Interactive Brokers Group Inc (IBKR) 2013 Q3 法說會逐字稿

Good day, everyone, and welcome to the Interactive Brokers' third-quarter 2013 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.

Thanks, operator, and welcome, everyone. Hopefully by now you have seen our third-quarter earnings release, which was released today after the market close, and which is also available on our website. Our speakers today are Thomas Peterffy, our Chairman and CEO, and Paul Brody, our Group CFO. They will start the call with some prepared remarks about the quarter, and then we'll take questions.

Just to remind everyone, today's call may include forward-looking statements which represent the Company's belief regarding future events, which, by their nature, are not certain, and outside the Company's control. Our actual results and financial condition may differ, possibly materially, from what's indicated in these forward-looking statements. We ask that you refer to the disclaimers in our press release. You should also review a description of risk factors contained in our financial reports filed with the SEC.

Now I'd like to turn the call over to Thomas Peterffy.

Good evening, everyone, and thank you for joining us to review our third-quarter performance. This was another strong quarter for our brokerage business, which continues to grow at an impressive rate relative to our peers in terms of customer trading activity, number of accounts, customer equity, and margin balances. I will elaborate on these as I get into the segment discussions, but first I would like to provide you with a clean picture of our third-quarter results without currency or tax effects. For the quarter, our pre-tax income, excluding currency effects, was $150 million. This is composed of $108 million of brokerage, $41 million in market making, and $1 million in corporate. For the nine-month period to date, the corresponding numbers are $470 million, comprised of $343 million for electronic brokerage, $123 million for market making, and $4 million for corporate.

The operating environment was not nearly as robust as it was in the second quarter when we saw a pick up in [exchange] volumes and record customer DARTs. However, despite slightly subdued summer activity levels, our customers are much more active this quarter than the same period last year, with total DARTs of 21% higher year on year. This growth rate exceeds that of other large eBrokers. It continues to be the case that our customers are more active even while industry volumes drop. As a result, we remain the largest US electronic broker as measured by total number of revenue trades, which averaged 471,000 per day in the third quarter.

In our market-making segment, lackluster market conditions continued to weigh on our profits, although our trading gains were strongly amplified due to currency movements as the dollar weakened against our global currency basket. As you know, we base our equity in GLOBALs, our self-defined basket of 16 currencies, in an effort to minimize our currency risk over the long run, given that we are a global company trading products around the world in multiple currencies, and reporting our results in US dollars. While this strategy can create large swings in our results from quarter to quarter, we are operating in an uncertain global economic environment, and we feel it prudent to diversify our capital base in order to reduce significant exposure to any one currency.

This quarter, the volume of the GLOBAL, as expressed in US dollars, rose by 1.5%, which boosted our comprehensive earnings by about $76 million, or roughly $0.12 per share. I will explain in further detail how this affects profits when I discuss market-making results.

While the environment for market making remains challenging for us and others in our industry, we continue to focus on the long term and things that we can control that is continuing to deliver high value to our brokerage customers in the form of sophisticated technology and trading tools, while keeping their trading and financing costs significantly lower than our competitors. These differentiators are driving market-leading growth.

So, first, I will discuss the results of our electronic brokerage segment. Customer accounts have grown to 231,000, a year-on-year increase of 13%. Year-to-date customer growth has averaged 2,300 accounts per month, compared to 1,700 accounts per month in 2012. This growing momentum is a testament to the solid reputation we are building, and the proliferation of positive feedback from our current customers, which [are] referrals, our leading source of new accounts.

Customer equity has reached $41.4 billion, 31% higher than a year ago. While the rise in market values have contributed part of that, as illustrated by the 17% year-on-year increase in the S&P, most of this growth comes from new customers opening accounts, or current customers bringing more assets to our platform. Also, the size of these accounts is growing as we attract more institutional customers. The average equity per account rose 16% year over year to $179,000.

We saw a [7%] decrease in DARTs this period compared to the second quarter, which reflects the industry-wide slowdown in volumes, or the less pronounced same-store active customer base. This slight decline in trading activity compared to the second quarter drove a 12% decrease in our pre-tax brokerage profits from the previous quarter, but we saw a 34% increase from the year-ago quarter. We also delivered a 56% profit margin this quarter, thanks to our extremely low fixed-cost structure. Margin balances have grown to $12.7 billion, a 38% increase over the prior year, primarily driven by our extremely low financing rates, which today range from 0.5% to 1.59%, depending upon the size of the loan.

