Interactive Brokers Group Inc (IBKR) 2011 Q2 法說會逐字稿

Please stand by for real-time transcript. Good day everyone and welcome to the Interactive Brokers second quarter 2011 earnings results conference call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Ms Deborah Liston, Director of Investor Relations. Please go ahead.

Thank you. Welcome everyone and thank you for joining us today. Just after the close of regular trading, we released our second quarter financial results. We'll begin the call today with some prepared remarks on our performance that compliments the material included in our press release and allocate the remaining time to Q and A. Our speakers are Thomas Peterffy, our Chairman and CEO, and Paul Brody, Group CFO.

At this time I would like to remind everyone that today's discussion might include forward-looking statements. These statements represent the Company's beliefs regarding future events that by their nature are not certain and outside the Company's control. The Company's actual results and financial condition may differ, possibly materially, from what's indicated in these statements. For a discussion of some of the risks and factors that could affect the Company's future results please see the description of risk factors in our filings made with the SEC. I would also direct you to read the forward-looking disclaimers in our quarterly release. With that, I will turn the call over to Thomas Peterffy.

Good evening. Before I get into the quarterly results, I would like to start with getting the global effects and OCI out of the way. In the past quarter, the downward movement of the US dollar against our basket of currencies to global had a favorable impact on our earnings to the tune of $50 million. This was counter balanced by OCI, or other comprehensive income. That deducted $56 million to reported earnings, but not from comprehensive income or net worth. Had none of this had happened, our pretax earnings for the quarter would have been $155 million instead of $149 million reported. So, this is one of those rare quarters in which the currency effects almost balance each other out, and the reported earnings are fairly close to the actual operating ones.

Pretax profit from our brokerage segment increased by 23% year over year. While the lighter trading volumes and global exchanges kept commissions at roughly the same level, we had an increase in the net interest income which rose 109% over the prior year and now accounts for nearly a third of brokerage net revenues. This is directly related to the 111% increase in customer margin balances that have grown in response to our extremely low financing rate, which currently range from 0.5% to 1.6%.

Customer account growth remains strong and steady, growing 21% year over year to 176,000 accounts. While the equity of our customers hold grew by 57% to $25.7 billion. We typically see account growth slow in the second quarter and dip in June, which was the case this quarter. Still, our growth rates continue to exceed our peers by a wide margin, and the reason is quite simple. We offer our customers an unrivaled value by allowing them to trade a multitude of asset classes globally in several currencies using sophisticated trading tools and our refined technology of industry low costs. And importantly, we do not sell our customer orders to internalizers, which ensures that we achieve the best prices at execution. Operating in the best interest of our customers is the principal we have built our business around, and we have never strayed from this strategy. The results speak for themselves.

If you have been following our progress over the past several quarters, specifically the graphs we published that show the growth of our brokerage expenses compared to other e-brokers over the past few years, you will see that we have exceeded our peers on all measures. This includes percentage growth in DARTs, number of accounts, customer deposits, margin loans, and average account size.

You also may recall that in my comments of the recent investor conference I have stated that one of our goals is to become the largest on-line broker in terms of total trade. I'm pleased to report that we have accomplished this goal for the first tame in May when our DART, or daily average revenue trade, exceeded those of every one of the larger e-brokers, and this also happens to be the case for the entire second quarter, so that as of the second quarter of this year, Interactive Brokers is the largest electronic broker as measured by daily average revenue trades. We reached this goal despite only having a small fraction of the number of accounts they have. We have been able to attain this status because we have always focused on attracting quality accounts. To us that means financially sophisticated active traders and investors.

To illustrate our typical customer in the second quarter made an average of about 140 trades. Compare that to our larger peers who have millions of accounts but the average customer made only an average of 3 or 4 trades in the latest quarter. Thanks to our highly automated business model, we can service our active customer base efficiently and realize significant economies of scale as we continue to grow this business. In fact, our brokerage profit margin rose to 52% for the quarter compared to 50% in the year-ago quarter. The average equity per account increased year over year by 31% to $147,000, primarily as a result of our success of attracting larger accounts. We have implemented several initiatives aimed at registered financial advisers and hedge funds which are boosting growth in this segment. And we expect to see this to continue with some recent developments we have just rolled out to our brokerage customers that will further enhance their experience, and we anticipate to attract more accounts.

