Late last week, Charles Schwab hosted its "Winter Business Update Agenda," a week after releasing its Q4'22 earnings the previous week. (See the release, "Schwab Reports Record Full-year Earnings Per Share.) CFO Peter Crawford comments in the earnings release, "Schwab's record financial performance in 2022 highlighted the resiliency of our diversified financial model. Sustained business momentum through an uneven macroeconomic environment helped drive 12% growth in total net revenues. Net interest revenue reached $10.7 billion, an increase of 33% versus the prior year, as higher interest rates more than offset the impact of balance sheet contraction due to client cash sorting. Lower market valuations throughout the year pushed asset management and administration fees down slightly to $4.2 billion, or 1% year-over-year."

He explains, "Over the course of the year, our approach to balance sheet management prioritized flexibility to help navigate through a dynamic environment. As rates rose from the ultra-low levels observed during the most recent period of the Federal Reserve's Zero Interest-rate Policy, clients allocated a growing portion of their assets to higher yielding cash and fixed income alternatives. As a result of this expected sorting activity, the balance sheet shrank by $115 billion, a decline of 17% versus December 31, 2021. To facilitate these movements, we took steps to further bolster liquidity by limiting new portfolio investments to help build available cash and utilizing a limited amount of short-term funding sources such as Federal Home Loan Bank Advances and retail certificates of deposit."

On the Winter Business Update, Crawford tells us, "I'll ... provide some more empirical data and some more information analysis around our clients' behavior with regard to their cash, and explain why we're confident that this behavior will abate during 2023 and we'll see at some point this year a resumption of deposit growth."

He says, "Turning our attention to the balance sheet, our balance sheet reflected the reaction by our clients to the dramatic increase in rates as they move some of their uninvested cash off our balance sheet into higher yielding alternatives, oftentimes with our active help and encouragement. Total balance sheet assets declined 17% for the year, driven by declines in both bank deposits as well as payables to brokerage clients. [W]e finished the year with roughly $17 billion of FHLB advances and other short-term borrowings. [W]ithin interest earning assets, we saw a 28% reduction in margin balances, a function of the lower equity markets and more negative investor sentiment as well as higher rates."

Crawford explains, "I mentioned in the CFO commentary last week that we've entered what we believe is the later innings of the client cash sorting cycle.... This is not necessarily the last inning, but the later innings of this cycle. So, we wanted to build off the commentary provided at the fall business update to explain why we're confident this is the case and why, again, we'll see a resumption of the balance sheet or the deposit growth over the course of 2023." (See our Nov. 1, 2022 Crane Data News, "Schwab CFO Crawford Says Cash Sorting Will Abate, in the Middle Innings.")

He continues, "So, our clients, recall, tend to keep a certain level of transactional cash in their accounts for liquidity purposes, and as their cash levels approach that sort of minimum floor of transactional cash. As more accounts approach that level, the cash that we receive from new accounts offsets any lingering sorting activity that we see in the existing accounts."

The Schwab CFO shows a graph of cash balances by tier, and says, "Now, this [graph] is a particular wealth tier, particular tier of clients who have, for example, between, let's say $1 million to $2.5 million dollars of total assets in their account. We've done this analysis across 30 different wealth tiers, across five different client segments. And the pattern is exactly the same. What you see and what these lines represent is different cohorts of clients within that wealth tier, based off on how much cash they had at the beginning of the of the rising rate cycle. So, the upper one, of course has more cash, lower one has less cash. And again, we've done this for multiple ... cohorts of clients based off of their cash levels."

He continues, "What you see, of course, is that as interest rates increase, those cash balances for that entire cohort start declining, but they don't decline to zero. They decline, they sort of converge around this. We call here an equilibrium line, or we called previously [a] floor. [I]mportantly, the pace of that decline, the pace of that sorting roughly corresponds to the distance they are from. Their cash flows are from that equilibrium level. Now, that may not be totally surprising. But what may be more surprising is what happens with client cash, with clients whose cash balances are below that level at the outset of the of the rising rates. What we see there is their cash balances actually increase. And this is why we say this is better to think of this more as an equilibrium versus a floor."

Crawford explains, "The point is, even clients who start out with low cash, even as rates are increasing, ... rates have increased by 400 plus basis points in the last year, they're actually increasing the level of transactional cash, the level of cash on our balance sheet during that period of time, which supports this idea that there is this equilibrium level of transactional cash that clients want to maintain. Now, we saw this pattern in the last rising rate cycle and we've seen in this rising rate cycle as well. The same pattern is holding true here."

He adds, "Here's another demonstration of the existence of that equilibrium level. Each of these lines represent a group of clients who placed their first purchase money fund trade during that month. What you see is a place where they start using purchase money funds and they basically reduce their cash level to a certain equilibrium level and then they are content with that. It doesn’t go to zero. You stay at that level.... Regardless of when they start that process, they all end up basically in the same place. So again, we're very confident there is this level of transactional cash within the different accounts. And of course, it varies based on how much assets they have in their account, but it should be at each of those have a pretty consistent level of equilibrium transaction cash they want to have in their account."

Finally, Crawford states, "So, what we've seen is that the sorting activity that that we have seen thus far follows almost identically to the analytical models that we developed based off of the last rising rate cycle and following the same behavior ... that we saw from the 2015 to 2019 cycle. And we continue to believe that the magnitude of this sorting activity for existing clients will be not that much different from what we saw in the previous cycle. And therefore, at some point during 2023, that sorting activity will continue to will slow and it will be offset by organic cash that comes in via new accounts and we'll see a return of deposit growth."

Email This Article




Use a comma or a semicolon to separate

captcha image

Money Market News Archive

2024 2023 2022
February December December
January November November
October October
September September
August August
July July
June June
May May
April April
March March
February February
January January
2021 2020 2019
December December December
November November November
October October October
September September September
August August August
July July July
June June June
May May May
April April April
March March March
February February February
January January January
2018 2017 2016
December December December
November November November
October October October
September September September
August August August
July July July
June June June
May May May
April April April
March March March
February February February
January January January
2015 2014 2013
December December December
November November November
October October October
September September September
August August August
July July July
June June June
May May May
April April April
March March March
February February February
January January January
2012 2011 2010
December December December
November November November
October October October
September September September
August August August
July July July
June June June
May May May
April April April
March March March
February February February
January January January
2009 2008 2007
December December December
November November November
October October October
September September September
August August August
July July July
June June June
May May May
April April April
March March March
February February February
January January January
2006
December
November
October
September