Our customer mix continues to shift away from direct individual accounts, which currently comprise less than 60% of our accounts, and just slightly more than half of total commissions. Our fastest growing segment, introducing brokers' fully disclosed accounts, which have increased 23% year over year, followed by prop-trading desks and financial advisors, which increased 12% and 11% year over year, respectively.

The surge we have seen with introducing brokers is mostly in Europe and Asia for now, but we expect to gain stronger penetration in the US in coming quarters. We find that we can partner with local brokers that excel at offering personal, high-touch client service, while we can provide robust trading technology, advanced trading tools, and grow global market access, in addition to clearing and [cuts] to the customized reporting, and all the other advantages we provide to our direct clients at lower prices. These local brokers are able to consolidate their clients' trading volumes to take advantage of our lower-price tiers, and add a markup to compensate for the personal services that they provide.

We are also making strong headway with independent financial advisors. Our focused marketing efforts to this audience and our state-of-the-art tools for allocating block trades across separately managed accounts have been a strong draw. An especially effective feature of our platform for transitioning and establishing [registered] investment advisors is that we provide advisors with one-stop solution for costs of [the clearing] and execution, with much of the back-office support they normally have to seek out with separate providers, and end up paying extra for these services.

With our platform, we offer all these tools for no additional charge, including rebalancing software, model portfolios, billing and customized reporting. And as a technology firm with a strong focus on programming and development, we can be very nimble in responding to clients' changing needs and rolling out new products. We are also getting ready to roll out a customer relationship management, or CRM, module that will allow advisors manage their clients from prospect to account application to funded accounts.

We have been focusing on bolstering our prime brokerage offering. During the quarter, we hired a Vice President of Securities Lending Services to further strengthen our competitive positioning in the securities lending market. Our availability of hard-to-borrow stocks and our extremely competitive borrow rates have proven very attractive to hedge fund clients. This service, combined with our superior execution, and extremely low commissions and financing rates, has [drawn] many of these firms to our platform.

I should mention that our online capital introduction program has been quite successful. Our hedge fund customers can market their funds through Interactive Brokers' customers, who are accredited investors and qualified purchasers. In the past year, the number of hedge funds participating in this program has more than doubled, and approximately 40% of these funds have received investments.

Transaction Analytics Group, or TAG, a third-party provider of transaction analysis, has confirmed, yet again, that IB's price execution for stocks and options are significantly better than the industry [view] in the first half of this year. Specifically, our price improvement was $0.20 per 100 shares of US stocks, and $0.21 per contract for US options, better than the industry average. This is a key selling point for our active customers, many of which have moved to IB solely for our execution quality.

Our commissions are among the lowest in the industry across all products. During the third quarter, our average stock trade contained nearly 1,500 shares at the commission of $2.31. The average option trade contained 9 contracts at the commission of $6, and there were 3.5 contracts to the average futures trade at the commission of $6.28. Please keep in mind that these numbers include exchange fees, and are averaged over 100 exchanges, which have very different fee structures.

Now I'll review the performance in our market-making segment. Market-making pre-tax profit fell 3% compared to the year-ago quarter, but had a strong increase over the previous quarter. Backing out the translation effects paints a clearer picture. As I mentioned earlier, this quarter, the GLOBAL strengthened against the US dollar, contributing a gain of $76 million to our comprehensive earnings. Approximately $46 million of this is included in trading gains.

If you backed out the $46 million pre-tax profits in market making, ex-translation would have been $41 million this quarter. This compares to $49 million in pre-tax profits, ex-translation, for the year-ago quarter, and $50 million for the previous quarter. This decline can be attributed to lower volatility levels and weaker exchange traded volumes, which negatively impact our trading gains.

The VIX averaged 14 in the third quarter, compared to 16 in the year-ago quarter. The ratio of actual to implied volatility was sharply lower as well, falling from 71% in the year-ago quarter to 63% in the current quarter, and 95% in the previous quarter. As you know, this is an important profit driver for our market-making business, with the higher ratio driving higher trading gains. This is because implied volatility determines the cost of hedging, while actual volatility measures the price movement of underlying products over time and is directly related to our trading gains.

