Interactive Brokers Group Inc (IBKR) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Interactive Brokers Group fourth-quarter financial results conference call.

(Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to hand the floor over to Nancy Stuebe, Director of Investor Relations.

Please go ahead.

Thank you, operator, and welcome, everyone, to our fourth-quarter earnings call.

Our earnings were released today after the market closed and are 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 your questions.

As a reminder, 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 are outside of the Company's control.

Our actual results and financial condition may differ, possibly materially, from what is 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.

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

Thank you for joining us for our final 2016 earnings conference.

We finished the year with some surprises in the otherwise usually -- unusually seasonally [subdent] holiday quarter.

The results of the election surprised many investors, and people who read the New York Times and did not watch my interview on CNBC on October 3 may have mistaken its likely impact on the markets.

Kidding aside, the night and days following the election, there was some welcome trading volume to the markets in an otherwise lackluster quarter.

Our pretax income for the quarter was $28 million, and for the full year, $761 million.

Correcting for the unfavorable currency fluctuations, these would have been $181 million for the quarter and $801 million for the full year.

2016 was an unusually slow year for the markets.

Aside of a few days of sudden spurts of activity following the Brexit and the US general election votes, there was very little activity in the markets and volatility was at historic lows.

Indeed, our commission revenue declined from $617 million in 2015 to $612 million in 2016.

This, in spite of the number of accounts having increased by 16% to 385,000 and our customers [that's] increased by 27% to $85.5 billion.

Continuing with the trend of previous years, market-making pretax income diminished to $44 million from the previous year's $130 million.

Our brokerage have increased 41% from $536 million to $756 million, although, the 2015 number was diminished by $140 million differentially greater bad debt expense due to the Swiss franc debacle.

Without that, pretax profits from brokerage would have increased by 12%.

As I said earlier, commission income decreased for the year, so that this overall income increase is mostly due to $98 million increase in interest income.

As previously indicated, this week we are introducing the so-called high [beta] portfolios to be managed by our Covestor subsidiary.

These are unique products in that they compound -- combine the advantages of actively managed mutual funds, stock selection techniques, that we have automated with the low cost of passively managed ETFs.

There will be five different portfolios, broad-based equity, volume, growth, quality, and high dividend.

Each stock in the portfolio will be settled in the customer's individual account, and will be rebalanced automatically on a quarterly basis.

Our management [field] will be only 8 basis points, and the associated brokerage charge should amount to no more than 3 basis points.

We are starting our marketing campaign this week and would like to encourage you to look at the specific description on our website.

This year we set a number of new records for our brokerage business.

Our clients' equity grew by 27% to over $85 billion, while our customer count grew 16% to 385,000.

As a result of this ongoing (inaudible) organic growth, brokerage equity capital surpassed $4 billion in 2016, and brokerage profit of $756 million was the highest in our history so far.

Increasing brokerage profits was driven by interest income, tends to increase assets and higher average benchmark rates.

Our customers' margin balances and credit balance has moved higher, with margin loans reaching a period end high of over $19 billion at the end of the year, as our customers capitalized on year-end trading opportunities.

The cash deposits from our customers' credit balances are invested in reverse repos and short- and medium-term Treasury securities.

This has provided a continuing stream of higher interest income as our client balances grew.

Last year we had only two weeks of increased interest from the latest Fed fund rate hike.

Please remember that because at Interactive Brokers we believe in giving investors the most powerful tools and the greatest opportunities to succeed, we will be rebating to our clients most of the future increases in interest rates.

This is because the rates we pay to our customers are indexed to the benchmarks.

Accounts of over $100,000 of liquidating volume receive interest on daily cash holdings.

That's all but half of 1% of the benchmark interest rate.

Despite two significant events in the last quarter of 2016, the US election and the Federal Reserve increase in target interest rates, overall volatility remained very low.

In our brokerage business, we saw growth in all five different client types that we serve.

I will go over our five different client segments.

We saw particular strength in our Introducing Broker segment, which had 2016 account growth of 33% and [filed] equity growth of 63%.

As the operating and especially regulatory cost of running the brokerage firm continued to increase, smaller and mid-size brokers will find it difficult to justify managing their own technology have been coming to us to (inaudible) our state-of-the-art technology and capitalize on our low cost.

We are pleased to welcome [Zions Bank] as an Introducing Broker customer.

They have begun migrating their accounts over to us and will continue to do so over the coming weeks and months.

This will add about 6,000 accounts and up to $2 billion of client equity to our existing base.

We think this is the beginning of a larger trend, ever more so in US and Asia than in the United States.

Because we are fully automated, our costs are very low and we charge very little, making it much less expensive for a broker to come to our turnkey system than maintaining their own.

The Introducing Broker does the customer service and manages the relationship with the clients.

We provide the [trade and trading] customary regulatory infrastructure.

We have captured a tiny fraction of what we believe is perhaps a $1 trillion market, and we have much more room to grow here.

We are seeing new brokerage firms popping up all over the world as new businesses to take advantage of our offering.

We recognize that many may fail, but some will almost certainly succeed and become wonderful partners to us.

