Rapidly rising interest rates are waking people up to the earning potential of cash. It will be an adjustment for banks and brokers – but it is not the end of the world.
Across banks, there is concern among investors about how quickly cheap deposits may re-price or deviate in the search for better returns. For the broker giant and banker Charles Schwab,
This pressure comes in the form of what it calls cash sorting: People take some of their as yet uninvested cash, which earns very little, and move them to a money market fund or other higher return alternative. Even if the money is moved into a money market fund offered by Schwab, it typically provides less fees for Schwab than what it would earn by spending the same money on its own balance sheet.
Cash sorting should come as no surprise, and it probably hasn’t really started in earnest: Among the firms tracked by Wolfe Research analysts, only Goldman Sachs Marcus and Robinhood Markets have increased cash rates “in a meaningful way” “since the Federal Reserve’s rise in interest rates in March. But many expect this to be just the silence before the storm, with the Fed taking an increasingly hawkish tone. What may hit financial stocks now is the fear that this onslaught will become faster and more furious. The KBW Nasdaq Bank index has fallen more than 6% so far in April, which is worse than the S&P 500.
To prepare, Schwab reported last week that it currently holds more of its investment portfolio in cash – around 15% or 16% compared to the typical 5% to 7% – to help avoid being forced to sell securities or seek more expensive financing when cash migrates. This liquidity buffer comes at the expense of adding more higher-yielding securities in the meantime. Schwab said its experience during the last cycle of rising interest rates, which ended in 2019, which saw a reduction of about 20% in uninvested cash over three years, remains “a reasonable reference point.” How fast that process happens, and what will be the offsetting flow of new assets, are some key variables for the ultimate effect.
With an expected faster interest rate cycle, Schwab said last week that it could now see the net interest margin in the fourth quarter reach the middle of the 1.8% range, well above the first quarter 1.38% level. However, it was below what analysts’ consensus had been at the end of this year, at over 1.9%, according to figures tracked by analyst Christian Bolu in Autonomous Research. Some of the expectation gap may, according to Mr. Bolu is explained by the effect of the higher pull of low-interest cash on Schwab’s investment portfolio. Schwab’s stock fell last week after reporting earnings and has now fallen more than 17% in April.
SHARE YOUR THOUGHTS
What is your view on Charles Schwab? Join the conversation below.
Ultimately, however, fast cash sorting can be a short-term headache on the way to a long-term benefit at higher rates. Schwab attracts very cheap deposits as it offers trading and investing tools and many of its assets are rewritten quickly as prices rise. Remaining more liquid also allows the company to use its cash when prices stabilize, at higher returns than it could today. “Schwab remains a huge benefit of higher rates,” says Wolfe analyst Steven Chubak. “The question is more about timing.”
Investors with some patience and a longer time horizon can still look at Schwab as a strong game with higher rates. Schwab may even get a larger share of future activity from investors if people look at a wider range of investments than just speculative stock selection – especially if they stick to Schwab when choosing a money market fund.
As is the case across many financial stocks right now, the rapid change in prices will create noise in the short term. Investors should sort through their own portfolios and hang on to stocks like Schwab that should eventually come out ahead.
Write to Telis Demos at email@example.com
Copyright © 2022 Dow Jones & Company, Inc. All rights reserved. 87990cbe856818d5eddac44c7b1cdeb8