Uninvested cash balances have traditionally been a significant revenue stream for the wealth management industry, yet this landscape is shifting.
Wealth management firms now face growing pressure to increase the interest paid on clients’ uninvested cash, a development that could be a "credit negative" for some independent wealth managers, according to a recent research note from Moody’s Ratings.
Legal and regulatory challenges are adding to the pressure. Clients have filed lawsuits, and regulatory bodies are scrutinizing firm disclosures, which may result in reduced spread-based revenue from clients’ uninvested cash balances and increased legal and compliance costs, as outlined in Moody’s August 15 report.
For many wealth management firms, this represents a significant reversal. These firms have historically profited by sweeping clients’ uninvested cash into low-yielding accounts that, while highly profitable for the firms, offer little return to the clients.
Moody’s analysts highlighted the profitability of cash sweep revenue, noting that it typically does not contribute to financial advisor compensation. This is because these balances are not included in assets under management (AUM), from which advisors usually earn their fees.
The Federal Reserve’s interest rate hikes, beginning in 2022, have made investors more aware of the returns they earn on uninvested cash. Consequently, many are moving their money from low-yield bank accounts to higher-paying alternatives. This shift has led to lawsuits against major firms such as Wells Fargo, Morgan Stanley, and LPL Financial. Plaintiffs argue that these firms have breached their fiduciary duties by not seeking higher interest rates for their clients’ cash balances.
Regulators are also paying close attention. For instance, Wells Fargo recently disclosed that the Securities and Exchange Commission (SEC) is investigating its wealth management unit’s cash sweep practices. Similarly, Morgan Stanley revealed that the SEC requested information about its policies regarding cash balances swept into affiliated bank deposit programs and their compliance with the Investment Advisers Act of 1940.
While regulatory risk is significant, Moody’s analysts argue that the more immediate concern for wealth managers is the competitive pressure to increase rates on uninvested cash balances.
Over the past month, several firms have announced rate increases on uninvested cash. UBS is the most recent example, with the Swiss bank revealing that its U.S. wealth management division will raise interest rates on sweep cash in advisory accounts. UBS Chief Financial Officer Todd Tuckner attributed this move to "competitive dynamics" during the company’s August 14 earnings call, noting that the change is expected to reduce pre-tax profits by about $50 million annually.
Moody’s analysts suggest that other wealth managers may feel compelled to follow UBS’s lead, warning that a decline in spread-based revenue could be particularly challenging for highly leveraged firms that depend heavily on this income to service debt.
Private-equity-backed wealth management firms are especially vulnerable, according to Moody’s. These firms often have less diversified revenue streams and significant debt, making them more susceptible to the financial impact of declining spread-based revenue. Publicly traded companies, in contrast, typically have more conservative leverage ratios and diversified revenue sources, which can provide some cushion against these pressures.
The analysts identified several private-equity-backed firms at heightened risk, including Kestra Holdings, Aretec (the parent company of Cetera), and Osaic (formerly known as Advisor Group). These firms may struggle to manage the financial strain if the trend of increasing rates on cash balances continues.
In contrast, wealth management divisions within larger banks, such as Morgan Stanley and Wells Fargo, may be better positioned to weather these changes. These firms can rely on other business lines for revenue, and cash sweep income constitutes a smaller portion of their overall earnings.
Moody’s analysts also warn that as competition intensifies and rates rise across the industry, wealth managers may attempt to offset lost revenue by introducing new fees or raising existing ones. This could include higher advisory fees, reduced payouts to advisors, or the introduction of new account fees. However, such changes carry the risk of increased client and advisor attrition.
As the industry navigates these pressures, wealth managers must balance the need to remain competitive with the potential risks of altering fee structures and the broader impact on client relationships and advisor retention.