First, we have just introduced our fully paid stock lending program which offers qualified IB customers the opportunity to earn an attractive return along stock positions in their account. The program allows IB to borrow shares from customers in exchange for cash collateral and lending shares. The customer earns half of the borrowed fee, and we keep the other half for managing the program. Other brokers also offer fully based stock lending programs, but typically their programs are more manual, and as a result, only available to larger accounts with big positions. Our program is fully automated, and as a result, most of our customers can participate. In fact, we have an on-line calculator that allows customers to see at any point in time, based on the stock position in their account, the extra yield they could earn if they were to participate in the program.

The important advantage IB customers have is the substantially higher return they can earn on their shares. They are completely transparent in the process. Customers can view the actual market rates they are earning on the stock as well as IBC, where as most other brokers do not disclose the market rate in order to keep a higher portion of the fee for themselves. In a nutshell, our program is automated, transparent, and more profitable for our customers. We anticipate this new feature will bring more accounts to us.

This month we also introduced an on-line capital introduction program for hedge funds that use IB as the exclusive prime broker. This program will allow these institutions to market the funds directly to our sophisticated high level of customer base. Qualified customers will be able to broad participate in hedge funds, download literature, and invest in the fund directly through their IB account. This further broadens the selection of investment options available to our customers who can already trade a wide universe of global asset classes seamlessly from one account. And it is an incentive to encourage hedge funds to exclusively clear with us. The requirement for carrying all positions with us assures that we can verify the amount under management and the performance of the fund. We have been working on other important initiatives that we expect to roll out in the course of the second half of the year. So, please stay tuned.

Now I will discuss our market making segment. As I mentioned earlier, currency movements had much less effect on our earnings than the year-ago quarter in which the global growth dropped by 2.5% and negatively impacted our trading gain. This quarter the global stock bumped 1.2% which had a positive impact on our income by $50 million. This was counter balanced by a deduction of $56 million OCI which we report as part of comprehensive income under the net income line. Removing the effects of currency movement, our pretax income from market making was about $65 million which trailed by $10 million short of the year-ago quarter due to calmer markets, lower actual volatility.

Despite brief spikes of turbulence this quarter on news of the Greek debt crisis, the markets were relatively subdued, which only averaged about 17 compared to 26 in the year-ago quarter, which coincides with the timing of the flash crash. The actual to implied volatility was unfavorable as well. It was slightly over 70% this quarter compared to over 90% in the year-ago quarter. These negative factors that are partially offset by wider (Inaudible) spreads which increased about 20% over the prior year quarter and they are flat from the previous quarter. Expense have stabilized and it appears competition has as well. While we have seen some trade [and sharp seas] operations, others may still enter the race. It will be interesting to see how the SEC's (Inaudible) will effect the competitive landscape. The new rule will impose the requirement that will most certainly inject higher latencies into HFC's processes and cause them to rethink their market excess and trading strategies.

Market volumes from exchange rate options in the US and globally have decreased 7% and 9% respectively, from the first quarter. This compares to our market making option volume which rose 1% during the same period. As a result, our market share during the first quarter increased from 8.4% to 9% globally, and from 11.4% to 12% in the US. Just as a reminder, market share is not a driver of profit, volumes are.

Overall, while we have not witnessed any significant improvement in the market making environment, there has not been any further deterioration either. This quarter we did dented our market making capital since we have earned slightly less than 10% pretax return on the capital in this segment which would be about $75 million. You will recall that we initiated a quarterly dividend last quarter which pays out $0.10 per quarter from our market making subsidiary, and dictates whether we accumulate or distribute capital based on whether we achieve our stated goal of 10% pretax return on the capital in our market making segments.

Our brokerage business is the primary focus of our global expansion and software development efforts. We are always looking for ways to improve customers access to valuable products in a cost-effective fashion. This quarter we introduced 29 exchange trade funds provided by GlobalX that IB customers can trade commission free. GlobalX has designed the sector fund in order to provide developed and emerging market investment opportunity to investors. We have also introduced gold futures available for trading in Hong Kong. These new products further out to our extensive universe of tradable products available to our customers. And now to CFO, Paul Brody, who will discuss the financials.