This is especially true in countries in Eastern Europe and Asia, where investing is a relatively new concept, and to a lesser extent, in South America.

Because we offer value that is most obvious to active clients, we have a high concentration of active traders among our customers.

As we grow our customer base, we are naturally recruiting customers who, on average, trade less frequently.

Our success in recruiting Introducing Brokers emphasizes this point, because while highly profitable for IB, Introducing Brokers tend to have lots of accounts who do not trade as frequently.

As a result, our average customer accounts transacted 400 times last year compared to 450 times the preceding year.

Or, to illustrate the point in another way, while the average Introducing Broker customer spent $463 in commissions, the average direct individual customer spent more than 3 times that much, or $1,437 in commission.

Second, hedge funds.

We saw good growth in the hedge fund customer segment.

This group is 1% of all our accounts, 9% of our client equity, and 9% of our commissions.

For the year, we saw 13% hedge fund account growth, 29% customer equity growth, and positive commission growth of 7%.

As big banks in both in the US and internationally look to preserve their balance sheets, they are asking their smaller, less profitable hedge fund clients to leave.

Barclays and Deutsche Bank made announcements to this effect in this past quarter.

This encourages more potential hedge fund clients to try Interactive Brokers, see the quality of our platform, evaluate the strength of our balance sheet, and ask themselves why did they not come to Interactive Brokers sooner.

Hedge funds are a large, multi-trillion-dollar global market, and we have tremendous room to grow in this area.

Thirdly, individual customers, which make up 56% of our accounts, and 37% of our client equity, and 51% of our commissions, saw account growth of 13% for the year.

Our client equity grew 24%, but commissions were unchanged.

The slow trading environment meant that commissions for these customers were flat for the year.

We have opportunities to grow our customer base in this segment.

We are looking at ways of making it easier for individuals to learn our platform.

As an example, last year we had started to produce short videos that explained different parts of our offering.

Number four is proprietary trading firms.

They represent 3% of our accounts, 13% of client equity, and 17% of commissions.

For the year, this group grew 10% in accounts and 18% in customer equity.

However, because [prop] traders are the customers most sensitive to the lack of volatility in the current trading environment, their commissions were down by 8% versus last year.

We are well penetrated in this segment, so while we expect some growth, it will not represent our largest customer development opportunity.

Fifth and final category is financial advisors.

They are 19% of our accounts, 26% of our customer equity, and 17% of all commissions.

This group grew accounts by 14% and customer equity by 21%.

However, the slow trading environment led to a 4% decrease in commissions.

We focused this year on making it even more seamless for registered financial advisors to achieve their independence with the launch of Greenwich Advisor Compliance Services.

Greenwich Compliance provides registration and compliance assistance for our new, existing RIA business.

Going independent means RIAs can keep all the fees they earn.

Given the increase in advisors looking to become independent, our low commission and financing rates, and our Greenwich Compliance Assistance, we believe we have the right formula for continued growth in this segment.

Globally, investment advisors have about $20 trillion in AUM, so we have plenty of opportunity in this area.

We look forward to the upcoming quarters.

We are dedicated to continually introducing new capabilities and improve the power, control, and customization of our platform for our customers.

If you are not already a customer, try our free demo; look for the launch of our new, more powerful portfolio analyst tools.

And at this point, if I had to guess, I would say that our market-making business will not improve in the coming year.

But the brokerage business will continue to grow at a rate in the high teens, although we will certainly try for more.

We have a practically unlimited runway in front of us.

And with that, I will turn the call over to our CFO, Paul Brody.

Thank you, Thomas.

Thanks, everyone, for joining the call.

I'll start with our summary results and then move on to segment highlights before we open it up to questions.

The fourth-quarter operating results reflected a solid performance in brokerage, led by gains in net interest income and a positive swing in mark-to-market value of investments on US government securities versus the prior-year quarter.

These were largely offset by currency translation losses and lower earnings in the market-making segment.

Full-year results showed strength in core brokerage and continued decline in market-making.

Our pretax income of $761 million represented a return on average equity of 13% and a profit margin of 55%.

Excluding currency translation effects and Treasury marks, our profits were $775 million with a similar pretax margin.

Overall operating metrics reflected a somewhat better trading environment, but still sluggish market volatility.

While we saw an increase in activity around the US presidential election in November, the subsequent decline in December activity led to quarterly total DARTs at about 3% below the average for the year.

Average overall daily trade volume for the quarter was 1.32 million trades per day, even with the fourth-quarter of 2015 and up 5% sequentially, as the average VIX level declined 18% and rose 6% respectively over the same time period.

We continue to see strength this quarter in asset gathering and margin balances in brokerage, as I'll describe in my comments on that segment's performance.

Electronic Brokerage metrics showed solid increases in the number of customer accounts and customer equity, up 16% and 27% respectively.

Total and cleared customer DARTs were unchanged and up 2% respectively from the year-ago quarter, even in the face of low volatility.

Orders from cleared customers who clear and carry their positions and cash with us and contribute more revenue held steady at 92% of total DARTs this quarter.

Market-making contract and share volumes were down across product types.

