Global warming aside, the macroeconomic weather has definitely become better for broker-dealers over recent years for at least one important reason: rising interest rates.
Those rates dipped effectively to zero for many years after the 2008 financial crisis as the Federal Open Markets Committee in the U.S. and other central banks around the world fought the financial crisis. The near-zero rate held steady until the Fed raised rates at the very end of 2015—it rose to three hikes in 2017, four in 2018. In December last year, the federal funds rate was raised to the 2.25% to 2.5% range.
As the price of borrowing has increased, it’s given broker-dealers a chance they haven’t had in a long time—to make money off the cash they hold for clients, an income stream that for a long time had gone bye-bye.
Raymond James, Ladenburg and LPL have all said in earnings calls and SEC filings that they are seeing a boon from higher interest rates.
“You’ll see that [B-D] performance is improving very dramatically, and a portion of that is the spreads that they earn on cash,” says Larry Roth, a veteran who in the past has run two big broker-dealers, both AIG’s Advisor Group and Cetera. (He’s now a founder and managing partner at RLR Partners offering strategic consulting.)
In its 10-Q released December 31, Raymond James Financial wrote: “These increases in short-term interest rates have had a significant impact on our overall financial performance, as we have certain assets and liabilities, primarily held in our [Private Client Group] and RJ Bank segments, which are sensitive to changes in interest rates.”
Sharing Is Caring
“The way their platforms work,” says Roth, “let’s say their clients open an account at say any one of the firms—if the accounts are held on [a] platform and a client keeps, say, 10% of their assets in cash, in the past they were money market accounts. Today they are almost all FDIC sweep accounts, so it’s essentially a bank account. When people trade in and out of securities, when they are in cash, the cash is swept over night and held in these banks, and the banks share their spread between what they’re investing in, let’s say it's 10-year Treasurys [and] you’re trading now at whatever it is, 270 or 265 basis points.
“The difference between what the bank earns and what the client earns is shared with the brokerage firms,” Roth continues. “So if the 10-year [Treasury] finds its way back up to say 4 percent, which is historically not an unreasonable number, then the firms themselves … they can earn anywhere from 60 to upwards of 200 basis points on that cash.
“In the aggregate, it’s a really material number,” he says. “It’s tens of millions of dollars at all these bigger firms, and it could be even more than that at firms like [Merrill Lynch].” At giant firms it could mean well over $100 million, he adds.