Interactive Brokers Group Inc (IBKR) 2014 Q3 法說會逐字稿

Good day, everyone, and welcome to the Interactive Brokers third-quarter 2014 earnings results conference call. This call is being recorded.

At this time for opening remarks and introduction, I would like to turn the call over to Ms. Deborah Belevan, Director of Investor Relations. Please go ahead.

Thanks, operator, and welcome, everyone. Hopefully by now you've seen our third-quarter earnings release, which was just released today after the market closed, and is also available on our website.

Today our speakers are Thomas Peterffy, our Chairman and CEO; and Paul Brody, our Group CFO. They're going to start the call with some prepared remarks about the quarter and then we'll take some Q&A.

Our call may include forward-looking statements, which represent the Company's belief regarding future events and 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 the risk factors contained in our financial reports filed with the SEC.

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

Thank you for joining us to review our third-quarter performance. This quarter we set new records in our brokerage business due to our total number of accounts, customer equity, margin balances, profits and profit margins reaching all-time highs.

The message that IB is the best platform to minimize trading costs and optimize execution quality is spreading among professional traders and investors around the world. Our brand recognition is strengthening not only in the US but in markets throughout Europe and Asia, where we are still way behind in terms of market penetration and where our primary advantage of being the lowest-cost broker is even more pronounced.

In international markets, our competitors are priced even higher by comparison, and word-of-mouth advertising is very effective. All this bodes very well for our prospects of continued strong performance and economic growth.

Unfortunately, the stellar performance was overshadowed by unusually strong currency movements, namely the strengthening of the US dollar, which negatively impacted our reported results in market making. As you know by now, we maintain our equity in a basket of 16 currencies that we call the Global in order to stabilize the currencies we would otherwise be exposed to as a global Company doing business in various currencies around the world. However, when we translate our results into US dollars for reporting purposes, the relationship between the US dollar and the Global is reflected our financial statements.

Usually the fluctuations are less than 2% from quarter-to-quarter. However, this quarter the dollar strengthened considerably against all other major currencies globally, which created an unusually large currency translation [load] for us. This quarter, the Global fell by about 4% compared to the US dollar, which reduced our comprehensive earnings by $211 million. This total of $133 million reduced our trading grains, and $78 million is reflected in other comprehensive income, or OCI.

If we back out the currency effects from our results, the picture is much more clear. For the quarter, we reported pretax income of $40 million. Backing out the currency effects, this was $172 million, comprised of $152 million in brokerage, $21 million in market making, and also $1 million in corporate. As you can see, our brokerage continues to be the dominant segment, accounting for 88% of adjusted pretax income this quarter.

Customers are coming to our platform. A key differentiator that is driving this trend is our significant cost advantages over other brokers. Not only do we offer much lower commissions, our customers achieve the industry's best price execution, thanks to our superior order-routing technology and firm commitment to not engage in the practice of selling our customer order flow like most other brokers do.

In August, I submitted a letter to the SEC recommending that they require all brokers to publish costs of execution metrics that would once and for all allow investors to compare trading costs across brokers. This letter is published on our website under About IB, and Comment Letters and Papers.

While the SEC is currently evaluating payment for order flow, the market structure issues that may favor high-frequency traders over retail investors, it remains to be seen how the regulator will proceed. The repeated call for transparency speaks in our favor. Hopefully by now, you have seen the [regular] of execution data we started including with our electronic brokerage metrics that we publish monthly.

The bottom line is, our customers have paid nearly 1 basis point or 100th of 1% year-to-date in total trade costs as a percent of total trade volume. Total trade cost is comprised of commissions, fees and market impact. The way we calculate this number is that we compare total all-in trading costs with executing the daily volume rate of moving average price, or RMAP, without any additional cost.

A key observation whether viewing these statistics is that in certain months, and for the entire nine months year to date, our customary execution cost or market impact is actually a negative amount. This is due to our smart routing technology that automatically routes each customer order to the venue that we'll have any moment [automatically] produce the lowest net trade cost for the customer by taking into account accumulated rolling statistics and potentially better prices and rebates for fees. 1 basis point of total trade expense is the remarkable result, especially if you consider the fact that from this amounts the SEC and other regulatory fees of 0.23 basis points on sales.