Exchange traded option volumes decreased 14% in the US, and decreased 11% globally from the second quarter. By comparison, our Firm's total option volume decreased 17%. As a result, our Firm's market share decreased from 11.8% to 11.7% in the US, and from 9.3% to 8.7% globally. In the market-making segment alone, our option volume decreased by 20% during the third quarter, which drove our market share in that segment from 6.2% to 5.9% in the US, and from 5.9% to 5.3% globally. Our market share in this segment has slowly been declining as we reduce our participation in markets that are less profitable for us.

We continued to pay a $0.10 quarterly dividend, which comes out of the market-making unit's capital. We seek to earn at least 10% pre-tax return on capital in order to sustain this dividend. Otherwise, we naturally [exchange] capital in this Business. This quarter, we earned 6.8% pre-tax return on capital, and as a result, our capital is now $2.4 billion in this segment after dividends.

The fate of this Business has been a prime focus to investors, but we are continuing to monitor the environment, as well as keeping an eye on discussions around regulatory capital requirements for banks and brokers. We are not about to make any hasty decisions at the risk of missing potential opportunities, especially in the business we have been in for four decades.

Our financial condition is solid, which gives comfort to our customers and investors. The S&P credit rating on our brokerage unit of A-, outlook stable, is superior to all major banks, except JPMorgan, which is an A, outlook negative. We have organically grown our equity capital to over $5 billion, over half of which roughly is in excess of regulatory requirements. We feel it is prudent to remain a significant -- to maintain a significant liquidity cushion in order to weather rough times or take advantage of opportunities that may present themselves.

We are executing on our vision, which is to create a global marketplace for professional traders where investors can shop for hedge funds on our online cap intro side, where wealth advisors can select money managers in our money manager marketplace, and where investors can trade from all over the world -- can open an account and trade nearly any exchange traded product in 22 countries and counting. Customers are not only drawn to our platform for best-in-class technology and industry, of course, but also because they understand the importance of selecting a well-capitalized broker with solid credit rating and sound risk controls for protecting their assets.

This leads me to address the recent event that will likely result in a charge to the earnings in the fourth quarter. While we have a solid track record for minimizing customer and Firm losses, thanks to our automated risk management controls, we are not completely immune to swift and unusual market movements. A group of our brokerage customers took a large position in [four] stocks -- this was on the Singapore Stock Exchange -- and in early October, within a very short timeframe, these stocks lost over 90% of their volume. The accounts [were margined], and we were able to liquidate only a small part of the position. The accounts are currently in deficit to the expense of approximately $68 million.

We believe that the customers have substantial assets, independent of the companies involved, and we are currently organizing our legal team to collect on these debts. We are currently also in the process of modifying our margin lending methodology to limit the chances of similar events happening in the future.

On a different matter, in November we are planning to launch the first phase of our [novel] option trading suite of interactive tools and educational materials. You have never seen anything like it. We are preparing to heavily advertise this initiative both in print and on television. I will tell the essence of what I have learned about options in my 40 years in the business, and give our customers the tools to take advantage of that knowledge on our platform. I believe that this effort will have a significant impact on the options industry, and propel Interactive Brokers to a number-one position by far among options brokers.

Now, Paul Brody will tell you about the financials.

Thank you, Thomas. Thanks, everyone, for joining the call. As usual, I will first review the summary results, give segment highlights, and then we'll take questions.

Third-quarter results showed continuing strength in the brokerage business, and slightly lower earnings in the market-making segment, as Thomas said. As compared to the year-ago quarter, net revenues this quarter were driven by rising brokerage commissions and net interest income, partially offset by declines in trading gains. Market-making profits, though lower, were supported by currency translation gains on the weaker US dollar.

As a reminder, our financial statements include the GAAP accounting presentation known as comprehensive income. Comprehensive income reports all currency translation gains and losses, including those that reflect changes in the US dollar value of the Company's non-US subsidiaries, known as other comprehensive income, or OCI. These are reported in the statement of comprehensive income. In light of the weakening of the US dollar relative to a number of other currencies, adding OCI to net income increased our reported earnings per share by $0.07 for the quarter.

Overall operating metrics for the latest quarter were mixed. Volumes were up in futures and stocks, and down in options, versus the year-ago quarter. Average overall daily trade volume was 987,000 trades per day, up 14% from the third quarter of 2012. Electronic brokerage metrics showed healthy increases in the number of customer accounts and customer equity.

