Gilts dealers produce record profits

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THE 19 firms that run the market in government stocks reported record profits of pounds 65m last year as the Treasury stepped up its demand for funds to cope with a ballooning public sector borrowing requirement.

But the turmoil in the markets in September and October did most to boost profits, rather than higher volumes of new issues. There was heavy trading in gilts as interest rates came down in the wake of Britain's withdrawal from the exchange rate mechanism.

According to a review of the market published this morning by the Bank of England, this made up for the market's poor results in lacklustre summer trading, as the post-election euphoria faded.

With profits improving, confidence returning and an assurance of heavy future borrowing by the Government, gilt-edged market- makers (Gemms) as a group injected new capital into their businesses for the first time since the period after Big Bang.

The annual profit, the third in a row, was pounds 16m higher than in 1991. A small number of firms made losses, but on a 'modest scale', the Bank said in its review, released ahead of publication in today's Quarterly Bulletin.

Gemms withdrew capital from the market in the three previous years, but they injected pounds 24m last year. The capital employed in the market rose for the second year running, from pounds 432m to pounds 521m, but this was the first increase involving new money rather than retained profits.

Capital has still not regained the pounds 600m level at the time of Big Bang in 1986, when the new market was inaugurated.

But the review suggests that the market is in good shape to handle sales of new stocks as the Government's need for funds continues to grow. The gilts market-makers are the conduit for all the Government's new issues.

Separately, a Stock Exchange survey found that average dealing cost for institutions has halved since 1991, to 0.003 per cent for short-dated stock. There was a much smaller fall in private investors' costs, from 0.224 per cent to 0.173 per cent for shorts.

The Bank review says strong competition has led to changes in the pecking order of firms, with the middle-ranking market-makers raising their market share from 25 per cent in 1991 to 29 per cent in 1992.

The six smallest dropped from 13 per cent to 8 per cent between the first and last quarters of 1992. The top six also lost market share but still had 60 per cent of the market.

Warburg and Greenwell Montagu Gilt-Edged are known to have the biggest individual market share, with 15 per cent or above each. But market sources said that aggressive bidding in gilts auctions had put Salomon Brothers, the US firm, only a couple of percentage points behind Greenwell on a rolling three-month average, putting pressure on firms such as BZW and Lehman Brothers.

UK institutions were the main buyers of the pounds 31.2bn of new stock issued in 1992, and they tended to buy longer-dated gilts than before. Total stock outstanding rose from pounds 122.4bn to pounds 144.1bn, exceeding the previous peak reached in March 1988. This was after redemptions of pounds 9.5bn. Average turnover rose pounds 500m to pounds 2.5bn a day, but reached pounds 3.7bn a day in September.

A Bank survey of institutions found they each used fewer Gemms than in 1991, but that there was 'an encouraging degree of investor satisfaction'. Investors also approved of the pounds 2bn- pounds 3bn size range of auctions. But the review rejected pressure for a fixed auction calendar because it would remove flexibility.

----------------------------------------------------------------- PROFITS OF GILT-EDGED MARKET-MAKERS ----------------------------------------------------------------- Oct 1986 to end 1988 1989 1990 1991 1992 pds m pdsm pds m pdsm pdsm Net injections/ withdrawals of capital +15 -13 -40 -12 +24 After-tax profits/losses -190 -12 +40 +49 +65 Gemms' capital at end of period 420 395 395 432 521 ----------------------------------------------------------------- Source: Bank of England -----------------------------------------------------------------