We are nowhere near finished with building this system. We keep refining it and updating it, as new transaction venues and new rules appear all the time. While our competitors are trying to figure out how to maximize their income from selling their customers' orders to others, we in turn are trying to work on maximizing their income that they derive from taking the opposite side of those orders. We dedicate our software development (inaudible) to execute the best price for our customers.

These are two entirely opposite business models. How can they both be right? We believe that the better the prices we get for our customers, the better their performance will be and the more business they will bring to us. On the other hand, our competitors believe that most customers cannot tell the difference between good and bad executions.

I think we're both right. As a result, they end up with the customers who cannot tell the difference, and we end up with those who can. I like the side we are on, and so do more and more traders and investors around the world.

Now I will review the third-quarter highlights for our brokerage. In spite of the usually subdued summer activity levels, we were helped by 18% growth in the number of customers by the end of this quarter over the same period last year. And as a result, our total DARTs were 13% higher year-on-year. By comparison, average daily volume on US exchanges for equities fell by 4%, and options increased by 8% during the same period.

Our growth rates in DARTs also exceeds those of our larger peers. It continues to be the case that our customers are far more active, and for that reason we continue to be the largest US electronic broker as measured by total number of revenue trades, which averaged 534,000 per day in the third quarter, despite having significantly fewer accounts than the large E brokers. And we expect our lead to widen further in the future.

The annual increase of 18% resulted in 272,000 customer accounts as of September 30. And this growth rate is picking up steam. Last year at this time, our annual growth rate was 13%.

Year-to-date customer account growth has averaged 3,700 accounts per month compared to 2,400 accounts per month in 2013. Growing momentum is a testament to the this product variation of positive feedback from our current customers, which attract referrals, our leading source of new accounts, and the solid reputation we have earned.

Customer equity has reached $54.9 billion, 38% higher than a year ago, while the rise in market values as of September 30 contributed somewhat, as demonstrated by the 17% year-on-year increase in the SMP. Most of this growth comes from new accounts, and current customers bringing more assets to our platform. The average equity per account has also [resent] 13% year-over-year to $202,000.

We also delivered record pretax profit margins of 63% this quarter, thanks to our highly automated and scalable business model, which allowed us to achieve industry-leading profit margins while also still being the lowest-cost broker. Margin balances have grown to a record of $17.3 billion, a 38% increase over the prior year. Customers are attracted to our industry-low financing rates we changed from 0.5% to 1.58%.

We continue to focus on enhancing our trading technology and developing new trading tools to maximize the volume of our platform, while keeping our trading and financing costs significantly lower than our competitors. This quarter we have announced a number of new features we have added to our administrating and risk management tools, including enhancements to the Risk Navigator, Charts and Mosaic Market Scanner. And two important new features for option traders.

People who would like to run an option overlay strategy are often reluctant to do so because if the option is assigned, they may have to give up a stock in which they have a gain that they do not wish to realize for tax purposes. In times like that, it is ordinarily too late to buy new stock to deliver because that settles in three days, and the assignment settles in two days. To get around this problem, we are now enabling our customers in these circumstances to buy stock for two days' settlement to deliver against the assignment and to hold on to the unrealized gains.

Another issue for option traders is that they often leave money on the table when they do not exercise sufficiently in the money options before [ex] dividend dates. We are now using our option valuation model to calculate if an option is worth more when exercised. In such cases, we notify our customers and also give them the ability to provide us with a standing instruction to exercise for them in such situations in the future.

I should also mention that our clients can now optimize their routing preferences for non-marketable option orders, to find the sweet spot between maximizing the profitability of execution and minimizing the venue fees. To illustrate, they can select among several options, including maximizing the rebate or preferring a [field order] to the rebate, or vice versa, and balancing between getting a rebate and filling the order.