Total and cleared customer DARTs were both up from the year-ago quarter, though down from the highly active second quarter, in line with industry options' volume declines. Orders from cleared customers, who clear and carry their positions in cash with us, and contribute more revenue, accounted for 90% of total DARTs, holding fairly steady with recent quarters. Market-making trade volume was up, though contract and share volumes were mixed across product types. Other negative metrics, such as the decrease in actual-to-implied-volatility ratio, were somewhat offset by gains on our currency diversification strategy.

Net revenues were $326 million for the third quarter, up 2% from the year-ago quarter. Trading gains were $123 million for the quarter, assisted by currency translation effects. While trading gains compared to the year-ago quarter decreased by 18% -- excluding the translation trading gains, would have dropped 29% from the year-ago results.

Commissions and execution fees were $120 million, up 20%. Net interest income was $62 million, up 21% from the third quarter of 2012. Brokerage produced $56 million of that, and market making $6 million. Other income was $21 million, up 21%.

Non-interest expenses were $130 million, down 11% from the year-ago quarter. Within the non-interest expense category, execution and clearing expenses totaled $56 million, down 9% from the year-ago quarter, driven by significantly lower market-making fees. Compensation expenses were at $44 million, a 23% decrease from the year-ago quarter. At September 30, our total headcount was 878, reflecting a small reduction from the year-ago quarter and the prior year-end count. However, within the operating segments, we continue to add staff in brokerage and cut back in market making.

As a percentage of net revenues, total non-interest expenses dropped to 40% from 46% in the year-ago quarter. And out of this number, execution and clearing expense accounted for 17%, and compensation expense accounted for 14%. Our fixed expenses were 23% of net revenue.

Pre-tax income was $196 million, up 14% from the same quarter last year. For the quarter, brokerage accounted for 55% and market making 45% of the combined pre-tax income. Ex-currency effects, the contributions were 72% for brokerage and 28% for market making. For the third quarter, our overall pre-tax profit margin was 60%, as compared to 54% in the third quarter of 2012, and brokerage pre-tax profit margin was 56%, up from 48% in the year-ago quarter. Market-making pre-tax profit margin was 67%, up from 59% in the year-ago quarter, and excluding translation effects, market-making pre-tax profit margin was 49% in the latest quarter.

Comprehensive diluted earnings per share were $0.39 for the quarter, as compared to $0.30 for the third quarter of 2012. On a non-comprehensive basis, which excludes OCI, diluted earnings per share on net income were $0.32 for the quarter, as compared to $0.26 for the same period in 2012.

Turning to the balance sheet, as a result of the growth of our brokerage business, and withdrawal of capital from our market-making operations through regular and special dividends, brokerage now accounts for about 70% of our balance sheet assets. From the year-ago quarter, cash and securities segregated for customers rose 3%, and secured margin lending to customers rose 36%, while positions and securities held by our market-making units were pared back by 22%. According to our announced policy, regular quarterly dividends will continue to temper the capital employed in the market-making segment. In the third quarter, our market-making earnings exceeded the amount needed to fund that dividend.

Our balance sheet remains highly liquid with low leverage. We actively manage our excess liquidity, and we maintain significant borrowings facilities through the securities lending markets and with banks. As a general practice, we hold an amount of cash on hand that provides us with a buffer, should we need immediately available funds for any reason. At September 30, we maintained over $3 billion in excess regulatory capital in our broker dealer companies around the world, of which about 60% is in the brokerage segment. We continue to carry no long-term debt. Our consolidated equity capital at September 30, 2013 was $5.07 billion.

The segment operating results are summarized in the earnings release, and will be more fully detailed in our quarterly 10-Q report, so I will now just highlight the noteworthy items. Starting with electronic brokerage, customer trade volumes were up across all product types. Cleared customer options and futures contract volumes were up 15% and 21%, respectively, and stock share volume was up 49% from the year-ago quarter. Customer accounts grew by 13% over the total at September 30, 2012, and by 3% in the latest quarter.

Total customer DARTs were 471,000, up 21% from the year-ago quarter, but down 7% from the active second quarter of 2013. Our cleared customer DARTs, which generate direct revenues for the brokerage business, were 426,000, up 15% on the year-ago quarter, and down 8% sequentially. The average number of DARTs per account on an annualized basis was 469, up 3% from the 2012 period, but down 11% sequentially.

