Prominent Main Street Investment Firm Customers Drive Stock Prices Down

Over the past week, some of the most prominent Main Street investment firms, including Charles Schwab and LPL Financial Holdings, have experienced significant declines in their stock prices, driven by their own customers. With short-term interest rates remaining high, these customers are demanding better returns on their cash holdings. This pressure from investors is likely to continue.

Schwab has faced a particularly challenging period, with its shares dropping more than 14% following disappointing second-quarter results tied to its banking operations. Similarly, shares of LPL Financial and Raymond James Financial have also suffered, with LPL down 15% and Raymond James down 8% over the past week. TD Cowen has cut price targets for both stocks, citing similar concerns.

The issue at hand is "cash sorting." As interest rates rise, investors are moving their deposits from low-yield accounts, which are highly profitable for investment firms, to higher-yielding accounts that are less profitable. This is a move investors should have considered years ago, but it has gained attention recently as rates on money-market funds and other cash vehicles have climbed to the 5% to 6% range.

Big Wall Street banks are also grappling with similar challenges. Morgan Stanley recently announced it would raise rates on cash held for some clients, while Wells Fargo made a similar move last week, which is expected to cost $350 million. Despite these actions, larger and more diversified banks have not seen the same stock price declines. In fact, Morgan Stanley's shares have risen 3.4%, and Wells Fargo's shares are up 2% in the past week.

While casual investors might view brokerage firms primarily as stock-trading entities, a substantial portion of their profits comes from cash held in sweep accounts. These accounts are temporary holding places for cash before it is used to purchase stocks or bonds, or where dividend checks are deposited if not automatically reinvested.

Because sweep accounts are often overlooked by investors, they typically offer interest rates much lower than other cash instruments like money-market funds or high-yield savings accounts. Brokerages then lend out these low-cost deposits at higher rates, similar to a bank, profiting from the difference.

This has become a significant profit source. Schwab's net interest revenue was $2.2 billion last quarter, far exceeding its $777 million in trading revenue and accounting for about 46% of its total revenue. At LPL, interest income represents a smaller portion of overall revenue, but TD Cowen noted that sweep-related revenue accounts for up to 30% of gross profits.

LPL did not respond to a request for comment. Schwab stated that when appropriate, they encourage clients to move long-term cash to higher-yield options like money-market funds or CDs, which benefit the client.

Recently, investors have begun to understand this dynamic, likely driven by the Federal Reserve's efforts to combat inflation, which have increased yields on competitive cash products. Legal actions, such as a lawsuit against Morgan Stanley, may also have contributed to this awareness.

Schwab has been dealing with cash-sorting issues throughout the year, with deposits at its banks dropping from $328 billion a year ago to $258 billion today. Despite hopes that these problems were behind them, the latest quarter proved otherwise.

Data indicates that many depositors have not yet taken advantage of the opportunity to earn higher rates on their cash. While precise figures on brokerage account interest rates are elusive, the national average interest rate on savings accounts is just 0.36%, according to Federal Reserve data.

The disparity in rates advertised by Schwab highlights this issue. Uninvested cash in Schwab brokerage and retirement accounts currently earns 0.45%, while their standard retail money-market fund pays 5.14%, more than ten times as much. Schwab also points out that sweep accounts carry FDIC protection and offer features like check writing and free debit cards.

Investors need to recognize the value of their cash. The competition for this value is a zero-sum game between them and their investment firms.

Popular

More Articles

Popular