City limits: Credit crunch hits home

The credit crunch has come home to roost, with Collins Stewart warning of a slump in profits and the City's best-known brokers set to merge to save money. By Nick Clark
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Two years ago, the British broking industry was awash with talk of consolidation. Companies in a cramped sector feared for their future after a correction in the market saw business suffer, but the M&A floodgates never opened.

Those fears are back with a vengeance in the wake of the credit crunch, with experts predicting the fragmented broking industry will be shaken-up this year with as few as four players left in the market when the dust settles.

One senior manager at a brokerage firm yesterday called 2008 a "critical year" for the industry, while another said it would be "astonishing" if all the brokers survive the deteriorating market conditions.

Andy Stewart, chief executive of Cenkos Securities, said: "The industry is set for a shake-up. There probably are too many small and mid-cap broking firms around and some consolidation would be sensible."

The sector has been in the public eye for at least six months, as every week brings news of another potential tie-up in the sector. This has come at a time when brokers' core business has dropped off a cliff.

Collins Stewart signalled a warning shot to the industry on Monday. It revealed its corporate broking revenues had slumped as companies shelved fund-raising plans and dealing volumes retreated signalling a year of pain for some of its rivals.

Richard Grainger, executive vice-chairman of Close Brothers Corporate Finance, said: "The length of the current malaise must be causing concern for some companies. How long it goes on for could be critical to their survival. In today's climate, nobody wants to be left without a dance partner."

The problem facing the industry is the core business has spiralled since the sub-prime mortgage crisis in the US sparked a wider downturn. Brokers make their money from primary issuance – bringing corporate clients to market through initial public offerings – as well as commission-generated sales on behalf of companies.

For many, AIM is their lifeblood, so any dip in the market and waning confidence among small companies translates into lower revenues. Data provider Thomson Financial found that floats on AIM have fallen 75 per cent this year. There are concerns over how long those that concentrate on this area of the market can survive.

Mr Grainger said: "The question is who has a strong balance sheet? Companies aren't making money on a daily basis so people are looking at their burn rate."

"Many of these brokers simply no longer have the cash to carry on," one market participant said, adding: "the fallout will see small brokers collapsing, companies merging and predatory attacks on rivals' client lists."

Small and mid-cap brokers emerged in the wake of the "Big Bang" in London in 1986. As the market opened up, traditional merchant banks like Morgan Grenfell were bought by big European and US financial groups, desperate to get their hands on the FTSE 100 and international client lists. "That left a huge void for smaller financial groups servicing small businesses who were screaming out for cash," one market participant said. Their position was cemented with the launch of the Alternative Investment Market, the London Stock Exchange's growth market in 1995.

"The exchange wanted the bigger banks to be nominated advisors on AIM, but the fees were never going to be big enough and they didn't want the legal responsibilities. This left the door open for smaller firms," the source said.

Companies like Close Brothers, Collins Stewart, Numis, Evolution Securities and Panmure Gordon all filled the gap to become the predominant names at the small- to mid-cap end.

Jeremy Grime, analyst at Arden Partners, said the marketplace became crowded four years ago around the time the Sarbanes-Oxley Act was enacted in the US. The tougher regulation in New York drove many companies to seek a listing on the "lighter touch" AIM and the brokers emerged to cater to them.

As feast has turned to famine, many predict a shift as clients slim down their broker lists and demand consolidation. "The market is too fragmented," one said.

The spotlight, inevitably, has fallen on mergers with industry insiders saying "everybody is looking at everybody". The latest round was sparked in earnest when Cenkos Securities made an audacious £1.6bn bid for rival Close Brothers which fell apart in February. US private equity giant Blackstone signalled its interest in Close, with a plan to sell assets to Collins Stewart.

Talks also emerged last month between Panmure Gordon and Evolution Securities which have since collapsed, and Blue Oar approached WH Ireland. The larger companies are looking to build scale, add to their client base and diversify the business to offset downturns on AIM, into M&A advisory and asset management.

Stephen Georgiadis, the managing director of Altium Capital, said: "I think two or three deals will be done. But ...if the chemistry isn't right you can't force it."

The smaller houses face other threats. The larger brokers see poaching clients and staff as better business sense than paying the costs associated with a takeover. "If a rival is haemorrhaging staff and losing business, the client list is the obvious way to go," one source said.

There will be winners by this time next year, experts agreed, with the consensus being the emergence of four to six "strong" brokers targeting the small to mid-cap sector. Many expect the winners to emerge with a diversified revenue stream and a strong balance sheet that will actually boost the UK economy

"It will not be good for the UK if all the brokers disappear; there will be no one to service the smaller companies and UK industry will suffer as they will lose access to financing," one said. He added: "If the industry responds well and a few strong houses emerge in the old school UK merchant banking mould then it will be a good thing for British business."

Volatility proves a winner for Icap as it posts record revenues

The credit crunch has claimed many victims and, while some have remained resilient, few have been able to profit from the turmoil that has dominated the markets. Icap, the world's largest inter-dealer broker, is one of the exceptions. Run by the Conservative Party treasurer, Michael Spencer, it has just announced record revenues, profits and adjusted earnings per share for the year to the end of March, driven by the volatility in the markets.

Profits rose 31 per cent to £330.2m from £251.6m a year ago, while revenues were up 18 per cent to £1.3bn. Mr Spencer said: "We have benefited from higher volatility in the interest rate, foreign exchange, equity, commodities and in parts of the credit and emerging markets that began in June 2007."

In the medium term, he added, the industry revenues would grow by more than 10 per cent. "The active markets we have enjoyed since June 2007 have continued into the new financial year and we believe that higher volatility will continue to drive volume growth."

The group added that it was well placed to make acquisitions.

Nick Clark