Stock broking companies were on a roll last year. Business was good as the indices broke record highs almost every other day. They expanded their branch network at a furious pace, even in small towns, and the staff strength multiplied. Money to fund this rapid expansion was not a problem as private equity investors were chasing stock brokers with bagfuls of cash. Some established stock brokers sold out to foreign buyers at good valuations while others formed alliances.
New businesses to leverage their strengths were the next step and investment banking was invariably the most fancied. Most industry observers were stunned when a domestic brokerage lured the entire investment banking team from a foreign player, by offering an astonishingly high initial pay out. Some brokerages ventured into real estate and even consumer finance – a segment where established commercial banks like ICICI and SBI are struggling with bad loans. Brokerages were unconcerned about the risks as capital was plentiful and their main focus was on bulking up an array of businesses.
The tide seems to be turning now. Geojit Securities, partly owned by French banking giant BNP Paribas, has announced a sharp fall in fourth quarter profits. The company, which focuses on retail business with little reliance on proprietary trading, was affected by the substantial fall in trading volumes. It also made a Rs4 crore provision for potential customer defaults. Last month, Prime Securities – another brokerage – had announced a Rs23 crore mark-to-market loss following the decline in value of its holdings.
Stock prices of some brokerages had soared more than 15 times in last year’s bull run. But, most brokerage stocks have nearly halved in value in this year’s correction. A popular theory supporting high valuations of these stocks is that foreign banks will be interested in their customer base and branch network in the post-2009 liberalisation promised by the RBI.
Global players entering financial services will be interested in large brokerages with access to high net-worth customers. But, that doesn’t justify the excessive valuations as they also have the option to buy out the smaller banks. Retail broking is a low margin, highly volatile business which may not hold much value except for buyers seeking to expand their customer base. Further improvements in technology will lead to even lower commissions and profitability.