Thank you, Thomas, and thanks, everyone, for joining the call. As usual, I will review first our summary results and then give segment highlights before we take questions. The net revenues are driven by increases in trading gains and net interest income this quarter. But despite the continuing low interest rate environment, net interest income grew on a 52% increase in customer cash credit balances and a 117% increase in margin debit balances over the year-ago quarter. The increase in trading gains was largely a reflection of currency translation effects, which negatively impacted the year ago quarters earnings and are reported in the results of the market making segment. The other driver of pretax income was a 4% reduction in non-interest expenses as lower volume levels brought down the variable costs of execution and clearing.

Before we discuss our results further, I would like to briefly explain the new accounting presentation known as comprehensive income. In prior periods, we discussed a currency translation as an item that we view as material to our operating results. Historically, the reporting of our currency translation gains and losses under GAAP arbitrarily shifted a portion of our currency hedging results from the income statement to the balance sheet. More specifically, the amount shifted was the change in dollar value of our foreign subsidiaries, also known as other comprehensive income. We included this item in our non-GAAP reporting of income so as to give a clearer presentation of the state of our operating businesses.

Under the new GAAP guidance, a portion of the current period -- currency translation gains and losses, reported as other comprehensive income, is now reportable in the statement of comprehensive income. That's a new statement which replaces the traditional income statement. The GAAP guidance requires this method to be applied starting January 1, 2012, and as permitted, we have adopted its usage early. Given our approach to managing our currency exposure globally, we have always believed that currency translation gains and losses should be recognized in the income statement. It should also be noted that the new GAAP guidance only permits the presentation to reflect the effects of adding other comprehensive income funds, so it's below the line.

Comprehensive income is presented in a table on the last page of our earnings release. Adding other comprehensive income to net income increases diluted earnings per share by $0.09 for the quarter. Market making conditions were relatively stable in the latest quarter with pre-tax profits coming in slightly above the average for 2010 after adjusting for currency translation effect.

Electronic brokerage continues to perform well as we gather more customer assets and in the year. Commission revenues, while slightly below the year ago quarter, still outpace the declines and general options industry volumes. As a reference period, the second quarter of 2010 included some high-volume days around the time of the flash crash in May. Performance across the 2 segments led to an overall pretax profit margin of 50% for the latest quarter.

Overall operating metrics for the latest quarter were generally up in brokerage, so down in market making. Average overall daily trade volume was 882,000 trades per day, down 11% from the second quarter of 2010. Electronic brokerage metrics showed strong increases in the number of customer accounts and customer equity. Total customer DARTs, however, were down 3% and cleared customer DARTs were down 2% from the active year-ago quarter. Orders from cleared customers who clear and carry their positions in cash with us and contribute more revenue continued to account for over 90% of total DARTs. Market making trade volume was down 29% from the prior year quarter. And this is spread across all product types, options, and futures contract volumes were down 20% and 19% respectively. Stock share volumes were down 53%. A reduction in market making volume in part reflects our decision to pair back trading of certain instruments and in certain markets that we determine to be less profitable.

Net revenues were $297 million for the second quarter, up 31% from the year-ago quarter. Trading gains were $121 million for the quarter, up 55% from the same period in 2010. Commissions and execution fees were $107 million, down 1%. Net interest income was $55 million, up 136% from the second quarter of 2010. And other income was $15 million, down 15%.

Non-interest expenses were $148 million, down 4% from the year-ago quarter, and within the non-interest expense category execution and clearing expenses were $66 million, a decrease of 13% from the year-ago quarter. This reduction in variable cost came from the market making segment through a combination of lower trade volume and execution at venues that pay participants to provide liquidity. Compensation expenses were $53 million, a 6% increase over the year-ago quarter. At June 30 our total headcount was 857, unchanged from the prior year end count. We continue to hire in targeted areas, including software development and customer service.

As a percentage of net revenues, total non-interest expenses were 50% and out of this number execution and clearing expense accounted for 22% and compensation expense accounted for 18%. Our fixed expenses were 28% of net revenues. Pretax income was $149 million, up 107% from the same quarter last year. For the quarter, market making represented 40% of pretax income and brokerage represented 60%. These proportions shifted market lead from the prior year quarter. When due to currency effects, market making contributed only 5% and brokerage 95%.

