Case 070Forensic accountingCore

Tanmora Textiles' promoter owns 60% and has pledged 70% of that stake. The lender makes a margin call if the share falls 30%. What is the risk to minority shareholders?

The situation

Tanmora Textiles has 20 crore shares trading at Rs 300. Its promoter owns 60%, 12 crore shares, and has pledged 70% of them, 8.4 crore shares, against a loan of Rs 1,260 crore taken at 50% of the shares' value, so the collateral covers the loan twice.

The loan terms: if cover falls to 1.4x, which happens at a 30% fall in the share price, the promoter must add collateral to restore 2.0x; if he cannot, the lender sells pledged shares in the market until cover is back at 2.0x. Tanmora trades about 20 lakh shares a day.

Your task

Trace what happens as the share price falls, how many shares could be sold and how fast, and what that means for minority shareholders.

Quick check

At the first margin call, how much of the promoter's free stake does the top-up use?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

A 30% fall uses up every free share the promoter has; a further fall to about Rs 147 forces the lender to sell about 5.1 crore shares, 26% of the company. That is roughly 26 days of normal trading volume, so the selling itself drives the price down and can trigger more. Minority shareholders face a forced-selling spiral and a promoter whose stake falls from 60% to about 34%.

Step 1Why does a pledge turn a price fall into forced selling?

A family that pawns its gold for a loan must hand over more gold if the gold price falls, or the lender sells it. A share pledge works the same way: the loan is fixed in rupees, the collateral is valued at the market price, so a falling price shrinks the cover until the lender demands more shares or sells the ones it holds. Tanmora's pledged shares are worth Rs 2,520 crore against a Rs 1,260 crore loan, 2.0x cover. At 1.4x the lender acts, and 1.4 / 2.0 is exactly a 30% fall, to Rs 210.

Step 2What happens at each trigger?

At Rs 210 the promoter restores 2.0x by pledging 3.6 crore more shares, which is all 3.6 crore he has free. He survives the first call, but with no spare collateral left, the next trigger is only another 30% away. With all 12 crore pledged, cover falls to 1.4x again at Rs 147. Now the lender sells: to restore 2.0x it must sell Rs 756 crore of shares and repay the same amount of loan, 5.14 crore shares at Rs 147, 25.7% of the company.

Two trigger prices: the first uses up the free shares, the second forces a saleRs 100Rs 150Rs 200Rs 250Rs 300First call at Rs 210: all free shares pledgedSecond call at Rs 147: nothing left to pledgeLender sells 5.1 crore sharesabout 26 days of full volumeRs 300 todayTime, as the price falls
Tanmora's first margin call at Rs 210 absorbs all of the promoter's free shares, and the second at Rs 147 leaves nothing to pledge, so the lender must sell about 5.1 crore shares, roughly 26 days of normal trading volume.
Step 3Why is that sale so dangerous for everyone else?

At 20 lakh shares a day, 5.1 crore shares is about 26 trading days of the stock's normal volume. Even selling a fifth of each day's volume, which is already heavy, would take about 129 trading days. A seller that large cannot sell without pushing the price down, and every fall lowers the cover again, so forced selling can feed on itself. Minority holders take the price fall without having borrowed a rupee. The promoter's stake also falls from 60% to about 34%, which can change who controls the board, and a promoter under pressure may be tempted into related-party transactions to raise cash.

The promoter's 12 crore shares through two margin callsToday8.4 pledged3.6 free60.0% of the companyAfter first call, Rs 21012.0 pledged60.0%, no free sharesAfter forced sale, Rs 1476.86 left5.14 sold34.3% of the company
Tanmora's promoter starts with 8.4 crore pledged and 3.6 crore free shares, pledges all 12 crore at the first call, and after the forced sale at Rs 147 is left with 6.86 crore, 34.3% of the company.

What would you check? The pledge percentage and its trend in shareholding disclosures, the lenders and their trigger terms where disclosed, what the loan funded (a promoter's other ventures are a governance question), and the stock's daily volume against the pledged quantity. Pledge disclosure rules and thresholds are set by the market regulator and change over time; confirm the current requirements before relying on any figure.

Where candidates lose it

The common loss is saying pledging is fine as long as the business is sound. A pledge makes the share price itself the risk, whatever the business does, because the lender acts on the price.

The second is stopping at the first trigger. The first call is survivable; the danger is that it uses up the promoter's buffer, so the second call arrives with nothing to meet it.

What the interviewer asks next

  • How would you size a position in Tanmora given the pledge?
  • The promoter releases half the pledge by selling a stake to a financial investor. Is that good or bad news for minorities?
  • What would make a lender reluctant to sell even after a trigger is hit?

Company names and figures are illustrative.