Last week, both Charles Schwab and Morgan Stanley reported Q3 earnings, and, as usual, both earnings calls discussed brokerage sweeps in detail. Schwab's retiring CEO `Walter Bettinger says on the latest earnings call, "In the quarter, we made strong progress across virtually all key areas.... Our clients are growing transactional sweep cash balances. We've made meaningful progress in paying down supplemental funding.... We all know that net new asset levels can be fickle as multiple factors influence them, from investor sentiment to market performance, interest rates and even the level of promotional cash for assets temporarily offered by some competitors. But, when we dig through the various factors that do influence net new assets, we remain quite confident in our plans to build our way back to our historical ranges." (Note: We look forward to seeing those of you headed down to Nashville for AFP's Annual Conference. Come visit us at booth #432!)
Retiring CFO Peter Crawford comments, "With Ameritrade related attrition receding and ceasing to be a major drag on our organic growth, a continued moderation of client cash realignment activity, which allowed for sequential growth in client transactional cash in the third quarter due to strong net inflows during September, [we've seen] sequential growth in both net interest revenue and overall revenue and ... a steady and continued increase in our capital levels.... And, while we all appreciate the uncertain nature of the world we live in, our positive momentum sets the stage for what we expect will be even better operating and financial performance in the quarters and years ahead."
He explains, "As Walt mentioned, 2024 has been characterized by strong equity markets and consistent client engagement.... And ... `client cash realignment activity continues to decelerate enabling strong growth in overall client cash and transactional cash for the quarter and especially robust growth in the month of September. Now, while we repeatedly cautioned against overreacting to a specific month's or even quarter's transactional cash flows, this recent activity is further evidence that we are at or near truly transactional levels of client cash, enabling us to pay down a meaningful amount of supplemental borrowing at the banks and creating a good launching off point for Q4 as Mike will discuss in a moment."
New Schwab CFO Michael Verdeschi tells us, "As Peter alluded to earlier, we saw a healthy rebound in transactional sweep cash during the quarter, including $17 billion of net inflows in September. This positive development in cash enabled us to reduce high-cost supplemental funding at the banks by $9 billion. At the same time, we also continued to take proactive steps at the broker dealer to both support sustained client activity in areas such as margin lending and further diversify our funding profile. Those actions included transferring $4 billion of client cash sweep balance to the broker dealer, bringing the total year-to-date transfers to $14 billion. This allows us to align funding where it's needed to support the large and growing activity of our former Ameritrade clients."
He continues, "The trends in transactional sweep were quite encouraging for the third quarter with total sweep cash balances growing $9 billion, including a $17 billion net inflow during the month of September. This result reflects the continued slowdown of rate related realignment activity. Cash trends during September also benefited from anticipated seasonal trends as well. Moving forward, it's important to keep in mind that while cash trends do not move in a straight line month-over-month, we anticipate making further progress over time, ultimately resulting in cash balances growing in proportion with client accounts and assets. So, while we will continue to monitor factors that can influence the trajectory of cash, such as interest rates, investor engagement, as well as seasonality, these encouraging trends help support our strategy and momentum into the end of the year."
Verdeschi adds, "The cash trends also positioned us to make incremental progress on reducing the amount of outstanding supplemental funding at the banks. We reduced the balances by $9 billion from the June 30, 2024 level to just under $65 billion at the end of the third quarter. Supplemental funding balances are now down over 30% from peak levels back in May 2023. Further pay down progress remains a priority as cash as well as principal and interest proceeds from the bank securities portfolio continue to be key drivers in paying down borrowings. The exact timing for achieving our pay down goal will also be influenced by some of the same factors that we see in our transactional cash trends."
During the Q&A session, Verdeschi replies, "In the quarter, we did see organic growth of cash. And I would say, we also saw some of the variability that we typically see in client activity as they engage us. So, as you highlight, we did see that pick up in September. But over the course of the quarter, as we've been saying, this is further evidence of that realignment activity normalizing. So, a combination of organic growth and some of that variability as well. So, we feel good about this progress."
Replying to another sweep question, Bettinger says, "We have cautioned for a long time an excessive focus on monthly cash movements, because you can simply have a one day difference making a huge impact in a monthly number depending on when fixed income maturities mature. Although the numbers are big, if you look at these numbers as a percentage of a $10 trillion client base, they are actually quite modest. And so the right way to look at it is at a quarter, not at a month. And we feel very good about where we ended up for the quarter. I don’t think there is anything unique or one off in the results for the quarter. And that's why we feel confident about the fact that we continue to make progress in building of our balance sheet cash and anticipate that as we move forward taking into account the seasonality that Mike previously referenced."
On Morgan Stanley's call, CFO Sharon Yeshaya states, "Total deposits increased sequentially to $358 billion. While average sweeps were down slightly, ... we've seen recent signs of stabilization, particularly as the Fed began cutting rates. This is encouraging. Net interest income was $1.8 billion. Looking ahead to the fourth quarter, we would expect NII to be modestly down from the third quarter results, largely on the back of lower rate expectations, consistent with the forward curve."
She comments, "I'd say actually all the KPIs [key performance indicators] and all the underlying is strong, sweeps being one that I called out, as the deposit trends are certainly encouraging, especially since the Fed began to cut rates. We've seen that over the back end of September and even as we look into the beginning of the fourth quarter on a relative basis in terms of expectations. So, that has been positive.... There continues to be investments into markets on a monthly level from brokerage sweeps, which you didn't see last year."
Asked about deposits shifting, Yeshaya says, "When we look at where we've been and the types of language that we've used historically, I'd say that just to put it in context, the rate environment has changed. It's changed since the second quarter and I'd say it's changed pretty materially. So, we don't have control as we all know in terms of where interest rates are going. What I can speak to is where we are from a deposit level. And as I said, the trends that we've seen are extremely encouraging. If you think about where we've come from and where we are over the course of the last couple of weeks, especially ... since the Fed has cut interest rates."
She tells us, "The near-term guidance that I gave is that we will likely be modestly down ... on a quarter-over-quarter basis. And where we will be as we look into 2025, I think we will re-evaluate based on where sweeps are [and] where interest rates are ... when we sit at the beginning of January. But I just want to put a little bit of perspective around the conversations that we've had about sweeps and NII over the course of the last couple of years. I understand that it's been a very important topic for investors, especially when you think about sweeps, in particular. But sweeps, as I said, have been, to some degree, stabilizing."
Finally, Yeshaya adds, "So, we just need to gain a bit of perspective now that we see where sweeps are, that the markets are coming back and that we continue to see asset management fees rise and that is the durable revenue and what we expect to see from this business model as we move forward.... Things like a savings product will have a much higher beta than something like a sweeps product, which will have a much lower beta. They ... are two different products with two different purposes in terms of the dynamics of what they're used for."
