratio of 50% or below and imposes strict requirements on what kind of shares can be pledged. For example, only Group 1 securities can be used as collateral for loans of more than Rs500,000 and is subject to central bank approval. Group 1 securities are highly liquid stocks with a low mean impact cost.

It is a tricky time for India’s companies. When making a decision to raise funds through promoter financing, a treasurer should be mindful the rules surrounding it could change any time. He should also be ready to communicate very clearly with shareholders what exactly the company is doing with its stock, and why. n