All four of the independent broker-dealers rated by Moody’s Investors Service are seeing their bottom line squeezed by investors moving money from lower-interest cash balance sweep accounts into higher-interest cash equivalents, the rating agency reported in its new quarterly report.

The four companies—LPL, Oppenheimer Holdings Inc., Raymond James Financial Inc. and the Charles Schwab Corporation—all reported lower pretax earnings in the second quarter, driven almost entirely by ongoing outflows from client cash balances, said Moody’s in its report, calledRetail And Independent Brokers—U.S. Q2 2023: Interest Rate Benefits Recede As Client Cash Sweeps Balances Decline.”

“All the firms in the report had pretax earnings declines and a slowdown in revenues that is definitely due, in part, to this client cash sorting triggered by investors moving their cash balances into higher yield alternatives that don’t benefit brokers much,” said Gabriel Hack, assistant vice president at Moody’s and the lead author of the report.

Hack said the drop comes after firms benefited from higher interest rates in 2022 and that analysts expected cash in sweep accounts to decline. “Did client sorting exceed our expectation? I wouldn’t say that. But we are monitoring the situation closely,” Hack added.

While Moody’s anticipated cash outflows in the second quarter, they were significantly lower than what these firms experienced in the first quarter. “We still expect some outflows, but we’re monitoring to see if the pace abates. We’re not expecting anything as severe as Q1 outflows,” the analyst said. He also noted that since both Schwab and Raymond James own their own banks, some of their profitability issues stem from the interest rate exposure affecting the banking sector at large.

According to Moody’s, Charles Schwab suffered an 8% drop in revenues in the second quarter and a 21% plunge in pretax earnings, mostly due to cash sorting. Raymond James saw a 1% increase in revenues, but a 13% drop in pretax earnings, while LPL experienced a 2% increase in revenues and a 13% drop in pretax earnings. Oppenheimer was hit with a 5% decline in revenues and a sobering 161% decline in pretax earnings as that firm swung from a gain to a loss; it also booked a loss from a legal settlement in the quarter.

Year over year, Schwab also experienced an 8% decline in revenues and a 26% decline in pretax earnings, while Oppenheimer saw a 29% increase in revenues and still suffered a 90% decline in pretax earnings.

In contrast, Raymond James and LPL both experienced increases in profitability year-over-year, with Raymond James seeing a 7% increase in revenue and 17% increase in pretax earnings and LPL reporting a 21% jump in revenue and an 83% increase in pretax revenues.

“It’s the house view that we’re likely to see future outflows, and while not as severe, we may start seeing some more difficult year-over-year comparisons as we move into the second half of the year,” Hack said.

Exacerbating investors’ cash sorting was the move by the Federal Reserve to raise its target federal funds rate by 25 basis points in July 2023 to a range of 525-550 basis points, after raising it 75 basis points during the first two quarters of 2023, Moody’s said.

Larry Roth, the former chief of both Advisor Group and Cetera, said that outflows from independent broker-dealers to higher-yielding vehicles was definitely a trend.

But he also said, “The economic impact on firms like RayJay, LPL, Advisor Group and Cetera will likely be minimal, because most of the cash in sweep accounts is there for the convenience of clients. Many advisors are moving ‘excess’ cash to money markets and CDs. Note that the recent bank crisis is making clients nervous about CDs.”

On a positive note, client assets ended the second quarter near record highs, driven by solid organic growth and higher market valuations.

Schwab, Raymond James and LPL all reported solid quarterly organic growth rates, although they were lower than growth in 2021, Moody’s said.

“These three firms operate at significant scale and are in a solid competitive position, which will support their asset-gathering capabilities,” the rating agency added.

Advisory and commission revenue streams at all the firms “also benefited from broad increases in equities markets and will partially offset pressure from declining client cash balances,” Moody’s reported.

—Additional reporting by Eric Rasmussen.