Case 075Lending and leverageHard

The promoter family of a listed cement company has pledged 40% of its stake. The stock falls 30%. Work out the lender's margin trigger, the forced-sale risk and the effect on the family's wealth and control.

The situation

The promoter family of Vindhavar Cement owns 5.5 crore of the company's 10 crore shares, 55%, worth Rs 2,750 crore at Rs 500 a share. To fund a new venture it has pledged 40% of its holding, 2.2 crore shares worth Rs 1,100 crore, against a loan of Rs 550 crore: a cover of 2.0 times.

The loan agreement asks for more collateral if cover falls below 1.75 times, and lets the lender sell pledged shares if cover falls below 1.5 times and the call is not met within days. The stock then falls 30% to Rs 350 on a weak quarter. The shares trade a modest volume each day, so heavy selling moves the price.

Your task

Where are the triggers, what does the lender demand at Rs 350, and what happens to the family's wealth and control if it cannot pay?

Quick check

At what share price does the lender first ask for more collateral?

Worked solution

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

30-second answerThe answer to give first

The top-up trigger is Rs 437.5 and the sale trigger Rs 375, so a 30% fall to Rs 350 is past both. Cover is 1.4 times. To restore 2.0 times the family must pledge 0.94 crore more shares or repay Rs 165 crore within days. If it cannot, forced selling pushes the price to about Rs 320, the lender sells 1.24 crore shares, and the family's stake falls from 55% to 42.6%, below majority control.

Step 1Where are the lender's triggers?

A gold loan works the same way: borrow against jewellery, and if gold falls far enough the lender asks for more or sells it. Cover is the value of the pledged shares divided by the loan; with Rs 550 crore lent against 2.2 crore shares, cover of 1.75 times is reached at Rs 437.5 and 1.5 times at Rs 375. Those are falls of only 12.5% and 25% from Rs 500, well inside a normal year's range for a cyclical stock.

Where the triggers sit: a 30% fall is past both of themRs 500: pledge made, cover 2.0x0%Rs 437.5 (-12.5%): cover 1.75x, top-up call-12.5%Rs 375 (-25%): cover 1.5x, lender may sell-25.0%Rs 350 (-30%): cover 1.4x, the case-30.0%about Rs 320: price after forced selling-36.0%Below the sale trigger the lender, not the family, decides when shares are sold.
The lender asks for more collateral at Rs 437.5, a 12.5% fall, and may sell at Rs 375, a 25% fall, so the 30% fall to Rs 350 is already past both triggers, and forced selling pushes the price further to about Rs 320.
Step 2What does the lender demand at Rs 350?

At Rs 350 the pledged shares are worth Rs 770 crore, cover of 1.4 times. To restore 2.0 times the family must either pledge 0.94 crore more shares, taking the pledged share of its holding from 40% to 57%, or repay Rs 165 crore in cash. More pledging keeps control for now but leaves even less room if the fall continues; repaying needs cash the family raised the loan precisely because it did not have.

Step 3What happens if the family cannot meet the call?

The lender sells, and the selling itself moves the price. At Rs 350 the lender would need to sell 0.94 crore shares to restore 2.0 times cover; if heavy selling drags the price to about Rs 320, it must sell 1.24 crore, because each share raises less and the shares left behind are worth less. This forced sale spiralWhen selling pledged shares pushes the price down, which lowers the value of the remaining collateral and forces yet more selling. is why pledge disclosures unsettle markets. The family's stake falls from 5.5 crore shares to 4.26 crore, from 55% to 42.6%, below the 50% that gave it majority control.

A pledge turns a price fall into a loss of control1 Pledge2.2 cr of 5.5 crshares pledgedLoan Rs 550 crCover 2.0xstake 55.0%2 Price falls 30%Rs 500 to Rs 350Collateral Rs 770 crCover 1.4xbelow 1.5x triggerstake 55.0%3 Margin callPledge 0.94 cr moreor repay Rs 165 crwithin daysor the lender sellsstake 55.0%, more pledged4 Forced saleSelling drives theprice to about 320Lender sells 1.24 crshares to restore 2.0xstake 42.6%Bars: family's share of the company; the dashed mark is 50%, the line for majority control.Net wealth: Rs 2,200 cr before, Rs 1,375 cr after the fall, Rs 1,210 cr after the forced sale.
The pledge of 2.2 crore shares at cover of 2.0 times becomes cover of 1.4 times after a 30% fall, triggering a margin call; if it is not met, forced selling near Rs 320 takes 1.24 crore shares and cuts the family's stake from 55% to 42.6%, while net wealth falls from Rs 2,200 crore to Rs 1,210 crore.
Rs croreBeforeAfter 30% fallAfter forced sale
Share price, Rs500350320
Family shares, crore5.505.504.26
Value of family shares2,7501,9251,364
Loan outstanding550550154
Family net wealth2,2001,3751,210
Stake55.0%55.0%42.6%
A 30% share price fall cuts the family's net wealth by 37.5% because the Rs 550 crore loan does not fall, and the forced sale takes it to Rs 1,210 crore, 45.0% below the start, with the stake down to 42.6%.

Close with what an adviser to the family says before this happens. Size a pledge so the sale trigger sits beyond a realistic bad year, say a 50% fall rather than 25%, which here means borrowing about half as much, and keep a cash or unpledged-asset reserve ready to meet a call. The loan magnified a 30% price fall into a 37.5% fall in net wealth before a single share was sold. The limit: the numbers assume one lender and one agreement; families with several lenders can face calls from all of them at once.

Where candidates lose it

The common error is thinking the lender acts only when the loan is no longer covered, at a 50% fall. Triggers are set on cover ratios well above 1.0, so margin calls begin after falls of 12.5% and 25%.

The second miss is computing the forced sale at the pre-sale price. Selling a large block moves the price, and a lower price means more shares must be sold, which is how a family loses control in a single bad month.

What the interviewer asks next

  • What loan size would keep the sale trigger at a 50% fall?
  • The family meets the call by pledging more shares. What happens if the price falls another 15%?
  • How should minority shareholders read a rising pledge percentage in the promoter's disclosures?

Company names and figures are illustrative.