This quarter we also extended our Risk Navigator, as requested by some [excellent] customers who want to analyze their positions in terms of individual stock data rather than straight percentages. And finally, we added on-demand transaction cost analysis. Our customers can now, at any time during the day, examine data executions against various benchmarks, either singly or in any grouping of their choice.

Now I will review the performance in our market making segment. As I mentioned, market making will slip this quarter with an unusually large currency translation loss. The portion of the loss that impacted the P&L was $133 million, which reduced trading gains. If we back this out, pretax profits in market making, ex-translation, would have been $21 million this quarter. This compares to $41 million in the pretax profits ex-translation for the year-ago quarter, and $31 million for the previous quarter.

This thick line can be attributed, among other things, to ongoing difficult competitive environment, low volatility levels, a large error to the tune of about $16 million in the quarter -- that in retrospect we did not handle well -- and increased M&A activity, all of which negatively impacted our market making results. The weeks averaged 13 in the third quarter compared to 14 in the year-ago quarter. The ratio of actual-to-implied volatility was actually higher, rising from 63% in the year-ago quarter to 72% in the current quarter, and 73% in the previous quarter.

Exchange trade option volumes increased 5% in the US, and increased 13% globally from the second quarter. By comparison, our Firm's total option value increased 5%. As a result, our current market share decreased from 11.4% to 10.9% in the US, and 8.7% to 8.1% globally.

In the market making segment alone, our option volume increased by 4% during the third quarter, which drove our market share in that segment from 5.1% to 4.5% in the US, and from 4.7% to 4.3% globally. Our market share in this segment has slowly been declining as we reduce our participation in less profitable markets.

We are executing on our vision to create a global marketplace for different types of customers and service providers to meet, link-up and enter into relationships to do business with each other on our platform. For example, individuals can shop for financial advisors, wealth advisors can peruse a list of money managers, hedge funds can select administrators and the contents and investors can evaluate and invest directly in hedge funds on our platform.

We believe that facilitating these relationships will attract more new customers and expand business amongst our current customers, who will hopefully remain on our platform. We think that people who get far enough on our platform to explore our new marketplace really believe that we do everything we can to maximize their return. And we do. It's a consequence of our relentless focus on ways to maximize our customers' returns that keeps us ahead of our competition.

Finally, having reached the age of 70, I think its prudent to have a public secession plan for the Business. Accordingly, this morning, Milan Galik was appointed as President of IBG LLC, our holding Company, and Interactive Brokers Group Inc, the public Company.

Milan graduated from the Technical University of Budapest in Electrical Engineering 24 years ago and became a software developer on our platform in the same year. He is currently in charge of developmental trading systems, market data delivery and order routing systems, both for our market making and brokerage businesses.

For several years he has been an important member of our Steering Committee, chairing meetings in my absence, and he is familiar with most aspects of our business. We are fortunate and proud to have him, and he's had [that drawl]. We expect that practical changes in the management of our Business will be very gradual and occur over a long period of time.

And now, Paul Brody will go over the financials.

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

The results of the third quarter were driven by two stories -- outstanding results in brokerage and tepid profits in market making, both of which were overshadowed in the headline numbers by large currency translation losses on the strength of the US dollar. Brokerage results benefited from higher commission revenue, and especially net interest income. Market making results were further impaired by the trading error that Thomas mentioned.

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 in the Company's non-US subsidiaries, known as other comprehensive income, or OCI. These are reported in the statement of comprehensive income.

The US dollar strengthened relative to all other major currencies during the third quarter of 2014. As a result, the currency basket in which we keep our equity -- which we call the Global -- weakened against the US dollar by an unusually large 4%. OCI is a component of the total Global effect, and the rest is contained in trading gains. We estimate the total negative effect from the Global on our reported EPS for the quarter to be about $0.38, with $0.18 reported as OCI and $0.20 as trading loss.

Overall operating metrics for the quarter were generally up across all major product types versus the year-ago quarter. Average overall daily trade volume was 1.13 million trades per day, up 14% from the third quarter of 2013.

