Post Bear, Regulatory Reform May Squeeze Brokerage Margins

Increased regulation of the brokerage industry in the wake of the subprime crisis and Bear Stearns debacle could tighten the screws on brokerage business revenues and margins, says Ladenburg Thalmann analyst Dick Bove in a research report today.

Increased regulation of the brokerage industry in the wake of the subprime crisis and Bear Stearns debacle could tighten the screws on brokerage business revenues and margins, says Ladenburg Thalmann analyst Dick Bove in a research report today.

Bove notes that the Securities Exchange Commission and the Federal Reserve announced Monday that they signed a memorandum of understanding (MOU) to increase information sharing and cooperation. The MOU will cover bank holding companies and the entities that own securities firms and will build on recent cooperation on banking and investment banking capital and liquidity following the Board's emergency opening of credit facilities to primary dealers, among other things.

“Presumably, the next steps will be regulations that increase the capital requirements of the brokers and restrict their operating freedom,” writes Bove. “Additionally, by saddling the brokers with a number of the requirements that banks now face, the cost of running a brokerage firm will increase at the same time as the revenue generating power of these companies is cut back.”

Meanwhile, Fed Chairman Ben Bernanke said Tuesday that he is considering giving investment banks more time to get emergency loans from the central bank to help them overcome credit problems. The Federal Reserve has long offered these loans to commercial banks, but extended them to investment banks in March following the run on Bear Stearns that almost led to its collapse. These emergency loans to investment banks were initially meant to last only through mid-September.

Brokerage stocks fell Monday, with the Amex Securities broker/dealer index closing down 3 percent to close at 140.10. They may have been partly depressed by rampant speculation during the day that new accounting rules (FASB 140) may take effect, requiring all banks and financial institutions to take all qualified special purpose vehicles (QSPEs) back on to their balance sheets. Lehman analyst Bruce Harting wrote in a research report that if this change did occur, Wall Street firms might need to raise billions of dollars of cash to meet capital requirements. But Harting also said that the accounting board would never actually let that happen. FASB 140 has been around since 2000.

Bove notes that the SEC and Fed MOU comes just five days after Secretary of the Treasury Henry Paulson said banks should be allowed to fail during a speech before world economic leaders at Chatham House in Britain.
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