Fourth-quarter net revenues declined 29% versus last year, while pretax income was down 78% for a pretax margin of 15%.

Excluding our Treasury marks and currency translation effects, net revenues were up 4% versus last year, while pretax income was down 3% for a pretax margin of 54%.

Our brokerage results were boosted somewhat by strong gains in customer accounts and equity, while low volatility and a decline in volumes continued to impact the market maker.

Other market factors had the following impacts.

First, we saw continued low market volatility.

The average VIX fell 18% year over year, and to bring some historical perspective to this, only 6 quarters in the last 10 years have exhibited a lower average VIX.

Actual to implied volatility fell 29% from the prior-year quarter.

Generally, a low VIX dampens trading volume, and therefore, brokerage revenues, while both measures affect our market-making business.

While we saw increased activity around the US election in November, in December, volatility returned to the low levels we experienced during the summer.

Except for this brief opportunity, we continued to see fewer opportunities for our market-making business.

Next, the US dollar strengthened markedly in the fourth quarter versus other major currencies.

As a result, the currency basket in which we keep our equity, which we call the GLOBAL, fell 3.4% against the dollar for the quarter.

This resulted in a loss of $201 million, which includes a loss of $153 million reported in other income and a loss of $48 million in other comprehensive income, or OCI.

We estimate the total impact to earnings per share from the GLOBAL to be a loss of $0.35 for the quarter, with $0.24 reported as other income and $0.11 as OCI.

For the full year, the US dollar strengthened 0.9% relative to other major currencies, resulting in a loss of $65 million, which includes a loss of $40 million reported in other income and a loss of $25 million in OCI.

We estimate the total impact to full-year earnings per share from the GLOBAL to be a loss of $0.13, with $0.07 reported as other income and $0.06 as OCI.

Finally, medium-term interest rates rose in the quarter as the Federal Reserve followed through on its expected target rate increase of 25 basis points.

As a result, mark to market losses on our Treasury portfolio were $11 million.

Although we plan to hold these securities to maturity, we must, as brokers unlike banks, mark them to market quarterly.

Net revenues are $193 million for the quarter, down 29% on a reported basis from the year-ago quarter.

Several factors that fall outside our core operating activities should be considered in comparing the current quarter's revenue to the prior year's.

First, our currency strategy caused a loss of $153 million versus a loss of $19 million in the year-ago quarter.

And the Treasury portfolio marks-to-market deducted $11 million from our revenues in the current quarter compared to a loss of $52 million in the year-ago quarter.

So adjusting for these two factors on a pro forma basis, our total net revenues would be $357 million in the current quarter and $342 million in the year-ago quarter, or up 4%.

This core increase was driven primarily by strength in our Electronic Brokerage segment, somewhat offset by lower trading gains in our market-making business.

Increases in commissions and especially in net interest income, plus the significant improvement in our Treasury portfolio performance versus the fourth quarter of 2015 were the drivers in our Electronic Brokerage segment this quarter.

Commissions and execution fees were $150 million, up 4%, and interest income was $138 million, up 17%.

Brokerage produced $129 million, and market-making $6 million, with the remainder in corporate.

As the Federal Reserve rate hike took effect in mid-December we expect most of the benefit of this increase to be reflected in our numbers going forward.

Trading gains were $39 million, down 26% from the year-ago quarter.

With the continuation of low volatility, our market maker has had fewer opportunities for trading.

Other income, which as I described earlier, includes the effects of our currency diversification strategy and Treasury portfolio marks, was a loss of $134 million versus a loss of $44 million in the prior-year quarter.

Non-interest expenses were $165 million for the quarter, up 15% from the same quarter last year.

The rise reflects specific increases in fixed expense categories, in particular, software development, legal, and compliance costs.

Generally, we continue to closely manage our expenses, as we selectively build our capabilities in growth areas.

At December 31, 2016, our total headcount stood at 1,204, an increase of 11% over the prior year-end count, and up 1% sequentially.

We have continued to expand in a few key areas, notably customer service, legal and compliance, and software development, all of which support the growing brokerage business.

Our reported pretax income this quarter was $28 million, leading to a 15% pretax margin.

However, excluding non-core items, our pretax margin -- our pretax income would have been $192 million for a 54% pretax margin.

This compares with fourth-quarter 2015 adjusted pretax income of $197 million, for a 58% margin net of the same factors.

Brokerage pretax margin was a reported 57% as compared to 52% last year, and adjusted for non-core items, brokerage pretax profit margin was 59% versus 61% in the prior-year quarter.

And market-making pretax profit margin was 27% versus 39% last year.

And for the full year of 2016, we earned pretax income of $761 million on net revenues of $1.4 billion, versus $458 million on $1.2 billion of net revenues in 2015.

Excluding non-core items, our pretax income would have been $775 million, for a 55% pretax margin.

This compares with full-year 2015 adjusted pretax income of $816 million, or 58% pretax margin on the same basis.

Comprehensive diluted earnings per share were a loss of $0.05 for the quarter, as compared to a gain of $0.18 for the fourth-quarter of 2015.