Electronic brokerage metrics continued to show solid increases in the number of customer accounts and customer equity. Total and cleared customer DARTs were up 13% and 14%, respectively, from the year-ago quarter, and up marginally from the prior quarter. Orders from cleared customers -- who clear and carry their positions in cash with us and therefore contribute more revenue -- accounted for 91% of total DARTs, holding steady with recent quarters.

Market making trade volume was up from the prior-year quarter, though contract and share volumes were down. Other metrics were also mixed, as volatility levels were down, but the actual-to-implied volatility ratio was up this quarter.

Net revenues of $171 million for the third quarter, down 48% from the year-ago quarter. Trading gains netted to a loss of $76 million for the quarter, driven largely by currency translation effects. Excluding the currency translation, trading gains would have fallen by 26% from the year-ago results.

Commissions and execution fees were $133 million, up 10%. Net interest income was $98 million, up 59% from the third quarter of 2013. Brokerage produced $93 million and market making, $6 million. And other income was $16 million, down 24%.

Non-interest expenses were $132 million, up 1% from the year-ago quarter. Within the non-interest expense category, execution and clearing expenses totaled $52 million, down 7% from the year-ago quarter, driven by lower volumes in market making.

Compensation expenses were $49 million, a 12% increase from the year-ago quarter. At September 30, our total headcount was 937, an increase of 7% from the year-ago quarter and the prior year-end. Within the operating segments, we continued to add staff in brokerage, and cut back in market making.

As a percentage of net revenues, total non-interest expenses rose 77% from 40% in the year-ago quarter. Out of this number, execution and clearing expense accounted for 31%, and compensation expense accounted for 29%. Our fixed expenses were 46% of net revenues. Of course, all these measures were inflated by the negative currency translation impact on net revenues.

Pretax income was $40 million, down 80% from the same quarter last year. And for the quarter ex-currency effects, brokerage accounted for 88%, and market making accounted for 12% of the combined pretax income.

For the third quarter, our overall pretax profit margin was 23%, as compared to 60% in the third quarter of 2013. Brokerage pretax profit margin was 63%, up from 56% in the year-ago quarter, and market making turned in a pretax loss. But excluding translation effects, market making pretax profit margin was 34% in the latest quarter.

Comprehensive diluted earnings per share were a loss of $0.13 for the quarter, as compared to earnings of $0.39 for the third quarter of 2013. On a non-comprehensive basis -- which excludes OCI -- diluted earnings per share on net income were $0.05 for the quarter, as compared to $0.32 for the same period in 2013.

Turning to the balance sheet, as a result of the growth of our brokerage business and the withdrawal of capital from our market making operations through regular and special dividends, brokerage now accounts for about 75% of our combined balance sheet assets from the two segments. From the year-ago quarter, cash and securities segregated for customers rose 17%, and secured margin lending to customers rose 36%, while positions in securities held by our market making units were pared back by 23%.

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 fell short of the amount needed to fund the dividend. Our balance sheet remains highly liquid, with low leverage. We actively manage our excess liquidity and we maintain significant borrowing 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 68% is in the brokerage segment. We continue to carry no long-term debt, and our consolidated equity capital at September 30, 2014, was $5.19 billion, of which approximately $2.9 billion was held in brokerage, $2.1 billion in market making, and the remainder in the corporate segment.

Turning to the segment results, we'll start with brokerage. Customer trade volumes were up across all product types. Cleared customer contract and share volume was up 33% in options, 2% in futures, and 69% in stocks. Much of the stock volume increase came from trading in low-priced stocks. Foreign-exchange volume also declined from the year-ago quarter.

Customer accounts grew by 18% over the total at September 30, 2013, and by 4% in the latest quarter. Total customer DARTs were 534,000 up 13% from the year-ago quarter and 1% from the second quarter of 2014. Our cleared customer DARTs were 485,000, up 14% on the year-ago quarter, and up marginally in the prior quarter. The average number of DARTs per account on an annualized basis was 455, down 3% from the 2013 period, and 4% sequentially.

Commission revenue rose on a product mix that featured larger average trade sizes in all product types. This resulted in an overall average cleared commission per DART of $4.21 for the quarter, lower by 3% from the year-ago quarter, but up 5% sequentially. The large volume executed in low-priced stocks, on which our commission is capped, can skew these numbers somewhat. Also note that commissions include exchange fees, which can vary widely.

