Executives of clearing firms are rooting for two things: a rise in both interest rates and trading volume.
Dirt cheap rates and low trading volume, which has only recently begun to pick up, have been causing problems for brokerages, several industry sources report.
"This is really a big deal for a lot of firms. Margin business can make up 25 percent of a typical firm’s revenues," according to Doug Dannemiller, a clearing industry analyst with Aite Group. He adds that margin combined with transaction volume comprises about half of the typical firm’s business.
"If you don’t have the scale and an efficient platform, you are in trouble. I think a lot of core players will have challenges over these issues," said Steve Sadoff, chief information officer for Knight Capital Group.
The root of the problem is a low federal funds rate, with a recent unusual target rate of between zero and 0.25 percent.
These factors, combined with a significant loss in margin loans, are squeezing correspondent clearing brokerages.
"Spreads on margin loans used to be two or three percent. Now they’re almost nothing," according to Craig Gordon, president of RBC Dain Rauscher Correspondent Services.
The only way to make significant money in this environment is through a large volume of margin loans, Gordon notes. Ironically, even low interest rates haven’t coaxed many investors to borrow.
For some firms going through difficult times, it is almost impossible to turn a profit on their money market/sweep accounts, Gordon noted, adding that some of them are running at a loss.
"They really need the rates to go up by fifty to seventy-five basis points just to be whole again," Gordon said. In the meantime, He says that net interest revenue is on the decline at most clearing brokerages.
Industry sources say the fallout is being felt across the business, which, some believe, could lead to further consolidation of the clearing business.