And on a non-comprehensive basis which excludes OCI, diluted earnings per share and net income were $0.07 for the quarter as compared to $0.25 for the same period in 2015.

Excluding the impact of non-core items, comprehensive diluted earnings per share were $0.32 for the current quarter versus $0.36 for the year-ago quarter on the same basis.

And for the full year of 2016, comprehensive diluted earnings per share were $1.19 versus $0.62 in 2015.

On a non-comprehensive basis, excluding OCI, diluted earnings per share on net income were $1.25 versus $0.78 in 2015.

Excluding non-core items, full-year comprehensive diluted earnings per share were $1.29 for 2016 versus $1.37 for 2015 on the same basis.

In terms of 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 81% of our combined balance sheet assets from the two segments and 70% of the consolidated equity.

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 December 31, we maintained over $4 billion in excess regulatory capital in our broker dealer companies around the world, of which about 78% is in the brokerage segment.

We continue to carry no long-term debt and our consolidated equity capital December 31, 2016 was $5.8 billion, of which approximately $4.1 billion was held in brokerage, $1.5 billion in market-making, and the remainder in the corporate segment.

Turning then to the segments, we'll begin with Electronic Brokerage.

This quarter, we saw a rise in stock volume, largely driven by increased trading in low price stocks in the US, Hong Kong, and Australia versus the prior-year quarter.

Customer trade volumes were higher in futures and stocks and lower in options.

While cleared customer DARTs rose 2% over the prior-year quarter, cleared customer volume was mixed, with options contracts falling 1%, and futures and stock share volumes rising 5% and 27% respectively from the year-ago quarter.

Foreign exchange volume was off 8% from the year-ago quarter.

Contributing factors were the overall contraction in the retail FX market, as well as our policy change, which took effect around September 1, limiting customers with less than $10 million in assets from making FX trades using leverage.

We adopted this limitation due to a lack of clarity on the regulation of retail FX business in the United States.

However, the impact on our overall FX volume was not substantial.

Commission revenue rose 5% on a product mix that featured smaller average trade sizes and options, slightly larger in futures, and substantially larger in stocks.

This mix resulted in an overall average cleared commission per DART of $4.01 for the quarter, up 5% from the year-ago quarter and up 3% sequentially.

For the full year, commission revenues were down less than 1%, while net interest income rose $98 million, or 25%, to $498 million.

Customer equity grew to $85.5 billion, up 27% from last year.

The source of this growth continues to be a strong inflow of new accounts and customer assets.

We continue to attract larger customers, along with financial advisors and Introducing Brokers, but manage groups of smaller accounts, all of which results in a blend that affects both average trade size and average account equity.

Our average account equity rose 9% year on year to $222,000.

And in addition to the larger accounts that we're attracting, part of this growth was fueled by new services to targeted customer types, including our Greenwich Advisory Compliance Services for RIAs and new services we have made available to administrators of employee stock plans, in which we can act as broker first to the administrator's issuer clients, and later, directly to the employee participants.

To the extent we're successful, we would expect these client segments to produce more commission revenues with some lag time.

[Arch] in debits rose 14% year over year, reaching a record level of $19.4 billion.

Customers' appetite for increased risk, along with our expanded prime broker financing, were responsible for this increase.

Customer credit balances continued their steady growth, rising 13% over the year-ago quarter.

Net interest income rose to $129 million, up 25% from the fourth-quarter of 2015.

For the full year, net interest income rose to $498 million, up 25% from 2015, representing now 40% of net revenues as compared to 36% in the prior year.

The Federal Reserve's increase in the federal funds target rate this past December, together with increased customer balances, has generated more net interest income on cash balances.

Our continued success in asset gathering sets the stage for larger revenue contributions from interest-sensitive assets going forward.

And our stock yield enhancement program, where we share revenues from lending out fully paid securities with our customers, continues to provide an additional source of interest revenue on securities assets.

In addition, we continue to improve our securities lending utilization to capture more revenue from lending hard-to-borrow stocks.

With a growing customer asset base, we continue to believe we are well positioned to prudently maximize our net interest income, given the opportunities presented by the market.

Based on current balances, we estimate that a general rise in overnight interest rates of another 25 basis points would produce an additional $41 million in net interest income annually.

Further increases in rates would have a smaller impact, because the interest we pay to our customers is pegged at benchmark rates less a narrow spread.

Fixed expenses and brokerage were $80 million, up 14% over the year-ago quarter and 4% sequentially.

The primary component of this increase was higher compensation cost, particularly related to software development.

We expect software development compensation and the securities industry regulatory burden to continue growing, but we believe our focus on applying technology to compliance and regulation will keep our costs with compliance lower than our competitors.

Customer bad debt expense was negligible this quarter, down from $1 million in the year-ago quarter and $3 million sequentially.

Our risk committee continues to enhance our scenario-based risk models in order to reduce exposures to world events.

Pretax income from Electronic Brokerage was $168 million, up from $113 million in the fourth-quarter last year.

Excluding Treasury marks, core pretax income was $179 million, up from $164 million last year for a 59% pretax margin.

Turning to market making, trade volume declined year over year across all product types.

