Securities earnings improve, future uncertain

After a significant revenue slump in Q3, the securities industry managed to post gains in the final quarter of 2007, according to the Investment Industry Association of Canada’s quarterly Securities Industry Performance Report. Industry revenues hit $4.3 billion in the final three months of the year, up 11% quarter over quarter.

“Despite considerable volatility … performance in the second half of the year held up considerably well,” says Ian Russell, the IIAC’s president and CEO. “Within the second half, we did have some stability in the market. It was punctuated particularly in late July and early August by a sudden steep decline in equity markets, but then it came back and held steady.”

The positive Q4 numbers, combined with a strong first half of the year, helped the industry achieve revenues of $17.1 billion for all of 2007. While that falls below 2006’s 18% growth rate, revenues are up 8% from two years ago, establishing a “high watermark for the industry,” says the report.

One particularly bright spot for the industry was in wealth management. The IIAC report notes that investors and advisors adjusted their portfolios to the changing market conditions. The result was a robust fourth quarter, resulting in high levels of activity and larger commission revenues than in Q3 and similar revenues to Q4 2006.

Mutual fund commissions and trailers set a new record, adding $2.2 billion to the securities industry last year, while the shift to a fee-based business model among advisors accounted for $800 million in industry revenue in the fourth quarter. For the year, fee-based revenues accounted for $2.6 billion, or 15% of the total industry revenues in 2007 — up from 10% five years ago.

“The industry will benefit from some very important structural changes put in place over the last four or five years,” says Russell. “There’s a higher proportion of wealth management business that is fee driven now. Fee-based accounts put more stability in wealth management earnings.”

He also says that the industry has done a good job broadening its businesses, so firms that specialize in retail wealth management are now offering entire product ranges and more conventional products and services.

Investment banking also had strong revenues in Q4, up 17% to $1.1 billion quarter over quarter. Last year, investment bankers brought in a total of $4.5 billion in revenues — an increase of 15% over 2006.

The report reveals that mergers and acquisitions activity remained strong throughout the year, setting a new record of $370 billion worth of deals. That’s up 44% from the old record of $257 billion in 2006.

Not every area of the industry saw year-over-year gains. Operating profits, for one, increased by 20% over Q3 but were still down 14% from the same time the year before. And despite an 11% increase in operating profits to $6.4 billion year over year, growth in profits was off 34% from 2006’s totals.

Equity trading improved too, by 205.7% in Q4, but revenues of $37 million were nowhere near Q4 2006’s revenues of $232 million. For the entire year, dealers made $460 million from proprietary equity trading; that was down 43% from two years ago.

While most areas of the securities industry at least posted some positive numbers, fixed income had no such luck.

Because of overnight rate slashes and risk repricing, fixed income saw a 54% drop in revenues in Q4 and a 48% fall year over year. In 2007, fixed-income trading revenues totalled $689 million, 13% lower than in 2006.

“No one wants structured products anymore,” says Russell, explaining why fixed income is in the doghouse. “The legacy of the asset-backed commercial paper debacle will put a cramp on fixed income.”

However, he says that more conventional corporate borrowing should improve in the first half of this year, and interest rates could rise, helping the fixed-income market, but activity will still be well below what the industry saw in 2005 or 2006. “Fixed income will have a tougher go,” he says.

Another area of the industry that’s in dire need of improvement is initial public offerings. According to a new survey by PricewaterhouseCoopers, the number of Canadian IPOs on the London Stock Exchange–run AIM market decreased by 46% last year. There were just seven new listings raising about $187 million, compared to 13 new listings in 2006 that made around $374 million.

The second half of the year was especially dismal, as only two Canadian IPOs took place on AIM.

Closer to home, the TSX and TSX Venture exchanges also saw new issues fall. In 2007 there were 90 IPOs with a combined value of $3.4 billion, while 2006 saw 109 new issues worth $5.6 billion.

Russell says the declining IPO figures have more to do with market volatility than anything else. “Institutional businesses found it very difficult in the second half because of the volatility and the drop in equity prices,” he says. “This caused financing activity in the domestic market to fall pretty steeply, and you see that reflected the numbers.”

He adds that Canada will see more IPOs when financing returns, which won’t happen until well into 2008 at the earliest.

Looking forward, Russell is optimistic that the industry won’t find itself mired in long-term economic troubles. He says that the country is in a “financial induced recession,” which means industry watchers are still trying to determine if, in fact, we are in a recession and how long and deep North America’s economic woes might be. “So that creates a lot of uncertainty,” he says.

But at the same time, there are many parts of the economy that are still thriving. Russell points to fairly good earnings, low unemployment and a strong consumer sector. “There are signs of weakening, but when we talk about next quarter [in 2008], there is still an underlying strength.

“We have the trade sector in the U.S. that’s strong because of the weaker dollar. Commodity markets benefiting Canada in particular are strong and robust, and, most importantly, there’s very strong global growth coming out of the developing world,” he explains.

If Russell’s prediction is right, that the recession will be “fairly shallow and short,” the industry will see better indicators soon enough. “If that happens,” he says, “we’ll see equity market conditions improve in the second half of this year.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(03/11/08)