Customer equity grew to $54.9 billion, up 33% from September 30, 2013, and up 2% sequentially, well outpacing the S&P 500 Index, which rose 17% over the past year and 0.6% over the last quarter. The source of this growth continues to be a steady inflow of new accounts and customer assets.

Margin debits continued to build steadily, increasing 36% over the year-ago quarter. Customer credit balances also continued to grow progressively, increasing 21% over the year-ago quarter, though spread compression persists in restraining that interest income.

Higher trade volumes resulted in top-line revenue from commissions and execution fees of $133 million, an increase of 10% from the year-ago quarter, and 7% sequentially. These revenues are spread mainly across options, futures, stocks and foreign-exchange.

Net interest income rose to $93 million, up 66% from the third quarter of 2013, and 21% 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 continue to boost customer margin borrowing. Our fully paid stock yield enhancement program continues to provide an additional source of interest revenue that is shared with our participating customers. And we continue to improve our securities lending utilization to capture more revenue from lending hard-to-borrow stocks. Net interest income as a percentage of net revenues rose to 38%, as our brokerage revenues are increasingly diversified between commissions and net interest income.

With a 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 $55 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 2% from the year-ago quarter, and 7% sequentially, reflecting higher trading volumes. Fixed expenses increased to $53 million, up 7% on the year-ago quarter. And pretax income from electronic brokerage was $152 million for the third quarter, up 41% on the year-ago quarter, and 16% sequentially.

Turning to market making, the market making trade volume, in terms of number of trades, was up 15% from the prior-year quarter, though contract and share volumes were down 13% in options, 17% in futures and 1% in stocks. Trading gains from market making for the third quarter of 2014 netted to a loss of $76 million, as compared to a gain of $123 million in the year-ago quarter. Currency translation had a large negative impact, reversing the third quarter's reported earnings by $133 million, a substantial swing from the year-ago quarter when reported earnings were increased by $46 million.

The pretax loss from market making was $112 million for the quarter, as compared to a gain of $88 million in the year-ago quarter. Eliminating the currency effects from each period, the year-over-year change in pretax income from market making would be a decrease of 49%.

Our overall equity as measured in US dollars was decreased by the strengthening of the US dollar against all other major currencies. More specifically, we measure the overall loss from our strategy of carrying our equity in proportion to the basket of currencies we call the Global, to be about $211 million for the quarter.

Because a $78 million translation loss is reported as other comprehensive income, this leaves a loss of $133 million to be included in reported earnings. To summarize this, if we eliminated all currency effects, pretax income from market making for the third quarter of 2014 would be about $21 million versus $41 million for the year-ago quarter and the same basis.

Execution and clearing fees expenses fell to $15 million for the quarter, down 24% on the year-ago quarter, driven by lower trading volumes, primarily in options. Fixed expenses were $27 million, up 11% from the year-ago quarter, primarily due to employee compensation, which reverted to a more normal run rate in comparison to the year-ago quarter, in which certain adjustments are recognized.

We continue our aggressive expense management as we monitor the performance of the market making business. Now I'll turn the call back to the moderator and we will take some questions.

Thank you.

(Operator Instructions)

Rich Repetto from Sandler O'Neill.

Yes, good evening. The first question, Thomas, if you could just give us a little more details on the $16 million trading loss, because that certainly weighed on the results this quarter, the market making results.

Well, it was an area of our software that is used from time to time, and -- it is kind of technical to really go into it in much detail. At this time, the situation that the -- that it was applied to had a strange twist in it, and the software misunderstood the situation and did their own thing.

So could something like this -- is this -- could ever happen again, or do you think it is prevented now that --?

This same thing will not happen again. But software can -- from time to time, errors can always happen with software, as you know. Apple comes out with -- or anybody comes out with a new chip, sooner or later, you find a bug in the chip.

Got it. And then, I know the market conditions -- you went through the metrics. Can you just give us a little feel -- the world has changed at least in October to-date. Can you give us a little color on the market conditions in 4Q, in October, that you've run into so far?