Options and futures contract volumes fell 10% and 14% respectively, while stock-share volume was down 39%.

As in brokerage, a substantial portion of the drop in stock volume came from low price stocks trading in Hong Kong.

Trading gains from market making for the fourth quarter were $39 million, down 26% from the year-ago quarter, but up 3% from the third quarter.

Market volatility measures were significantly lower than the year ago, and other than the US presidential election, which produced a few active days, there was a dearth of market events in the latest quarter that presented us with profit opportunity.

Pretax income was $12 million in the quarter, down from $27 million last year.

For the full year, pretax income was $44 million versus $130 million last year.

On the cost side, execution and clearing fees expenses were down 22%, in line with lower trading volume.

Fixed expenses decreased to $19 million, down 21% from the year-ago quarter, as we continue to pare down the cost of running this business.

Looking at the corporate segment, the earnings reported for this segment reflect the effects of our currency diversification strategy.

Our overall equity as measured in US dollars was decreased by the strengthening of the US dollar against all other major currencies.

We estimate the overall loss from our strategy of carrying our equity in proportion to the GLOBAL to be about $201 million for the fourth-quarter of 2016.

As I described, because $48 million of the GLOBAL loss is reported as other comprehensive income, this leaves a loss of $153 million to be included in reported earnings.

And for the full year, the overall loss from our strategy of carrying our equity in proportion to GLOBAL was $65 million, with $25 million reported as OCI, leaving $40 million to be included in reported earnings.

And as a reminder, at the end of the second quarter of 2016, we made some modest changes to the composition of the GLOBAL, as we reported at that time, and those changes are reflected in our results for the second half of 2016.

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

Thank you.

(Operator Instructions)

Our first question comes from the line of Conor Fitzgerald from Goldman Sachs.

Good evening.

A couple on your net interest income.

Leaving rates aside for a moment, you mentioned growing your stock lending business.

Can you help us get a sense of how much additional net interest income upside there is for you as you continue to grow that part of your business?

I'm not sure we could quantify it looking forward, but it certainly grows in line with the growth of our balances, naturally.

To the extent that we're successful in attracting more professional customers, more hedge funds, they seem to have an interest in the short side of the market more than individuals, since, to the extent that we can better our services there, so that portion of interest revenue will thrive along with that part of the business.

And we're being pretty successful in that lately.

Okay, and then I think I heard you say $45 million from the next Fed hike.

I just wanted to clarify, that's not what the Fed did in September, but prospectively another 25 basis points higher.

Right, with the next 25 basis point move, we would expect in the number's $41 million in terms of interest rate sensitivity.

As I said, further increases would produce much -- would produce smaller results, because once we are into positive rate territory, which we now are, the interest spread is locked in.

We give a very narrow spread to our customers on both the debit and credit side.

And so, we would benefit on smaller balances and on things like short stock borrow opportunities, but other than that, it would basically rise with the rising balances.

Okay.

I thought that your pricing model was 50 basis points of Fed funds, after that, you started sharing with the client.

So I just -- the $41 million was a little higher than I think I and a couple others would have guessed.

So want to understand why the Fed going up to, whatever, 90 basis points just was more asset sensitive than 90 to 115.

But that makes sense.

And then on the employee compensation, I think you had mentioned some of the compliance costs coming in.

Are those fully in the run rate at this point?

I'm not sure we can answer that question.

We -- as our business grows, we add on different kinds of legal and compliance support services, so we now have an entity called Greenwich Advisory Compliance Services, as Thomas mentioned.

And these costs go into revenue-producing activities.

They're not all in the background.

So there's a mix, and I'm not sure any of us know what the regulatory environment holds for us going forward.

So it's some combination of expanding the size and complexity of the business and a regulatory environment in general.

So Conor, I said in my part that we do not pay interest to accounts with liquidating values under $100,000.

And quite a few of our accounts are in that category.

That's helpful.

I think what I was just trying to understand is why that $41 million would then go to some de minimis amount if you're presumably not paying interest through the cycle on those smaller clients.

I'm trying to understand why it goes to $41 million, and then steps down to something de minimis and why it's not more sustainable.

Well, because it's not de minimis.

There is substantial amounts of money in those accounts.

That's helpful.

Thank you.

Thank you.

And our next question comes from the line of Rich Repetto from Sandler O'Neill.

Good evening, Thomas.

Good evening, Paul.

I just want to follow up on the comp question here a bit.

Because it just -- I know you've been adding people in the areas that you talked about, Paul.

But if you look at the quarterly comp for the year, it was the first three quarters had $58 million, and then you jump up $10 million in the fourth quarter.

And I thought you said the headcount didn't really -- it was only a single digit percentage, I thought quarter to quarter.

So the question is why the step-up in comp in 4Q?

There is bonuses, right, actually bonuses.

Well, most of it's accrued, and then sometimes we have adjustments to true up to actuals at the end of the year.

We paid higher bonuses than we accrued, right?

Right.

Oh, okay.

Because I'm looking back at prior years, and that hasn't been a trend in the fourth quarter except for this year, but that -- anyway --

A competitive world.

Okay.

The next question is on the net interest income, Paul, it was pretty flat quarter to quarter.

