Mark Blinch/ReutersLurking somewhere in the shadows of the credit crisis is a whole lot of trouble for Canada's independent brokerages, analysts say. “Deal flow has gone to zero, pretty much,” said a Toronto-based analyst ...

The signs that Canada's independent brokerages are being hit hard by the global credit crisis aren't as visible as for their U.S. counterparts that have gone under, been swallowed up, or converted into banks. But with equity underwriting all but dried up, trading down, and unprecedented government intervention at the big banks to ease credit conditions, times are tough and getting tougher, industry watchers say.

"Deal flow has gone to zero, pretty much," said a Toronto-based analyst who tracks the industry, adding that he would not be surprised to see some firms go out of business. "A lot of brokerages have launched in the last few years. The pie is getting smaller and you've got the same number of people fighting over crumbs," he said, speaking on condition that his name would not be used.

If Canadian firms do go under, it is more likely to be a slow death from lack of business, rather than a flameout along the lines of highly-leveraged industry giants such as Bear Stearns and Lehman Brothers south of the border, industry watchers said.

"The Canadian system is much simpler. No revenue equals the possibility of going out of business," said the analyst.

Among the challenges are double-digit declines in equity financing, and a loss of trading revenue as brokerages pull back on risky trades at the expense of fees, said Jeff Fenwick, an analyst at Cormark Securities.

Merger and acquisition transactions in the energy sector are also dying down, and the mining sector may follow with commodities prices softening.

Gabriel Dechaine, an analyst at Genuity Capital Markets said the third quarter, in which there were no initial public offerings, was the "most challenging" since the onset of the global credit crisis more than a year ago. Domestic equity financing was down 33% from a year ago, and 60% from the previous quarter.

In a note to clients ominously titled "the cracks deepen," Mr. Dechaine said independent brokerages are also suffering trading volume losses as investors shift "towards more liquid large cap stocks, which is the primary domain of the bank-owned dealers."

The impact of the challenging conditions is already being seen on Bay Street.

Last week, GMP Securities LP cut 37 administrative staff, or 8% of its workforce. The senior management group took a 10% cut to fixed salary.

Salary is most often the smallest component of compensation at firms that pay out in excess of half their revenues in bonuses in good times, and industry players say the "haircuts" are unlikely to stop there.

"For most people, you'll see bonuses go down this year, and they'll trim some fat around the edges," said Cormark's Mr. Fenwick.

A senior investment banker at an independent dealer based in Toronto agreed that it will be lean times for the independents until market conditions improve. But he said the compensation structure at firms including Canadian heavyweights GMP and Canaccord Capital should allow them to remain profitable and to retain their regulated capital cushions for some time despite the downturn.

"If 50% of your revenues goes to employees [in bonuses], you can be down 50% and your company's still in great shape - people just aren't going to be paid as much," he said. In tough times, disappointing bonuses are less likely to lead to mass defections, especially if the bonus cuts are taking place across the industry.

Canadian brokerages should also be in better shape to weather the downturn than their U.S. counterparts because they are required to maintain strict levels of risk-adjusted capital to cover their trading inventory and can't gamble in the virtually unlimited manner that brought down Lehman Brothers and Bear Stearns and forced Merrill Lynch & Co. into the arms of Bank of America.

"They don't have depositors [like banks], but they have a huge capital base that is regulated," the investment banker said. Canada and the U.S. operate in "totally different systems. It's not even worth comparing."

However, if conditions worsen to the extent that Canada's investment banks begin posting losses and dipping into their retained earnings, it is possible they could look to tap credit lines with the major banks to maintain their capital cushions, he said.

Whether or not such credit is available just when independent brokers may need it most depends on how the current federal intervention aimed at freeing up credit at the major banks plays out, said a financing executive at one of Canada's largest banks.

"If you have to choose between a long-term corporate creditor and a competitor, and you only have $1 to lend, who are you going to lend to?" he said. "This is the environment we're in."

Financial Post

bshecter@nationalpost.com

Close