Commissions hit by higher options volumes

Commissions hit by higher options volumes

The Indian markets closed at all-time highs on Thursday, overall volumes are near record levels and there has been strong growth in segments such as distribution of financial products and financing for clients. But shares of broking firms are still down between 55% and 68% from their peak in early 2008.

Some of this is reflected in the quarterly results of broking firms. In the quarter ended September, total revenues of Motilal Oswal Financial Services Ltd, Edelweiss Capital Ltd and India Infoline Ltd rose by 23% year-on-year (y-o-y), according to data collated by Prabhudas Lilladher Research.

Revenue from the financing business rose by as much as 79% y-o-y, driving overall growth. Commission revenue, which include brokerage, distribution, investment banking and asset management fees rose at a steady rate of 14%. Within this, the Prabhudas analysts point out, broking revenue has fallen by 10-12% y-o-y. Overall growth is due to a sharp rise in investment banking and distribution income.

Why are broking revenue falling at a time when market volumes are rising? One key reason: An increasing proportion of derivatives volumes is happening in the options segment, where commission is substantially lower since the broking fee is charged only on the option premium.

The drop in commissions has been accompanied by higher operational costs and increased competition. Besides, borrowing costs have increased, leading to a compression in margins of even the financing business. As a result, though overall margins grew by 23% last quarter for the three firms, cumulative profit before tax fell by 8.8%. Operating profit rose by 17.8%, but pre-tax profit was pulled down because of high interest costs. The picture is similar for the first six months of this fiscal—overall revenue grew by 21.8%, driven again by the financing business; but profit before tax fell by 7.1%.

On the positive side, there are signs of improvement in cash market volumes in recent months and, as the Prabhudas analysts point out, the sector’s valuations aren’t expensive at 13.8 times estimated earnings and 1.9 times estimated book value for FY12. But investors would be interested only when there are clear signs of improvement in the profitability of these firms.