And the balances looked like they grew either high single digit, more than what you would guess.

So was there -- I'm just trying to see how you didn't see a -- realize a bigger increase in net interest income, given the growth in the balances quarter over quarter.

You mean sequential quarters?

Yes.

Not versus the prior year.

Right, correct.

Right, right.

So we had a 7% sequential increase in debit balances; credits were roughly flat.

In fact, down very slightly.

And sequentially, we had a 1% increase in net interest.

Understand, partly, there's a couple of effects here.

One is that larger customers are going to get the best rates, meaning the smallest spread to us, that's one effect.

We're happy to take in that business.

It's just, perhaps, incrementally a smaller spread.

And there are sometimes extra costs around end of period, especially around end of year, when markets tighten up and things like the foreign currencies and there are a number of currencies that are in negative interest rate territory like the euro.

And to the extent that we don't pass on all of that cost to our customer, we absorb some of that.

Okay.

The last question, Thomas, is -- and you talked about this in the prepared remarks.

But you get the agreement with Zions and you got more potential there to do this for other banks and brokers, I suspect.

And the question is, will the incremental customer that you're getting from these Introducing Brokers or -- and even these banks where you have the relationship with, will you get the same customer that has a level of trading activity that you've been accustomed to in the past is the question.

Seems like you're growing.

As I said, Introducing Broker customers are yielding us roughly half as much as regular customers, all in.

So the commission they generate is about one-third or maybe even a less, maybe even a little less than that interest income [also is], but not that much less.

Okay.

Okay.

That's helpful.

Thank you.

I'll get back in the queue if I get more questions.

Thanks.

Thank you.

And our next question comes from the line of Chris Harris from Wells Fargo.

Thank you.

I want to follow up on that last question regarding the Introducing Broker relationships.

Do you guys handle all the customer service requests for those relationships as well?

No, no, the customer service is done by the Introducing Broker.

Got you.

Okay.

And I wanted to ask you a hypothetical here, might be hard to answer, but really wanted to talk to you a bit about tax reform here in the US.

I imagine your taxes are a little bit more complicated than some of your peers.

I think with some of the peers in the industry, we can just say, well, if there's a 10% reduction in corporate tax rates, maybe that flows through exactly the same in the P&L.

What do you think is going to be the impact on IBKR's P&L if we do see a lowering of the corporate tax rate by, say, 10%?

Paul?

Well, obviously --

I told you, you're going to get this question.

Yes, sure.

No, I thought that you'd respond.

Well, so our taxes are -- you're right, it's not as simple as an individual.

They fall into several streams.

There are taxes paid by our foreign affiliates and that won't change.

To the extent it then flows on through to the US and then on to our IBKR, the public Company, that portion will obviously benefit from a lower tax rate.

The other effect, as you've seen probably some things written about, especially with some of the big banks, is that they have large deferred tax assets.

We have a deferred tax asset that results from the structure that we created during the IPO.

It's a reflection of tax benefits to be gained over time in the future.

So to the extent that rates go down, the estimated value of that deferred tax asset as well goes down, and accounting convention requires the firm to take a write-down all at once.

Our estimates show that it's not going to have a big material impact on us the way it would on some of the larger banks that have been written about.

But on an operating basis, obviously, the portion that flows through the public Company will benefit from the lower tax rate.

Yes, but, so if they cut our tax rate by half, our income would rise by how much?

Can't give specific numbers at this time, but we could try to put those out at another time.

We have not done all the analysis on that.

Okay.

Thank you, guys.

Thank you.

And our next question comes from the line of Mac Sykes from Gabelli.

Just to jump on Chris' question, in terms of the actual makeup of the firm, owing that it's a public/private, have there been any talks in terms of some of the taxes for the partnership stuff causing any thoughts on maybe changing the structure of the overall entity?

No, we are not thinking about changing the structure.

And then what is driving the hedge fund lending?

Is it overall desire for leverage, a closer focus on your competitive spread rates, more active efforts by your salespeople?

Just curious if we could dig into that a little bit more.

They are all those, but obviously, our sales force is a driving force.

But one of the things that we do is we display our short availability and the rate at which our lending -- or that we would charge for lending those shares.

And hedge funds can come to us and look it up online.

And they do come to us and they look it up online, and then they go back and [beat up] their prime brokers and say, how come interactive broke is lending at that and you're charging me this?

And the prime brokers usually succumb, except when the hedge fund is small and they say, well we don't care, go to Interactive Brokers.

Okay, and then my last question, on Treasury management, now that balances are pretty significant, have you ever considered maybe starting a bank or perhaps like a --

Yes, but we don't want to take on the hassle.

Okay.

So you see, are a global broker and that goes with a lot of hassle, a lot of regulations.

So that is where we want to have our competitive fight, because we have relatively low competition on that because there are very few folks who do [the effective] brokerage globally.

And so that's where our focus is.

Great.

Thank you for taking my question.

Thank you.

And our next question comes from the line of Chris Allen from Buckingham.

Good afternoon, guys.

Thomas, if I heard you correctly, you talked about no growth, the [els] for no growth in market making, but double-digit growth in --

Speak into the phone, please.