For the second quarter, our overall pretax profit margin was 50% as compared to 32% in the second quarter 2010. Market making pre-tax profit margin was 47%, up from 5% in the year-ago quarter. And brokerage pre-tax profit margin was 52%, up from 50% a year ago. Diluted earnings per share were $0.22 for the quarter. That's compared to $0.09 for the second quarter of 2010, and on a comprehensive basis, which includes the full effect of currency translation, diluted earnings per share were $0.31 for the quarter as compared to $0.004 for the same period in 2010.

Turning to the balance sheet, it remains highly liquid with low leverage. We actively manage our excess liquidity and we maintain significant borrowing facilities through the securities lending market and with banks. As a general practice that we adopted when the credit market environment first tightened in 2008, we continue to hold in the amount of cash on hand that provides us with a buffer should we need immediately available funds for any reason. We also continue to maintain over $2 billion in excess regulatory capital in our broker dealer companies around the world.

Long-term debt to capitalization at June 20 was 3.7%, which was down from 6.5% at year-end 2010, primarily due to repayment of a short-term loan under our revolving senior credit facility and the gradual reduction in outstanding debt under our IBG notes program. Our consolidated equity capital at June 30, 2011 was $4.59 billion.

Segment operating results are summarized in the earnings release and will be more fully detailed in our quarterly 10-Q report, so I will just highlight the noteworthy items on the segments. Beginning with electronic brokerage, customer trade volumes were mixed with clear customer options contract volume up 20% and futures contract and stock share volume up11% and 3% respectively as compared to the flash crash quarter of a year ago. Customer accounts grew by 21% over the total at June 30, 2010, and by 5% in the latest quarter.

Total customer DARTs were $408,000, down 3% from the year-ago quarter and down 4% from the first quarter of 2011. Our clear customer DART, which generates direct revenue through the brokerage business, were $378,000, down 2% on the year-ago quarter and also 2% sequentially. The average number of DARTs per account on an annualized basis was 554, down 18% from the 2010 period and 7% sequentially. As we attract larger customers, we are observing increases in the average trade sizes in options and futures at a slightly higher average commission per DART at $4.36.

Customer equity grew to $25.7 billion, up 57% from June 30, 2010, and up 4% sequentially. These increases took place during periods in which the S&P 500 index rose 27% and fell less than 1% respectively. The source of this growth continues to be a steady inflow of new accounts and customer deposits, and to some extent customer profits. In addition, our favorable financing rate has lead to a 117% increase in customer margin borrowings. This is the primary driver between the 109% increase over the year-ago quarter and net interest income, which now accounts for 28% of net revenues in brokerage.

Mixed trade volumes resulted in top line revenue from commissions and execution fees of $107 million, a decrease of 1% from the year ago quarter and 3% sequentially. As a comparative period, the first quarter of 2011 also exhibited certain high-volume days spurred by unrest in the Middle East and North Africa. Execution and clearing fees expenses increased modestly to $37 million for the quarter, up 5% on the year-ago quarter and 5% sequentially. Pre-tax income from electronic brokerage was $89 million for the second quarter, up 23% on the year-ago quarter and down 1% sequentially.

Turning to market making, trading gains from market making for the second quarter of 2011 were at $121 million, up 54% on the year-ago quarter. This drove pretax income from market making to $59 million, up from $4 million in the year-ago quarter. The currency translation effects I noted earlier negatively impacted the year-ago quarters reported earnings by $72 million and the latest quarters reported earnings by about $6 million. Our overall equity, as measured in US dollars, was increased by the general weakening of the US dollar.

More specifically, we measured the overall gain from our strategy of carrying our equity in proportion to the basket of currencies we call the global to be about $50 million for the quarter. Because about $56 million of gain is reported pursuant to GAAP as other comprehensive income, which even under the new guidance is only reflected in EPS on comprehensive income and not in pretax income. This leaves negative $6 million to be included in the reported earnings. To summarize this, if we eliminated all currency effects pretax income from market making would be about $65 million.