Well, you see what I see, yes?

So it would be very strong, a vast contrast to 3Q then?

Well, volumes are much higher, as we all see, right?

Right. And actual-to-implied is almost -- right around 1, or up in the 0.9.

Oh, you mean as far as market making. I think we don't really -- we are not doing very well in market making.

Okay. I guess the last -- well, let me follow on that then. Even with the metrics that we normally follow, like the actual-to-implied, the volumes and the VIX all saw insignificant improvement in October. You're saying it's not significantly better so far compared to --?

It's not significantly better.

And would that be because of competition?

That's right. In the past when markets would get very active, we were able to widen out our bid offer -- our automated markets, right? This time when we tried, the volume fell off, so we had to narrow it back down. So the results are somewhat better, but not significantly better.

And this will be my last thing. The idea that the regulatory restrictions and demands on capital -- at this point, we're really not seeing that. We're not seeing any positive things from a competitive standpoint that we had talked about in the past, that you would hope would come, impact the other larger market makers.

I don't know what you just said, but you keep talking about market making, and our future is in brokerage, not in market making. (laughter) Focus on the brokerage results; they are spectacular.

Okay, well then I'll ask one more question. $2 billion -- it appears you've got -- you said 68% of the $3 billion is in excess, as in brokerage. So do you plan on --?

We are not making any -- we're not doing any special dividends. We want to keep accumulating money, because we have seen that we will have more and more opportunities in our brokerage business to employ that capital.

Understood. You continue to have solid good results on the brokerage. Congrats, Thomas. That's all I had. Thank you.

Thank you.

Niamh Alexander from KBW.

Hi. Thanks for taking my questions. On the brokerage business, which was a solid quarter, as it were -- and you talked about gaining momentum. The growth stats are really phenomenal in terms of the growth of the clients and the margin and the activity. Where to from here? You're talking about you're seeing more growth coming in from referrals, but are there any specific markets?

You mentioned Asia, but given the sense of maybe how far into the markets you are penetrating versus where you could be, and what kind of customers that you're targeting there? And then, that's geographic. And what can you share in terms of the types of clients that you feel that you're getting more growth from now? Is it the advisor community? Are you starting to see more momentum from the smaller institutional clients?

Our story is the same. It keeps growing, and it keeps growing in all market segments. And yes, as far as financial advisors are concerned, maybe we are now getting more interest from them than we used to in the past. And we have more -- the big prime brokers have tightened up on the requirements, as far as who they take on as their hedge fund customers and what their minimum profit requirement is, and the number of people who are getting rubbed off come to us.

Are you growing more aggressively in the sales side to go out and target more of those institutional clients, or is it, this is the platform and they'll come to us by word of mouth?

That's basically it. This is the platform, but it's a hell of a platform. (laughter)

All right, fair enough. Onto the succession planning. Thank you for updating us on that. I think it kind of signaled it there recently. But can you help me understand what are you going to do differently and what will Mr Galik be doing differently? I mean, leading a publicly traded Company, it's a whole different kind of a leadership role versus running software in different departments. We -- the public investors and then the analysts -- don't know Mr. Galik at all. What can you share here to further inform us on how the transition will happen?

The transition will happen over a long period of time. As you know, we have an executive group who has been together for many, many years. I am now 70; Milan is 48. He is, I think, one of maybe our youngest executives, and also the heaviest weight in the group. And I mean that intellectually, not physically. (laughter) As long as I am healthy, I like what I do, and I hope to stay around. But obviously over the next several years, I will become less and less capable. And you know, I defer to the executive group and I defer to Milan in many decisions already. So you can't expect any sudden drastic changes, but gradually, he will take over more and more of my responsibilities.

Okay, fair enough, Thomas. And then, if I could just go back to the market maker. I know you prefer to talk about the broker because it is a phenomenal growth story. But we're seeing the -- excluding the translation, and the translation is real -- but excluding that, we're seeing such a big drop-off in the profits. And the volatility picked up a little bit towards the end of the third quarter. I know the first two months were very challenging for everybody, but we're getting close to a point where -- are you happy with a break-even business? Are you happy with maybe the next stage getting to losses in this business?