I'm sorry, can you hear me?

Barely.

Is that better?

Yes, much better.

Yes.

Just the els growth moving forward, you're not expecting market making to grow, but you're expecting Electronic Brokerage to grow double digits.

Are you referring to the outlook for revenue growth or more accounts and customer equity growth?

Any color there would be helpful.

All of the above.

And is that for the revenue growth outlook, does that bake in a better environment from a volatility perspective?

No, no, no.

It's going to grow because our number of accounts are growing and our customer equity is growing.

So that's how it's going to grow.

Got it.

Okay.

And then just a quick question on the Treasury marks, $11 million that were set to about $0.02 in EPS impact, is that correct, Paul?

For what time period?

The quarter or the year?

The fourth quarter, just the fourth quarter.

The Treasury marks were about $0.02, yes.

Okay, thanks a lot, guys.

Thank you.

And our next question comes from the line of Kyle Wade from KBW.

Hi.

Good afternoon.

Just on the Greenwich Advisor Compliance Services, I think you start the roll-out of the subsidiaries in the third quarter.

I just wanted to get an update here.

Are you still adding significant functionality in headcount?

And then, can you give us any indication as to whether you're seeing more interest from FAs that you're onboarding or any feedback from the advisor community on the early roll out?

Yes, so the early roll out is very encouraging.

Yes, we are definitely focusing on adding more capabilities, and we have regularly, especially areas [toward] investment advisors who have previously worked for the [buy bracket] brokers tend to come and asking about going independent and how they should do that.

Okay.

Thank you.

And then just one for Paul.

Just a follow-up on the comp expense again.

Is there any way you can quantify the true-up on the bonus comp in the quarter?

Just trying to get a sense for the right run rate there going forward.

We don't have specific numbers on the true-up.

However, if you looked at the annual, I think that's probably accurate, as accurate as you can get on the run rate.

Okay.

Thanks for taking my question.

Thank you.

And our next question comes from the line of Michael Trica from Oakum Bay Capital.

Good evening, guys.

This is a question for, I think, Thomas.

From the perspective of not only an investor but a pretty active client as well, I had a question about the level and degree of iteration on improvements or changes on the TWS platform.

Candidly, we've experienced some latency in improvements and would even suggest maybe forming a round table of clients, larger clients, active clients of TWS of Interactive Brokers to better communicate potential changes and speed up the iterations of those changes.

We would be happy to do that.

And certainly we would love to participate.

Great.

Good, that's a good idea.

But you're saying that you have experienced latency or it was -- is it getting better or worse?

Just the, we've been customers for -- on an off for about a decade, and just the process of suggesting changes, I believe it's writing a ticket.

And in terms of what we've done in the past, we've written tickets and not heard responses for weeks, small changes on TWS.

Pass it to me and I'll tell you, you'll get a response.

Certainly I would gather a round table of large investors or large clients --

That's a great idea.

We will do that.

Thank you very much.

Thanks for your time.

Thank you.

And our next question comes from the line of Doug Newburger from SunTrust.

Hi, good evening.

Just had a question on the market maker.

You talked about how you're looking for alternatives for it if you can't fix it.

Of course, you're not in the best market right now with volatility being so low.

Do you have the same general plan?

I know there's a lot of different options, joint ventures, or sales.

Are you leaning one way or another if that contingency has to happen?

Well, we're continuing to explore different possibilities for the market maker, yes.

Okay.

And your commission per DART went up sequentially fairly nicely.

I assume it was the business mix.

Was there any unusual -- I know the futures volumes spiked because of the election.

Is that something that you think you could maintain going into this quarter and this year, or is the business mix -- or is the business mix going to go back to a normal historical level?

It depends on the business mix.

To the extent we get more hedge funds and large customers, our commissions per DART will go up.

To the extent we get more Introducing Brokers, our commissions will go down, per DART.

Okay.

That's helpful.

Thanks.

That's all my questions.

Thank you.

And our next question comes from the line of Rob Koehn from Ivy Lane Capital.

Thanks for taking my question.

So first, to follow up on Conor's question on a future Fed funds hike.

So with the next Fed funds hike, Paul, of 25 Bps, you cited $41 million.

So given that interest income is generated three or four different ways, say there was a second type.

Is that a, maybe a different way of asking the question.

How much net interest income increment would we expect from a second hike of 25 Bps?

Would it be $35 million?

Would it be, you know --

We actually looked at those two scenarios to come up with the $41 million.

If there were two sequential 25-basis-point increases, in other words, two sequential and then stay flat for the rest of the year, the number would be about $47 million.

Okay.

Okay.

And that takes into account the component.

In other words, our tiered schedule of paying interest and charging interest and the maturity schedule on our investments and so forth.

Okay.

Okay.

And then on the Electronic Brokerage for Q4, to make sure I have my numbers right, the reported net revenue of $294 million, if you exclude the $11 million of Treasury mark-to-market hit, that becomes a, is it $305 million net revenue?

Yes, that's right.

And therefore, that would flow -- all of that would flow down to brokerage pretax or [168] would become [179]?