Commission revenue rose on a product mix that featured larger average trade sizes in futures and stocks, and smaller in options. This resulted in an overall average cleared commission per DART of $4.32 for the quarter, 2% higher than the year-ago quarter, though down 4% sequentially. Note that commissions include exchange fees, which can vary widely.

Customer equity grew to $41.4 billion, up 31% from September 30, 2012, and up 11% sequentially. These changes took place during periods in which the S&P 500 Index rose 17% over the past year, and 5% over the last quarter. The source of the growth continues to be a steady inflow of new accounts and customer deposits, as well as customer profits.

In addition, our favorable financing rates have allowed us to attract customer margin borrowings. After falling to lows in the fourth quarter of 2011, margin debits have been building steadily to $12.7 billion, 38% over the quarter-end level a year ago. Customer credit balances, which increased 21% over the year-ago quarter, also continued to grow progressively, though spread compression, especially in certain foreign currencies, persist in restraining interest income.

Higher options and futures trade volumes resulted in top-line revenue from commissions and execution fees of $120 million, an increase of 20% from the year-ago quarter, but down 13% sequentially. These revenues are spread mainly across options, futures, stocks and foreign exchange. Net interest income rose to $56 million, up 19% from the third quarter of 2012, and down 4% sequentially. Low benchmark interest rates, which continue to compress the spreads earned by our brokerage unit, have been offset by steadily higher customer credit balances in each successive period. And our aggressive lending rates have boosted customer margin borrowings. Our fully paid stock yield enhancement program continues to provide an additional source of interest revenue that is shared with our participating customers.

Net interest income, as a percentage of net revenues, rose slightly to 29%. With the growing customer asset base, we believe we are well positioned to benefit from a rise in interest rates. Based on current balances, we estimate that a general rise in overnight interest rates of 25 basis points would produce an additional $56 million in net interest income annually. Further increases in rates would produce smaller gains because the interest we pay to our customers is pegged to benchmark rates, less a narrow spread.

Execution and clearing fees expenses increased to $37 million for the quarter, up 5% from the year-ago quarter, but down 9% sequentially, and in line with the volume changes. Fixed expenses decreased to $50 million, down 4% on the year-ago quarter. Pre-tax income from electronic brokerage was $108 million for the third quarter, up 34% on the year-ago quarter, but down 12% sequentially.

Taking a look at market making, trade volume was up 8% from the prior-year quarter, though mixed across the product types. Options contract volume was down 16%, while futures contract volume and stock share volume were up 42% and 35%, respectively. Trading gains from market making for the third quarter of 2013 were at $123 million, down 18% on the year-ago quarter. Currency translation effects positively impacted the third quarter's reported earnings by $46 million, a similar effect to the year-ago quarter when reported earnings were increased by $42 million.

Our overall equity, as measured in US dollars, was increased by the weakening of the US dollar against most other currencies. More specifically, we measure the overall gain from our strategy of carrying our equity in proportion to the basket of currencies we call the GLOBAL to be about $76 million for the quarter. As Thomas said, because a $30-million translation gain is reported as other comprehensive income, this leaves a gain of $46 million to be included in the reported earnings. To summarize, if we eliminated all currency effects, pre-tax income from market making for the third quarter of 2013 would be about $41 million.

Execution and clearing fees expenses decreased to $19 million for the quarter, down 31% on the year-ago quarter, driven by lower trading volumes and options. Fixed expenses were $24 million, down 33% from the year-ago quarter, primarily due to lower compensation expense and to our devoting fewer software development resources to this segment. We have continued our aggressive expense management as we monitor the performance of the market-making business. Pre-tax income from market making was $88 million for the quarter, down 3% from the year-ago quarter. Taking into account the currency effects from each period, the year-over-year decrease in pre-tax income from market making would be 15%.

Now, I'll turn the call back over to the moderator, and we will take some questions.

Thank you.

(Operator Instructions)

Chris Harris, Wells Fargo Securities.

First question, I guess, is on the growth of the broker. Thomas, you talked a little bit about some of the things you guys are doing to make a bigger push in some of these other customer groups. And, I'm just wondering some of these other customer groups like the RAs and the hedge funds, it seems to me that perhaps these customers might require a little bit more on the customer service side, and just wondering if that's true or not? And if it is, as you guys penetrate a little bit deeper, should we expect costs to maybe kind of inflate a little bit?

