Interactive Brokers Group, Inc.

Good day, and thank you for standing by. Welcome to the Interactive Brokers Group Second Quarter Financial Results Conference Call. At this time, our participants are on a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. To ask a question during the session, you'll need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the conference over to Nancy Studi, Director of Investor Relations. Please go ahead.

Good afternoon, and thank you for joining us for our second quarter 2021 earnings conference call. Once again, Thomas is on the call, but asked me to present his comments on the business. He will handle the Q&A. 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. Q2 was a fantastic quarter. With the exception of the first quarter this year, it was the best one in Interactive Brokers history. Total accounts grew 61% versus a year ago, a record, save for the first quarter. Client equity grew 79%. Growth also outpaced only by Q1. Total client darts of $2.3 million were also, except for Q1, a record. The same is true of our stock share and options contract volumes. Our business strength can also be seen in our overall metrics. While our client equity, or the cash and securities in client accounts, grew 79%, client margin loans rose even faster to a record high of $49 billion, up 96%. In contrast, client credit balances, or the cash in client accounts, grew 16%. Why? Strong markets and an active client base led our customers to utilize the Interactive Brokers platform to put proportionately more of their money to work in the markets. As a percent of our client equity, margin loans have risen from a pandemic outset low of 11.5% up to 13.4% as investors have grown more confident and want to participate in the market. This increase is even more impressive when you consider that while for margin loans, the numerator is based solely on client activity, the denominator of client equity is based on customer activity plus overall market performance. Even if there was no change in total margin loans, Rising markets mean that this ratio will naturally decline. Instead, we see that this ratio increased nearly 200 basis points within a backdrop of rising global markets, showing investor confidence and willingness to participate. And the more our clients participate, the stronger we become. Our reported pre-tax margin was 72%, and adjusted for non-core items was 67%. We know of no other broker who can claim margins close to this. We see this investor confidence and strong activity across the globe in all geographies. As we observed earlier this year, this activity appears to be led more by individual investors than by institutions. These customers tend to be sticky as they become familiar with our platform, and especially internationally, we offer the broadest geographic product offering and lowest costs to those investors, and there are many, who wish to invest internationally. It is expensive to provide global market access with compliance, legal, currency, and tax and reporting requirements different in each market, and the costs to comply with all these requirements is high. As three-quarters of our accounts are international, this competitive advantage continues to serve us well. Over time, even as this period of COVID winds down, we see global interest in the markets, and the rise of the electronic connectedness of individuals to financial markets, institutions, and each other, driving more people to participate, generating further interest in the financial markets among investors old and new. We continue to see year-over-year growth in total accounts in the high 20s to low 30%. This is well above the high teens level year-over-year growth we experienced before the pandemic. We continue to get better at giving our customers the power to navigate through our numerous high-quality features more efficiently. We continue to improve on giving them a customized work environment. We continue to listen to them to learn what products and tools they want added. And now to go over our record before the first quarter numbers. We ended the quarter with a record 1,414,000 accounts, a net increase of 61%. Once again, we saw account growth in all client segments in all geographic regions, with all areas showing over 50% growth, with modestly more rapid growth in Asia. We saw growth in all five of the client types that we service. I will now go over five client segments. Individual customers who made up 63% of our accounts, 37% of our client equity, and 54% of our commissions continued their growth this quarter, with 12-month account growth of 88% and client equity growth of 85%, while commissions grew 48%. In addition to the aforementioned factors, continued active interest in markets by investors worldwide, increases in market indices, and investor desire to improve on zero-interest rate environment alternatives are some of the reasons behind this segment's strength. All geographic areas we serve saw triple-digit individuals' account growth, with close to uniform growth rates across the Americas, Europe, and Asia. This proves the importance of providing a reliable platform to a global audience, offering wide