Because it doesn't sound like the competitive environment is reversing, and that some people are just going to get squeezed out of it, because there seem to be others coming into it as well. So where's your level of comfort with continuing to remain in this business if it gets to a point where you're breakeven for a few quarters, you're generating losses for a few quarters, does it still pay you to stay in this business?

To tell you frankly, I'm sort of ambivalent about it. But I have to accept the fact that many of the things that makes us such an incredibly good platform for customers comes from our market maker know-how. Not only as far as the trading itself, but the order routing software and the understanding of the order types and how the exchanges work and the speed of execution we have to keep up with as market makers so we are able to give the same technology to our customers.

I think that sets us apart. And as long as we stay in there trying to compete, we are able to impart those advantages to our customer. I think it's important. And as we get more and more institutional customers, it will become even more important.

In theory, you could have those capabilities within the brokerage business anyway. So it sounds like you would be even willing to tolerate losses as long as that market maker expertise informs the brokerage.

I don't know what losses you're referring to; we haven't had one.

If it progresses. It's been deteriorating, so if you get to a point where --

It's been deteriorating, but it hasn't hit losses yet.

Yes. So my question is, if it would get there, do you do still feel like the market maker, the contribution from that business is enough to offset to the broker?

It's not going to get there.

I see. Okay, so you'll just put it off. Okay, fair enough. Thanks, Thomas.

Mac Sykes from Gabelli.

Good afternoon, gentlemen. I wanted to dig further into the prime brokerage opportunity. Just two questions here. First, what are the current brokerage competitive advantages? I know cost of execution is certainly prominent, but maybe some other details on that.

And secondly, if a lot of the big banks are discarding some of these clients for unprofitable or lower profitability due to capital reasons, I was just curious as to why, if you took them on, would there be a more profitable advantage to you, in terms of your business model?

Okay. Well, the first question was -- I wish people asked one question at a time. The first question was, what advantages do we have other than superior execution. For example, the stock borrow capability. We are almost as good as anybody else, as far as -- almost as good as the best prime brokers, as far as availability to [short] stock is concerned. Our interest rates are very good, not only as far as margin loans, but also in stock loans. So our stock loan is very competitive. The gold mine is the Morgan Stanleys of the world. So these are the primary advantages.

Also I think that our Risk Navigator is very good for hedge funds. Our Trader Workstation itself has many capabilities that other trader workstations do not have. So I think that for traders, we have excellent software, institutional (technical difficulty). Now, your second question has to do with, why would we make money on the accounts that the large prime brokers cannot make money on? Simply because we are much more automated than the large prime brokers are. As you see, that our 63% profit margin -- our profit margin is much higher than everybody else's. So that's why we can make money on them.

And just -- I'm sorry, a quick follow-up just on the emerging hedge fund landscape. Do you get a sense that there is a cyclical bounce in the industry in terms of formation and new offerings? Or has it been fairly steady? Any color you're seeing in terms of the industry.

I didn't get -- new offerings of what?

New launches of hedge funds.

I have heard some hedge funds that are launching, but I think that happens all the time. So I have no evidence that there are more new hedge funds now than there were a year ago, or that there are more initiatives now than there were a year ago. But there certainly are some.

Okay. Thank you very much.

Sean Brown from Teton Capital.

Hi, guys. Congratulations on a continued broker performance. Just a few quick questions. First one is, for broker bad debt expense, what does that come in at for the quarter?

We'll have details like that in the 10-Q, but it was not out of the ordinary from prior experiences.

Got it. So despite [pretax] margin growth, it's still very low; that's very good to hear. Is there any color you can give on credit quality, or if aggressiveness in these loans, in terms of leveragability, has gone up or down for you guys?

I have two things to say about that. One is that we have always had a policy of automated liquidation. Each customer account is evaluated every minute of the day, and we see it's within margin tolerance and we send signals to the customers who are coming close to the limit. And if they don't re-use their positions, then at the moment they hit the limit, we close them up.