Yes.

So the margin would be 59% instead of the 57% that's listed.

The margin would be 59%, right.

Great.

And I understand that there -- the auditors probably don't make it easy for you to put out a pro forma table, and I know somebody's asked this before.

You got that right.

But I do think that one of the biggest challenges here is the fact that these are extremely confusing quarterly reports between the GLOBAL marks and the Treasury marks, being a brokerage instead of being a bank.

And there's not much you can do about that.

But if there's any way to make this more clear, I think that would be helpful to everybody involved.

What we'll do is, we just decided that at each month end, along with our brokerage metrics, we will publish the change in the GLOBAL for the month and quarter to date and year to date.

So you will always know what the number is.

If you like, along with that, we could also publish the Treasury marks.

Everybody should understand that the reason why we had these marks is that we are not -- we're must mark them to market, but at the end, it all becomes just part of the interest income.

Thank you.

And our next question comes from the line of Sean Brown from Teton Capital.

Hi guys, I have just one quick question around the individual account business vertical, and it's around IRAs in particular.

I see that two weeks ago, you've insourced the IRA custodian business.

I think that was outsourced before and customers had to pay an extra fee, and now it's going away.

Is this a big market space for the long term or -- ?

I don't know what you just said.

What did you just say?

Two weeks ago, what happened?

On January 1, I think, yes, Interactive Brokers insourced the IRA, individual retirement account custody.

Insourced?

Yes,

That's right.

It's primarily a fiduciary and reporting function that we did take in house.

It's not something that we would expect to turn into a business line to do for others.

We plan to do it -- our plan right now is we're doing our own IRA custodian and reporting function for our own customers.

I think that's what you're asking, yes, Sean?

Right, right.

It seemed that as you've presumably built out internal capabilities for that and some automation in the systems around that, maybe that is a business line that could be poised for growth, just on an organic basis.

Would that be correct?

Or is this just not a big enough market to grow for the long term?

I think, if anything, we might look at it along the lines of when we build automation for compliance services, in general, we think that, that attracts certain types of customers and makes them sticky customers, because we can perform those compliance activities for them and they might be brokers.

And I suppose this could turn into one of those.

But we've got to get it right on our own first and this is our first leg in.

Got it.

So for now, I should think of it as more of a cross-sale to our existing individual customer base, and then later on, it could be an attractive capability to the potential Introducing Broker customers?

I wouldn't call it a cross-sell, because it's a transparent function to the customer.

The customer just wants his custodian function and his reporting done on an annual basis.

In the background, it's now being done in-house at IB.

Right, right.

But due to the $30 per-year fee that was passed on to the customer previously, I'm guessing there were a lot of Interactive Brokers customers who had just created their IRA at Vanguard or ETRADE or Fidelity, somewhere that didn't have a fee previously, even if they had an individual broker account or margin account at IB.

I'm not sure what other brokers charge in terms of administration fee for IRAs; however, small IRAs are not of great interest to us.

They don't tend to trade a lot; they're retirement accounts.

They often are threshold accounts so that it allows the Introducing Brokers or financial advisors to bring a whole group of accounts over to us if we can support the IRA portion of those accounts.

So we have been doing that for a number of years and now we're just improved on the process.

Got it.

Got it.

Thank you.

Thank you.

And we have time for one more question.

Our final question for today is a follow-up from the line of Rich Repetto from Sandler O'Neill.

My question's been asked and answered.

Thank you.

Thank you.

And we would now like to take a question from the line of Rob Koehn from Ivy Lane Capital.

Thank you, just one follow-up.

So on Introducing Brokers, can you -- Paul, can you quantify a contribution margin?

Since you're not providing customer service to these Introducing Broker customers, even though they're generally at a lower commission rate because they're on the grid, is that still like a nearly a 90% or 95% contribution margin type of business then?

Thomas, you want to respond?

It's very hard to tell.

Our customer service is still being used by the Introducing Broker himself, up until his people are well trained, and that takes quite a long time.

And then our expenses, as far as customer service, it's not a major part of our -- it's not the majority of our expenses.

So to the extent we, at a later stage in the life of an account that no longer -- that expense is no longer imputable, it doesn't -- it's very hard to guess.

It's a theoretical question, okay.

But presumably, you've done the math and you're comfortable that it's still a very profitable business at any rate.

Sure, it's a profitable business, yes.

Okay.

And then -- well, I'll just leave it at that.

Maybe to follow-up on the one other comment the other gentleman made, maybe it would be a good idea to have like a hedge fund day at IB headquarters to allow people to come see the facility and learn more about the Company.

Thank you for the suggestion.

Okay.

Thank you.

Thank you.

And that concludes our question-and-answer session for today.

I'd like to turn the conference back over to Nancy Stuebe for any closing comments.

Thank you, everyone, for participating today.

And as a reminder, this call will be available for replay on our website.

We will also be posting a clean version of our transcript on our site tomorrow.

Thank you again, and we will talk to you next quarter end.

Ladies and gentlemen, thank you for your participation in today's conference.

This does conclude the program and you may now disconnect.

Everyone have a great evening.