Non-interest expenses in market making declined 15% from the year-ago quarter, primarily from lower execution and clearing costs and some reductions in employee compensation expenses. There's also some effect from a refinement in methods that we used to attribute certain expenses to the market making and brokerage segments as if they were stand-alone businesses. And now I will turn the call back over to the moderator, and we can take some questions.

Thank you. (Operator Instructions)

Our first question comes from Niamh Alexander from Keefe, Bruyette, and Woods.

Hi. Thanks for taking my questions. Congrats on a good quarter. If I could expand on the brokerage a little bit. Thomas, you've been making in-roads with the RIA community, the registered advisers. Help me understand what is it particularly that attracts those to your platform? Because I understand it's more of a custodian service they're looking for, it's kind of a lot of extra services on top of the platform that the existing brokers there are pretty embedded and it's hard to move over to another. So, could you help me understand how you are being successful and what else we should look for going forward?

Well, we do not find it difficult to make in-roads in that segment. What attracts these folks, in addition to our extremely low commissions and financing charges and better executions, is the fact that our software is more capable of managing a bunch of accounts by one or more individuals. Mainly, our allocation software is far superior, we are told, to anything else that's out there.

And are you finding the existing customers that you've got on board, are using more of your services? Are you kind of cross-selling some services?

Well, specifically, many of these registered financial advisers who are on an optional relay portfolio for their clients like what we have to offer, because they can basically come in and buy some securities and write options over them in blocks and then have our software allocated among the clients. As deductions then come due they roll them forward, for them it's only one trade and it can go into 10, 20, 30, 100 accounts.

Okay, that's pretty neat. All right, cool, that's helpful. We can follow up after. If I can touch back on the market making a little bit here, because you indicated you saw some market participants pull away, and you're looking to see if some of the rules have an impact. How do you feel? Do you feel like we're getting towards the end of the negative impact of some of those rule changes and new participants coming into the market, and should we say, of course, impacting the spreads negatively?

I feel that the market making environment has stabilized, so there is still that one rule, the naked excess rule that -- that's hanging out there. Then, of course, I have no idea what the fall out from the [DARTs franc] which is still yet to come. I can't tell what that will be. But for the time being, I feel comfortable that we -- that the environment for market making is pretty stable and we'll be able to go forward and generate a modest return.

Still a business you very much want to be in?

Yes.

Thanks for taking my question.

Thank you. Our next question comes from Ed Ditmire from Macquarie.

I just want to ask a little bit about your efforts to -- in terms of the capital introduction program. Sounds like a relatively unique program. I just wondered how difficult is it to get a hedge fund to commit to a program where they would only be able to get investment through your capital introduction program from people that were already Interactive Brokerage clients? Is that something that is a stumbling block, or is it something that would supplement other capital introduction efforts they might be undertaking?

I'd like to make a correction. I didn't mean to say that they are only allowed to take funds from current Interactive Brokers clients. What I said was that we at this time insist that all the funds that they are managing be with Interactive Brokers, so that we can make sure that no other -- we don't get into a made-up situation, right? We can see how much money the fund has and how much money it earns and we can see all the trades and anything we need to look at.

Great. And then I have a follow-up question on the RIA effort. You guys serve both RIA and independent brokers?

Yes, we also do business for introducing brokers.

Not introducing brokers, but independent brokers, meaning independent financial advisers that are series 7 commission-based sales people?

Series 7 commission-based sales. Well, yes, there are -- our registered advisers can either mark up our small commissions to a limited extent, or can charge a fee which we also regulate as to how much the fee can be.

Can you speak at all to the number of these kind of financial advisers on your platform or maybe how many you add in a given quarter?

Well, I'm sorry to say that I do not know the number, but I do know is that 18% of our accounts are financial advisor accounts. So, it's 18%, or 176,000. And 24% of our customer deposits belong to those accounts, and 16% of the commissions are generated by those accounts.

And one last question. Do you guys charge a fee based revenue at all on those accounts, or is all of the revenue model based on a net interest spread and commissions?

No, we only charge a commission.

Okay, thank you.

Our next question comes from Rich Repetto from Sandler O'Neill.

Good evening, Thomas. First, I wanted to congratulate you on the top number one position on the DARTs.

Thank you.

And my first question is when are you going to achieve the second goal, and that's the profits?