Well, you see what we would rather do is partner with some of these mini primes who would do the hand holding and the so-called customer service, so the costs would not show up on our books.

I see. Is there a big differentiation between the profitability in your various customer groups, or are you guys fairly agnostic to where you're getting the account growth from?

Well, I tell you, frankly, the individual customers seem to be the most profitable because -- the professional ones, they never need to call us for anything; they've been with us for years; they understand the system. We almost never have to interact with them, and so that's our sweet spot.

Okay, that makes sense. That's what I would expect. Okay. Then on the trading side, you guys had nice growth. But, I think with you guys, it's kind of a special case because you're having such strong growth in accounts, meanwhile, you're also having strong growth in trading. It's sometimes hard for us to differentiate whether the growth in trading is being driven by the accounts or if it's being driven by kind of a cyclical recovery in trading activity.

So, wonder if you could share any of your thoughts there? Do you think volumes are still cyclically depressed? Are you seeing improvement in how your customers are behaving? Are they engaging more, trading more? Anything you can share would be helpful.

Well, if I could find the number of trades per account, then that would be immediately obvious. Do any of you see this around the table here?

We do have the average DARTs per account.

Yes, I mean it's up 3% year on year. You guys have that in your --

So that should answer your question, right?

Yes, okay. That could be isolated to specific customer groups or what have you. I was just more thinking broadly across the whole franchise, but all right --

It's prop-trading clients are obviously the most -- they have the highest volume per account, followed by hedge funds, and the lowest volume per account we get from financial advisors and introducing brokers.

Okay, my last question, then, is on the charge, or the anticipated charge for the fourth quarter. How are you guys going to account for that do you think? Are you going to write-off all $68 million, or is it just going to be some portion of that?

At this point, it's too early for us to tell how much we can recover how soon, right?

Yes --

So, as we go into the quarter, we will make a decision by the end of the next quarter. And, we will make a conservative decision, so we will probably write down more than we really think, and then hope that we get some of it back.

Okay, because my understanding with how those margin accounts work is that really the only collateral that was securing them is the securities that were actually in the account, so --

No, people are personally liable for these debts, and these are well-known industrialists, so they have large positions, not only in these companies, but others also, so we will see.

Okay, got it. Thank you, guys.

Rich Repetto, Sandler O'Neill.

My question, my first question would be the $68 million, I'm assuming that's pre-tax? And, could you also say -- when you said a group, how many industrialists, or how you referred to them, were there?

It was roughly seven individuals involved. And of course, yes, the loss is pre-tax if it ends up a loss, yes.

Okay, so let's just say in the worst case scenario would be tax affected, and it would be much less than even 3% of your brokerage equity, is that sort of the worst case scenario?

That's correct, yes.

Okay. And then, I'm looking at just equity overall for the Company, now, $5.1 billion. And, I thought you said at one point that the market maker was $2.4 billion, and you have the brokerage segment in the earnings release is $2.4 billion -- well, you say surpassed $2.4 billion. Could that be -- is the brokerage all of the rest other than the $2.4 billion you said of the market maker?

Well, we also have some corporate and -- Paul this is your area.

It is mostly split between the two segments, Rich.

Okay. And then, on the comp, you had extremely low comp. Could you just -- Paul, could you just give the breakout of the compensation between market making and brokerage to see whether we got it clearly --?

Well, yes, in general terms, the headcount has been cut back in the market making side and increased in the brokerage side, so overall, there wasn't too much change. In the market making side, we tend to accrue according to our performance, so --

Yes, but the way you keep these books is that you also have, what you call general administrative overhead, which really has a lot of most of that is -- all of that, practically all of that is really compensation.

Well, it's spread, and in fact --

And that is because of the development staff that is being shared, so they basically allocate their charges to the two segments, so they come across as administrative overhead rather than compensation.

Right, and that's why I said in my remarks that it's not just a straight cut back, but also, devoting less software development resources ends up reducing the cost of market making segment.

Okay. One last final one, we are approaching getting closer to year end, and you did a special dividend last year. If you look at capital, I believe the -- how do you think -- is that even starting to enter into your thoughts as we approach year end, or what do you look at, how does this year --?

I basically am following what is going on in the banking brokerage business as far as demand for higher capital set asides from the various regulators, both in Europe and the United States. And, I still keep thinking that as a result of debt, certain lucrative areas will emerge for brokers who have substantial excess capital like we do.

