By Niket Nishant
(Reuters) -The spate of regulatory investigations into wealth managers' cash sweep programs could hurt their credit ratings, Moody's (NYSE:MCO) Ratings warned on Thursday, underscoring the threat to the high-margin business for firms like Morgan Stanley and Wells Fargo.
WHY IT'S IMPORTANT
A potential ratings downgrade would increase the costs for wealth managers at a time when worries about the economy are growing, with some forecasting a downturn due to the tight monetary policy.
CONTEXT
Cash sweep programs allow wealth managers to move un-invested cash in brokerage accounts to partner banks, enabling clients to earn returns on idle funds.
However, these arrangements have led to disputes, as the interest paid by partner banks is typically lower than what customers could earn through other options, such as money market funds.
To prevent these conflicts, wealth managers have started giving clients more choices. Customers can opt to park their un-invested money in tax-exempt funds or other vehicles instead of moving it to their brokers' partner banks.
Morgan Stanley, Wells Fargo and Bank of America have also raised the interest rates they pay on some brokerage accounts.
Despite these efforts, regulatory investigations remain a concern. Wells Fargo and Morgan Stanley have disclosed their cash sweep programs are under review from the SEC, while Bank of America highlighted it as a potential risk factor in its quarterly filing.
Moody's said that having multiple revenue streams will help mitigate the risk for larger firms. However, private-equity owned wealth managers with high debt burdens and less diversified business models are likely to be more severely affected.
The investigations could squeeze margins across the industry by prompting firms to increase the interest on brokerage accounts, the ratings agency added.
KEY QUOTE
"Increased competition could propel consolidation in this space, depending on how many sweep accounts are affected and how much revenue is lost," said Gabriel Hack, assistant vice president at Moody's Ratings and the lead author of the report.