18 June 2012

Nigeria: Merger, Best Option for Sustainability of Brokerage Firms - Analyst

The Managing Director Cowry Asset Management, Mr. John Chukwu has said that the merger of brokerage firms in the nation's capital market is inevitable as most firms' operational funds are insufficient to sustain their businesses.

The investment analyst said that the fact that most operators in the market are not able to cover their operating costs makes it imperative for some of them to either merge or close shop.

According to the Chukwu, who made this remarks in a report recently, said "I think that a shake-out is almost inevitable in the capital market sub-sector. The fact that most operators in the market are not able to cover their operating costs will make it imperative for some of them to either merge or close shop.

The reality is that the current volume of transactions on the floor of the Nigerian Stock Exchange, which is about N2 billion daily average, is not sufficient for the over 200 brokers in the market."

He said with the stock market gradually consolidating, "We now have about five to 10 operators controlling over 80 per cent of the market turnover. So for operators whose businesses are principally broker/dealer and who do not engage in other capital market activities like issuing house, financial advisers, etc, the likelihood that their income would be sufficient to sustain them in business is remote.

In the not too distant future business exigency now would compel those small operators who are not earning enough income to sustain their operations to either sell their operations to those who are capable of sustaining it or merge with such other companies.

On the believe that indiscriminate granting of margin loans by banks to most operators was responsible for the collapse of the stock market, Chukwu said, "It is a statement of fact that margin loans contributed to the crash in the market because there was so much leverage that it created an asset bubble in stocks.

Basically what happens in any economy where credit is cheap, easily available and pursues a particular asset class, is that that asset class would eventually be overpriced and then one day the bubble would burst. That was exactly what happened to Nigerian equities.

"By the time the banks finished their consolidation, they had so much liquidity and foreign fund managers were also granting them credit lines, which actually meant that their liquidity was further boosted by the foreign lines. The banks channelled most of these new found liquidity into the equities market, through margin lending and proprietary trading, leading to the pricing of equities beyond their intrinsic value.

At some points we were seeing PE multiples running into 20 times, which was clearly an indication that the equities had become overpriced and that a bubble had built into that asset class. Eventually, when the banks lost their liquidity through recall of foreign lines by offshore banks in response to the economic crises in US and Europe, Nigerian banks responded by also recalling their margin loans as well as selling down their equity positions in order to reflect their liquidity.

He explained that the market was also affected by the exit foreign fund managers who also had to sell down their portfolio partly to escape from riskier markets and to meet their credit obligations back home, "A combination of these factors and the impact of bubble capital created by some banks in the course of the capital raising exercise led to the capital market crash.

Of course there are other factors but I agreed with the former NSE boss that the level of margin loans contributed significantly to the crisis in the market.

It would be recalled that, to forestall a re-occurrence, the CBN and SEC have come out with a policy on margin lending, restricting the amount of margin loans that banks can actually give out.

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