Understood, so you're looking at it as opportunities out there?

Right.

Potentially.

Right.

Okay. Thank you.

Niamh Alexander, KBW.

Thanks for taking my questions. Thomas, sorry I'm going back to the potential charge, and thanks for giving us the heads up on it here. Help me understand how could this happen with seven customers -- was it all overnight? Did you let them kind of run the positions? Because, usually, your risk controls is one of your strongest characteristics, so I'm trying to get comfortable that it just won't happen again. You've got so many customers, $70 million almost from just seven. Now, I know they are extreme stock movements, but can you walk me through what happened and help me understand if it could happen again, or what's changed since then so it cannot happen again?

Right. So, the seven customers were invested in four specific stocks trading on the Singapore Stock Exchange. The stocks, on the first Friday of October, started to fall precipitously in price and the exchange closed' suspended trading in them. So, while they were trading around $2.70 or so, they fell to the region of around $0.80 and were suspended. And, on Monday, the charge, the stocks were reopened and they immediately traded around $0.10 to $0.15.

So, where we made our error is that these stocks were at a fairly lower level, similar to where they are today, several months ago. And, they were running up in price over the last couple of two or three months, and we had made the error of not noticing that. So, suddenly -- basically, you know they rose like, say Tesla, all right? And, as they rose, these customers were getting more and more margin and buying more and more of this stock. We have now put in rules, or are in the process of putting in rules, that will not allow us to lend margin at the same extent on rapidly rising stocks. So, I think that those rules will diminish the chances for something like this to happen again.

And what about -- I guess you couldn't have stopped them out earlier because it happened on Friday and it opened up lower on Monday --?

Oh, no, we ran into liquidation, but they were open for a very short period of time, and we learned eventually whether if our liquidation was pushing the price or not.

Yes, so it's not like it sat on it for days, or anything like that, you liquidated it pretty quickly but there wasn't much left. These are kind of industrialists, and they have other accounts with you, but you --?

No, they do not have other accounts with us. They do have other accounts with other brokers, and they are known to the exchange. It's a different world. It will take us some time to figure out what is the best way of recovering these moneys.

So, right now, the change you're making is when there's a lot of volatility in the stock and a lot of price movement, you're going to limit the margin, and that's across the board, not just specific to that market?

That's correct. It will go across all issues.

Okay, well that's helpful. Thanks for expanding on it. And then, if I could just to go back to the compensation cost, Paul, if I could, the $44 million was a big drop, and I know you said -- look, we accrue bonuses per the unit, but is there a bit of a catch up reverse accrual in here? Or, is this a good run rate to think about as we go forward the quarters? Because, we're trying to drop the number in the model, but are we going to get a bit surprised if it comes back up next quarter? I'm wondering if there was a catch up in the third quarter there.

I wouldn't characterize it as catch up, but neither would I say that it's indicative of a run rate going forward. For example, one component of comp expense is the stock incentive plan shares. And, when someone leaves the Company, there's a forfeiture involved there, and that can bring previously recognized expense back to us. And, depending on the size each quarter, that can have some impact. So, it's hard to predict that kind of run rate because it's sort of particular to the actual staff that are staying and going.

Okay, so I guess it will shake out somewhere in between where you've been tracking. And then, I guess the other thing is, Thomas, if I could go back to you, you'd mentioned earlier you brought on your strategy -- you're expanding on your strategy to get more business from the industries and brokers in the US. What are you going to do differently there to attract the business? And then, just other thing, you mentioned you've hired a VP of Securities Lending, what do you expect them to do differently than what you've been doing before?

I suppose I'll answer the second question.

Sure, do you want me to do that first?

Please.

Absolutely. We are putting a whole new focus on improving our capabilities to support customers who want a short stock. And, we have a multi-pronged approach there, starting with increasing the inventory we have available to us, and that means reaching out to new counter parties on the Street, and agent lenders, and the large banks, and so forth.

And then, extending the other way to bring better tools to the customers to allow them to analyze what we have available and when it becomes available. We have a realtime system so that when they indicate an interest to sell something short that is not yet available, we immediately go to the Street and we try to find it and we feed that information back to them. So, we're in the process of developing more and more of these tools that will just enhance the process on the offering to the customer.

