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The flight of cash out of brokerage accounts might be slowing, or even reversing. But what is sticking around might still be costlier to hold on to.
Since the Federal Reserve began raising interest rates in 2022, brokerages have seen a key revenue source come under big pressure: What they can earn on customers’ uninvested cash. When rates were super low, brokers could earn a good margin by sweeping that money into banks, either for fees from partners or as an ultra-low-cost deposit in their own banks to then deploy for a higher yield.
But as rates rose, investors started seeing that cash not as trash, but as a serious asset that could generate a return. So instead of letting it sit, people moved more of their cash to higher-yielding savings accounts, or out of bank accounts and into money-market funds.
Now, as the Fed starts to cut rates, that flow appears to be slowing or reversing course. Charles Schwab SCHW -0.21%decrease; red down pointing triangle reported that transactional sweep cash had a net inflow of $17 billion in the month of September. At Morgan Stanley MS 0.14%increase; green up pointing triangle, third-quarter brokerage sweep deposits were still down $12 billion from a year prior, but were up $2 billion from the second quarter. Bank of America BAC -0.21%decrease; red down pointing triangle Chief Executive Brian Moynihan told analysts that its wealth management deposits have “basically been flat” for the past several weeks.
These reports validated investors’ bets on shares of major wealth managers and brokerages as the Fed’s pivot came into focus this summer. Over the past three months, shares of firms including Schwab, Morgan Stanley, Raymond James and Stifel Financial SF -0.36%decrease; red down pointing triangle have all well outperformed the market, as well as broader bank and financial company indexes, according to FactSet data.
But while the huge outrush of cash might be finished, it isn’t yet clear that investors are ready to give up their yield-seeking altogether. Some of this stabilization also followed moves by brokers to improve their pricing on sweeps and other wealth deposits. Brokers’ net interest margin, or the difference in what they earn on customers’ cash versus what they pay for it, should be closely watched in the quarters ahead.
“I don’t think we’re going back to a zero-rate environment,” Stifel Chief Executive Ronald Kruszewski told analysts on the firm’s third-quarter results call. “So, I wouldn’t be baking in something that says that we’re going to drive [net interest margin] because people are going to go back into sweep. Sweep will always be there for transactional cash, but savings cash is the new normal.”
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The larger question is also whether there may be a broader brokerage industry shift going on. There have been class-action lawsuits related to the rates on cash sweeps, and the Securities and Exchange Commission has also scrutinized the practice. Even if these suits and inquiries come to naught, Moody’s Ratings has said the heightened attention could still play a big role.
“No new regulation has yet been proposed, and wealth managers with appropriate disclosures have a case to defend their current cash sweep practices,” the ratings firm wrote in August. “Nonetheless, they may end up yielding to competitive forces and offering higher rates, as well as incur increased regulatory compliance costs.”
This isn’t to say brokers won’t still see benefits from at least stability in the flow of money. For one, any cash they feel comfortable putting to work now can be doubly beneficial by replacing more expensive funding secured during the 2023 banking scare and the long period of rising rates.
Schwab told analysts that while it urges caution on extrapolating from a monthly or quarterly trend in cash movements, the firm believes it is at the point at which it can keep paying down a lot of its recent extra borrowing, helping its net interest margin.
Brokers’ other revenue sources can also help offset margin pressure. More investment and trading activity, perhaps as more investors look to get into bonds, would also boost fees and bring in more transactional cash, some of which accrues from holding more income-paying assets. And, in general, as more investors move toward independent advisers or managing their own money, retail brokers can still grab new customers and overall asset share.
But the bottom line is the days of being able to play with vast pools of cash paying little might not return for a while. If they ever do.
Write to Telis Demos at Telis.Demos@wsj.com
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Appeared in the October 29, 2024, print edition as 'Cash Still Isn’t Cheap for Brokerages'.