I said within five years.

That would certainly be forward looking. The first serious question is, you did --

My answer was serious. (laughter)

I'm with you on that. You broke out the category of brokerage customers in the five categories, and you've done -- you've given us some transparency along what you're working on as far as the hedge fund platform, et cetera. But which one is growing the fastest of the five broad categories?

I think that financial advisers have grown the fastest lately, but not by much.

Okay.

Slightly faster than others.

Right. And then super impressive, the margin loan growth, and we all know how profitable it is. I guess is there -- I'm just trying to think, any time you grow that fast, is there any other impacts or -- I know there's capital requirements on margin lending. Is there any -- are you more -- put in more safe guard -- it's collateralized loans, but as far as losses or anything like that, but is there any other -- is this growth just as smooth as it appears from the outside?

It seems to be as smooth on the inside as the outside.

Good for you. Last question is, on the market maker, you made the comments that it didn't achieve the 10% hurdle this quarter. You've been very transparent with the strategy there. I guess the question is, though, at some point, is there -- and this has probably been asked before, but is there a minimum capital level? You couldn't just let it -- not that it's going to eat in again, but if the got to $2 billion or $1.5 billion, couldn't -- at some point the market maker globally can't be effective, I would assume.

If it starts not making money or substantially under perform our target, then obviously we would shrink it and close it. We will not run a business that doesn't make money. But as long as, as I said, as long as we can make 10%, we'll do it.

Okay. Very last question then. On naked access that's being delayed, you perform all checks. So, your customers will see no -- or should see no impacts on the speed of it, their trades, because you're already performing -- you're not providing a service like that. Is that correct?

We -- you see, whenever a customer sends in an order, we assume that the order had been executed and we evaluate the customer's position with that additional position and see if the margin requirements are still met. If they are, then we execute the order, and if they aren't, we reject the order. We have always done this because I think it's suicidal to go into the brokerage business without such a check. I do not understand how people with substantial monies are willing to close their eyes and do this business without such a check.

That makes a lot of sense. Thanks, and we'll talk to you soon.

Thank you.

Thank you. (Operator Instructions) Our next question comes from Mac Sykes from Gabelli & Company.

Two quick questions. First, assuming that ETrade did get purchased by another competitor, can you explain how that might affect your business?

Well, if ETrade were to be purchased by Ameritrade, I guess for a few quarters we would not be the first broker by DARTs. But I think it would just throw us back not too many quarters.

Just at a higher level, because of your experience, Thomas --

I'd like to say that in addition, of course, if ETrade went to Ameritrade, or to any other existing broker, I think that we would get -- some customers would rub off, and hopefully the larger more sophisticated ones of those would come to us.

Fair enough. Just to get your thoughts on stuff that's going on in Washington these days, given your experience, I was just curious what you might think some of the fall outs from a US downgrade might be, how might that impact the derivatives market in general, and then are you taking any actions with Timber or your counter parties in advance of the August deadline?

Well, as you know, we have some years ago decided to keep our cash balances, all of our capital basically in global, so we are diversified in that way. Personally, I do not -- I would not attribute a great deal of significance to not raising the debt ceiling, so I don't think that there will be any substantial fall out whichever way it goes.

I appreciate it. Thank you.

Thank you. Our next question comes from Ed Ditmire from Macquarie.

I apologize if you have already said this but, did you guys say how much equity is in the brokerage unit this quarter?

I don't think we said it, but I have nothing against saying it. Do you know, Paul? I would guess it's 1.4.

And then one follow-up question to someone else's question. Do you think that if ETrade was sold to another broker and was no longer owned by their largest shareholder being Citadel, a key competitor, do you think you would market make more of their customers orders than you do today?

I don't believe so, because these guys like to sell their order flow, customer order flow to people who are willing to pay for it and fool around with the orders. We're not in that business. We're extremely straight. We want to give the best execution to our customers and we do that, and that works for us, and we will not play those games.

Okay, thank you.

Thank you. I'm showing no further questions at this time.

Wonderful. Thank you very much.

Thanks, everyone, for joining us. Just a reminder that a copy of this webcast will be available on our Web site. Thanks and having a great evening.

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program for today. You may all disconnect, and have a wonderful day.