Did the new VP come from the Street that there's some relationships that you haven't had before that you could build, or --?

Yes, our new guy is named Bruce Turner and he came from an outfit called Quadriserv where he was heading up the operations. Quadriserv runs AQS, which is an automated securities lending platform, of which we actually have an investment in. We have disclosed that before. And, we still hope that platform does very well. It's an interesting part of the industry that's hard to automate.

Okay, thank you.

As far as introducing brokers are concerned, this has been a long ambition in my mind that as technology is growing in the overall economy, it certainly is growing in the brokerage business, and smaller outfits find it extremely difficult to keep up with their technology needs. As I have said to some of your firms, along with others, is that if you really put -- if your executives put their minds to it, they would realize that there are immense savings of getting rid of much of the technology infrastructure that you are using. And, you would come onto our platform, or maybe another like ours, but I don't know any that is as efficient and inexpensive. So, I think that some of the future brokerage firms will specialize either in providing technology or providing relationship, like the kind of relationships that you are building with your customers.

Okay, fair enough. I'll get back in line, thank you.

Mac Sykes, Gabelli.

Not to harp on the Singapore issue, but just more broadly for the margin balances, in general, would you say the margin balances are diversified across your base, or are there still some concentrations there? It just seemed like this loss was a big outlier from your average account.

I am not the person that studies this. We have a department that studies this, and I'm told that we have 70 accounts, roughly, that have fairly large -- over $10 million exposure, and the top one is roughly $200 million.

Okay. On the positive note, I was curious about your comments on getting accounts referrals, so would it be incorrect to assume that as new account growth gets bigger, then in fact, your new account growth percentage could actually increase?

I'm sorry, you're cutting out -- I can't --

I'm sorry, Thomas. So, you talked about how a lot of the new account adds are coming from referrals --?

Referrals, yes.

Right, so as your base of accounts gets bigger, would it be wrong to assume that your actual growth rate could also get bigger?

Of course, yes. New customers beget new customers.

Great, thank you.

Sean Brown, [Teton Capital].

Two quick ones. First one is just a follow-up to the gentleman from Gabelli. You said you have 70 accounts with fairly large exposure, $10 million-plus exposure, the top one, $200 million. What exactly is that exposure to? If you could clarify exactly what you mean by exposures -- that's its overall account size?

We analyze our accounts for 30% move in the assets that the accounts hold; and then, we set that against the amount of money in the account. And, our biggest exposure is to an account that if the market were to move 30%, and we couldn't liquidate it during that -- if it suddenly opened 30% lower, we would lose $200 million on that account.

Got it. Okay, I understand that concept much better now. And then, my second question is, you mentioned a bit about outside US growth when you touched on the good performance of the introducing broker business line. And, I'm just wondering if you could give any more color on how the business is doing outside the US, be it in Asia or Europe or other regions?

Our biggest introducing broker customers are in Europe, specifically -- well, I'm not sure if it's still the biggest. No, I think now, by now, it's in Asia. We have three fairly large introducing brokers in Asia, and we have one extremely large one in Europe. And, we have about 50 or 60 smaller ones, but these are all brokers that recently have come online, and they are just revving up. So, it looks good.

Wow, and is there a lot of potential to either increase penetration within those brokers or interest in adding new brokers from those regions as they start to hear about Interactive Brokers?

That's what -- we have a sales force that goes around to more likely smaller brokers and tries to talk them into converting to our systems.

Got it. And, are the economics, in terms of pre-tax profit margin or gross margin, for Interactive Brokers attractive similarly to the existing book of business?

If we break it out by -- so overall, our direct expenses comprise roughly 23% of our commission income. And, as far as fully disclosed introducing brokers, that happens to be 25%, so it's slightly less profitable, but not any way out of line.

Yes, and I guess because you have such a large fixed-cost base on an incremental basis that a lot of that just drops down to the bottom line. So, it sounds like on an incremental basis, it's actually very profitable.

That is the idea.

All right, great. Thanks, guys.

Thank you. There are no further questions at this time. I'll turn the call back over for closing remarks.

Great. Thanks, everyone, for joining us today. Just a quick reminder, this call will be available for replay on our website, and I'll be posting a clean version of the transcript on our website tomorrow as well. Thanks, again, for your time, and have a great evening.

Ladies and gentlemen, this concludes today's program. You may now disconnect. Good day.