Zero commissions, zero interest rates: Is cash still king at custodians?

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Clients are parking more cash than usual in brokerage accounts as coronavirus fears roil markets. That would be a boon for retail brokerages and custodians where client cash is a critical revenue driver.

But there’s a problem. Lower interest rates.

On March 15, the Fed cut interest rates to near zero, and retail brokerages and custodians took a hit. Schwab’s average client yield dropped by 1.38%, while E-Trade’s dropped by 1.3%. By the end of March, float investments in TD’s bank deposit account balances had a negative return rate at -.05%.

Cash yields were just one element of a particularly scrutinized earnings season. The end of the quarter brought some companies’ first comments about how the coronavirus pandemic and accompanying economic shutdown has affected financial services and wealth management.

Even as many advisors urged clients to stay invested, investors pulled a record $326 billion from mutual funds and ETFs in March alone, according to Morningstar data. (They only pulled $104 billion from long-term funds at the peak of the 2008 financial crisis)

While money market fund flows rose more than 19% last quarter, many clients left their money in cash, earnings statements showed.

As clients parked more cash on the sidelines, Schwab’s balance sheet grew by $77 billion to $371 billion year over year. In the month of March, clients kept an average 15.1% of their assets in cash, up from 11.3% over the same period last year, according to the company.

“As has been the pattern during prior periods of high market volatility and bear markets, clients moved to cash,” Walt Bettinger, CEO of Schwab, said on the company’s earnings call with analysts April 21. “But part of what made this period different is that a significant degree of the movement to cash actually came from fixed income.”

For firms where net interest income constituted up to 62% of revenue, this boosted the top line.

“A record influx of $14 billion in customer cash bolstered our earnings power,” Chad Turner, CFO of E-Trade, said in a statement. (TD Ameritrade and E-Trade, which are expected to be purchased by Schwab and Morgan Stanley, respectively, did not hold earnings calls)

However, clients’ move to cash triggered expenses at TD Ameritrade due to its agreement with TD Bank, which owns over 40% of the brokerage.

In this arrangement, floating balances of over $20 billion in TD Ameritrade sweep accounts incur a management fee of 25 basis points. (Below $20 billion, fees to TD Bank range from 3 to 25 basis points)

Due to these fees, float investments were generating a negative yield of -.05% by the end of the quarter, with an annual revenue run rate of -$27 million. While fixed investments had a positive net rate at 1.57%, some analysts weren’t impressed. Steve Chubak, analyst at Wolfe Research, wrote in an equity research report that the commentary on these yields was “sobering.” Brian Bedell of Deutsche Bank ranked it as a key negative to monitor

Renegotiating this agreement with TD Bank was a key opportunity of the Schwab acquisition, according to acquisition materials shown to shareholders in a presentation. Schwab will pay 15 basis points, rather than 25 basis points, to TD, making bank sweeps at TD Ameritrade more profitable.

“We are excited as ever,” Bettinger said about the TD Ameritrade acquisition on the Schwab earnings call.

Market volatility stemming from the coronavirus pandemic challenged net income at retail brokerages, even as it bolstered account openings and new assets.

TD Ameritrade reeled in $45 billion in net new assets and $220 million in order routing revenue, which stemmed from historic trading volume. E-Trade gained $18 billion in new brokerage assets and $4 billion in new stock plan inflows this quarter. Clients opened 280,000 accounts at Schwab in March alone, and the company had $73.2 billion new assets.

Still, net income fell. Schwab’s net income dropped 18% to $795 million. E-Trade’s was down to $181 million from $290 million — or 38% — in the year-ago period. At TD, net income was $446 million, down 11% from $499 million year-over-year.

What will coronavirus uncertainty mean for the Schwab-TD deal?
Since the all-stock purchase was announced, TD Ameritrade's valuation has plummeted and both firms are now operating with most, if not all, staff working remotely.

Unexpected costs from equipping employees to work from home en masse contributed to the net income decline, as did some spot bonuses.

Schwab handed out $1,000 to all employees below the officer level (apart from contract workers) in March. TD made a similar move in April, issuing $1,000 stipends to help employees cover costs tied to working remotely, including technology or daycare, according to the company. The stipend went to all full-time and part-time employees at the director level and below, including temporary employees and interns.

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Clearinghouses/custodians Charles Schwab E-Trade Financial TD Ameritrade Cash Cash management M&A Earnings Broker dealers Interest rates Coronavirus
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