Capital Markets

Bear market erodes stockbrokers’ profits

The Nairobi Stock Exchange. Photo/FILE
The Nairobi Stock Exchange. Photo/FILE 

Stockbrokers are banking on improved economic growth to claw back part of the losses they incurred last year in a subdued market that left them with less commission and pulled down profitability across the industry.

Financial results published by the market intermediaries indicate that profitability dropped across the board in tandem with the changing fortunes of the equity market at the Nairobi Stock Exchange (NSE) as investors fled to the more secure fixed securities market.

With an estimated 90 per cent of brokerage income linked to commissions, low trading volumes, scarcity of new listings and the accompanying rush to the safety of fixed income securities brokers have been hard pressed to remain in the positive income territory – a position they hope to exit with improved growth this year.

Results released so far show that profitability dropped for the majority of brokers but confidence remains high in prospects of recovery this year.

“Last year was a difficult year for the [stockbrokerage] industry and the road ahead will be tough,” says Lucas Otieno, managing director at African Alliance Kenya Securities.

Kingdom Securities, NIC Capital, Sterling Investment Bank, ABC Capital, CfC Financial Services and Kestrel Capital are among the firms that have reported a drop in profitability with analysts predicting that the trend is likely to continue for the remaining brokers and investment banks.

That Kestrel Capital – the firm with the highest market share in terms of equity turnover – recorded a 65 per cent decline in profits last year from Sh69 million to Sh24 million, is a bold indicator of the tough times stock market players have fallen into.

Kestrel, with a firm stranglehold on foreign investors, saw its brokerage fees drop from Sh292 million in 2008 to Sh154 million last year, confirming the subdued business environment.

Only a third of the NSE market intermediaries reported positive earnings in half-year financial statements published in local newspapers for the first time in October last year.

The results reflected the market outturn that saw equity market turnover fall from Sh195.8 billion in 2008 to Sh76 billion at the end of last year as the economy grappled with the double hit of political violence in the previous year and global economic recession.

The stock market started 2009 on a bearish note with a 20.3 per cent drop in first quarter turnover saddled by foreign investor flight from frontier markets with the deepening of the global financial crisis.

The market however started to claw back some of the losses in the second half of the year as valuations started to look attractive due to the sharp sell off in the first and second quarter to close 7.8 per cent below 2008 as measured by the NSE 20 share index.

Analysts at AIG Investments said a combination of the slowdown in listed companies’ earnings and relatively higher returns from fixed income securities reduced the appetite for equity investments among domestic investors leaving the equity market on a slow motion track.

Stock market turnover fell by 40 per cent to approximately 40 billion in 2009, the lowest deep in five years reflecting the marginal improvement in economic growth from 1.7 per cent in 2008 to an estimated 2.2 per cent last year.

How they make money

Stockbrokers earn a maximum brokerage commission of 2.1 per cent of the value of shares traded.

This means that NSE’s 18 licensed intermediaries had to split the Sh1.6 billion earned in commissions.

The slowdown of equities market activity saw the fixed income securities outperform the stocks for the first time in the history of the NSE, having traded bonds worth Sh442 billion— a shift that also helped shape the brokers’ fortunes.

Commission chargeable on bond trades at NSE is capped at 0.125 per cent of sales valued at Sh5 million and below.

Institutional investors, who dominate the bonds market, are known to demand heavy discounts on trades leaving the agents with even lower commissions.

Besides, the bonds market is known to be dominated by three big players Faida Investment Bank, Standard Investment Bank and Dyer and Blair leaving other players with only meagre earnings from the market.

These key players in the bonds market have yet to release full year results for 2009, but people familiar with their financial outturn said all had recorded significant declines in earnings.

Equities turnover at the NSE declined by about 60 per cent with NSE 20 share index closing at 7.8 per cent below 2008.

As the economy came under a heavy splash of the global recession’s ripple effects, the bonds market proved to be a safety haven for thousands of investors running away from the turbulence of the equities market.

Since the year began, there have been no indications in a cooling off in the bonds market pointing to the perceived persistence of turbulence in the equities market and subdued earnings for brokers in the near term.

Bonds market turnover rose by 55 per cent in the first two months of 2010 from Sh26.7 billion in January to Sh41.6 billion in February reflecting last year’s stellar performance.

Heavy oversubscriptions

Last year, KenGen, Safaricom, CfC Stanbic, Shelter Afrique and TPS Serena went into the corporate bond market raising Sh34 billion in issues that were characterised by heavy oversubscriptions.

This robustness of activity in the bonds is what helped stockbrokers with established fixed income trading desks to boost their earnings with the resulting commissions and to outperform their rivals at the close of the year.

In recent months however, line of revenue has come under a serious threat as commercial banks – the biggest buyers of the bonds – push to be licensed as dealers, a move that will allow them to trade among themselves without going through brokers.

If authorised, the move will see investment banks and brokers, lose out on hundreds of millions of shillings in bond trading commissions further pulling down their incomes.

Commercial have in the recent months also invaded the corporate finance arena, another key revenue artery for investment banks, signalling a possible squeeze in earnings for the stand alone intermediaries.

Possible listings

“The first quarter volumes are encouraging and the planned privatisations this year are promising,” said Stanley Ngaine, the chairman at Sterling Investment Bank.

Turnovers in the equity market remain subdued falling from Sh6.36 billion in January this year down to Sh4.21 billion early this month.

But market players reckon that the interest in equities might improve in tandem with projections of a sustained economic recovery.

The expectation that the economy will grow at the rate of four per cent in 2010 from below two per cent in 2009 is expected to act as a confident booster for corporate earnings and ultimately improve the performance of market intermediaries.

“There is a feeling that the improving economy will translate into better performance at the stock market and with it the performance of brokers,” says Joshua Njiiru, general manager at Madison Asset Management.

Still, with a bulk of earnings for financial services providers coming from brokerage commissions on trades at the local stock market, licensee will be forced to seek new avenues for income.