Obviously there are some situations where stock specialties -- bio stocks can move 60%, 70%, 80%. And in some of those cases, we do end up with losses. And there's not a heck of a lot we can do about that. But they aren't large. So we look at concentration.

And the second thing that I'd like to point out is that we have instituted an exposure fee, where we examine accounts that would lose large amounts of monies as a function of market move, and at certain levels we start to charging them an exposure dollar. And the larger the eventual loss may be, the larger the charge is. On the one hand, it encourages people to cut down on such exposure, and on the other hand, it gives us some additional income.

Got it; excellent. And my last question is around the growth of the sales force that you guys discussed on the last call, if you can give some sort of update on that?

Well, we have expanded. We always expand. We work on expanding our sales force. We don't see -- to tell you frankly, we don't have a very good experience in doing it. (laughter) But we're certainly not giving up, and we're going to continue to do that.

Got it. Understood. So sales and marketing may take other means besides just hiring salespeople it sounds like.

Right.

All right, thank you very much.

Andrew Bond from Wells Fargo.

Hi, good evening. You spoke about this briefly in the prepared remarks. But was wondering --

Sorry, can you speak up a little bit, please?

Sure. You guys spoke about this briefly in the prepared remarks. But I was wondering if you could give a little more color on what exactly drove the large increase in interest income and interest expense, and if this is a good run rate to use going forward?

We have for years been working on software that optimizes our stock landing borrowing business, and we are scaling new heights in that business. And we will also have this quarter by certain hard to borrow inventory that we were able to utilize. So I do expect our interest income to continue to increase into the future, but this past quarter may have been a stronger bump than expected.

Got it. And just a quick follow-up on the Global. I was just wondering if you guys ever thought about changing the composition of the Global based on any changes in the global economic environment? Or if there's just something in particular that would change your thinking of how the Global composition should be?

I think about it all the time, but I don't think that we will change it.

Okay, fair enough. Thanks for your time.

Thank you.

(Operator Instructions)

Rob Koehn with Ivy Lane Capital.

Hi, Thomas. Thanks for taking my call. Congrats on the great quarter.

Thank you.

Can you talk a little bit about how you think about market share in the brokerage business and your runway for growth going forward? And who your competition is? And where this business -- where you see the brokerage business going in the next few years?

If you really want to know my honest opinion, (laughter) I think in 10 years we could be the biggest broker in the world. I'm not kidding. Because our technology is way out front there, and we are going to work away at it, and we are -- all of our emphasis is on keeping building the technology. And sooner or later, the world will realize what we've got.

What to you think you can do to help, from a marketing perspective, if you put out some new commercials? From a marketing perspective, what can you do to improve the brand recognition, the name recognition, and that sort of thing?

We do more advertising, we do more articles, we do more television appearances, not only in the United States, but around the world, in other countries. Because don't forget that part of our great attraction as a broker is that our customers are global, and where they can trade is global. So it is important for us that we are trying to brand ourselves not only in the United States, but all over the world.

Fantastic. Ultimately, we've seen really amazing growth coming from Asia. Is there anything more you can offer on that in terms of Asian growth rates going forward, and what you've been seeing in the last quarter in that regard?

The exceptional growth in Asia has continued in the last quarter. It certainly has grown faster than any other area. Maybe in the last few weeks I have been noticing some stronger growth from South America, where we are very underrepresented in terms of number of customers, but that suddenly seems to be perking up from a very low base.

Interesting. So you be taking -- they would be moving accounts from the big banks? Or where would you be --?

Most South American customers are with Pershing.

Got you, okay. That's it for me; thank you, Thomas.

Thank you.

Ladies and gentlemen, that concludes our Q&A session for today. I would like to turn the call back over to Ms. Deborah Belevan.

Thank you, everyone, for participating today. And just a reminder: this call will be available for replay on our website. And we'll also post a clean version of our transcript on our website tomorrow. Thanks again for your time, and have a great evening.

Ladies and gentlemen, thank you for participating in today's conference. You may all disconnect. Everyone have a great day.