product choices and worldwide access, and shows that clients want the maximum opportunities to invest in the variety of ways they prefer. We continued to see growth in the hedge fund customer segment. For the 12 months ended June 30th, We saw 2% hedge fund account growth, 54% customer equity growth, and 5% commission growth. We continue to benefit from a reputation for best price execution, low and transparent margin and securities financing rates, the quality of our platform, and the strength of our balance sheet. Hedge funds represent 1% of our accounts, 7% of our client equity, and 6% of our commissions. Proprietary trading firms are 2% of our accounts, 9% of our client equity, and 12% of commissions. For the quarter, this group grew by 34% in accounts for the 12-month period, 48% in client equity, and 21% in commissions. Prop trading firms are sensitive to the direction of volatility and trade more as volatility increases. While not as high as the spike in the first quarter, continuing strong volatility led to more active trading strategies, while accounts and client equity grew due to more traders wanting to be on our platform to capitalize on its reputation for seamlessness and efficient trade executions. Financial advisors are 10% of our accounts, 16% of our customer equity, and 10% of our commissions. This group grew accounts by 20% for the 12-month period, customer equity by 52%, and commissions by 6%. Account and client equity growth show our increasing penetration of this segment. Commissions were up by less than the account and equity growth, as advisors typically tend to trade more conservatively. While our independent advisor business is small relative to Fidelity or Schwab, those firms serve the advisor and individual segments only. Interactive Brokers also caters to hedge funds and prop traders, more demanding groups as far as certain functionality is concerned. We add tools and build out our infrastructure based on input from each client segment, and then make these improvements available to all of them. As a result, our platform has the richest set of tools and capabilities, and with this strategy, we get better and grow faster in each of our customer segments than our peers. Our final segment is introducing brokers. These represent 26% of our accounts, 32% of our client equity, and 17% of our commissions. iBroker segment account growth was 39% for the latest 12 months, while client equity more than doubled, growing 115% and commissions by 131%. Interactive Brokers Platform provides the global trading and seamless back-office functionality critical for brokers who want to provide a global offering in order to capture clients worldwide who seek to invest and want to be able to access many markets in order to do so. We continue to be excited about 2021 and beyond. I know you were all going to ask me about a Bitcoin introduction, and we expect it by the end of next month. In other areas, we have provided content to Coursera, creating a certificate program for them called A Practical Guide to Trading, which covers equities, forex, U.S. bond, and derivatives trading. You should also take a look at IBK, our campus. which offers over 50 courses on investment products, trading tools, and portfolio and risk analysis. We want informed clients who will have the knowledge and tools to be with us for the long run. And finally, we look forward to the Robinhood IPO so that our various metrics can be compared to another firm besides Charles Schwab. With that, I will turn the call over to our CFO, Paul Brody, who will go through the numbers for the quarter. Paul?

Thank you, Nancy. Thanks everyone for joining the call. As usual, we'll review the quarterly operating results, the non-core items, factors that drove those numbers, and then we will open it up for questions. Starting with the operating data, progressively stronger trading levels and record margin borrowing throughout the quarter drove robust operating metrics, albeit below the unusual spike in the first quarter. with a tailwind of rising world markets on positive vaccination and economic news and low interest rates. Continued global interest in financial markets amid the search for higher yields led to industry trading volumes that are still above the activity levels of 2020 in most products. Mean stock trading volume came down from the extreme highs of the first quarter, which impacted industry volumes, mainly in stock, though over the course of the second quarter, Trading by our active trader customer base rose from April lows. Volatility, as measured by the average VIX, fell from the unusually high levels it reached early last year at the beginning of the first phase of the coronavirus pandemic, a time of great uncertainty amid rising case numbers worldwide. The average VIX fell from 35 in the second quarter last year to 18 this quarter. And while it has come down recently, the VIX is still stronger than pre-pandemic levels, reflecting perhaps the unevenness of the reopening of economies worldwide. Compared to the second quarter of 2020, our quarterly total DARTs rose 32% to 2.3 million, second only to the unusually active first quarter. Our customer trade volumes rose year on year in several product classes, led by increases of 34% and 160% in options and stock volumes, respectively. Stock volume was inflated by trading in low-priced stocks, though even after removing those from our calculation, our share volume still rose 36%. Again, these volumes are second only to those of the first quarter. Futures volume declined 19% year-on-year, but remained modestly higher than the pre-pandemic levels. FX dollar volumes this quarter were lower, a trend we have seen since the explosion of volume in early 2020, and now are about even with pre-pandemic levels. Total accounts reached a record $1,414,000 of 61% over the prior year, contributing to customer equity growing 79% from the second quarter of 2020 to $363.5 billion. Our overall average commission per cleared commissionable order declined 15% versus last year to $2.38, though it rose 3% versus the first quarter. Factors impacting this decline include a product mix that featured smaller average trade sizes and options for Forex and our continued success in capturing liquidity rebates, some or all of which are passed through to our clients. Capturing these rebates reduces the overall commission our clients pay, decreasing the average commission per DART, but also reduces the exchange fees we pay on the expense side, making their net impact neutral to our bottom line. Moving to our net interest margin table, our net interest margin rose from 0.99% to 1.15% year-over-year, driven by margin lending and securities lending. Quarter over quarter, our NIM declined from 1.26% to 1.15%, partially impacted by a decrease in the average effective U.S. benchmark Fed funds rate from eight to seven basis points, with a further impact from most other rates worldwide remaining at or below zero. Securities lending and margin loans were the largest contributors to our net interest income. Securities lending was particularly strong this quarter, though down from a spike in the first quarter when several stocks presented us opportunities to lend at high rates. Utilizing our in-house developed system, our team executed on opportunities to lend hard-to-borrow names that investors were looking to short. Net interest income from securities lending reached $136 million this quarter, up 70% year-over-year. Average margin loan balances rose 94% versus last year as investors continue to grow more comfortable taking on risk and leverage. Higher year-over-year balances led to a 97% increase in marginal and interest income to $128 million. In light of the flat yield curve, we kept the duration of our portfolio relatively short and recorded an immaterial marked market loss on our holdings of U.S. treasuries. Outside the U.S., notably in Europe, where we have grown accounts at 55% and client equity by 70%, negative benchmark interest rates in some currencies have affected our ability to achieve acceptable yields on our segregated cash in this region. This has led to a couple of unusual factors. Over the past few quarters, we have earned interest on our customer credit balances as we pass through negative rate costs on large balances in these currencies. Our aggregate yield on segregated cash in this quarter was immaterial, but slightly negative. This was driven by increased customer cash balances and negative rate currencies, although offset by the pass-through of costs I just mentioned. Aggregate segregated cash balances fell 13% as clients used more cash to invest in the financial markets and more cash was used to fund margin lending in the U.S. This overall decline along with inflows in negative rate currencies, led to a drop in our segregated cash net interest to minus $2 million, including the pass-through of $8 million of the negative rate interest to customers. The net interest earned on segregated cash balances was $6 million for the quarter. Note that for accounting purposes, our FDIC suite program which was $2.7 billion in the second quarter, removed funds that would otherwise be included in segregated cash balances on our balance sheet. Now, for our estimate of the impact of the next 25 basis point increase in rates, calculating the impact of rate changes, we understand that as the possibility of a future rate increase becomes more certain, this expectation is typically already reflected in the yields of the instruments in which we invest. Therefore, we attempt to isolate the impact of an unexpected rise or fall in rates separate from the impact of rate hikes or cuts that have already been baked into the prices of these instruments. With that assumption, we would expect the next 25 base point unanticipated rise in rates to produce an additional $99 million in net interest income over the next four quarters and $102 million as the yearly run rate based on our current balance sheet. Our net interest income is highly sensitive to small rate increases due to the impact of low benchmark rates on the spread between what we earn on our segregated cash and what we pay to our customers. As U.S. rates fell below 50 basis points, our spread compressed as we earned less on our segregated cash. However, the converse is also true that as rates moved back up towards 50 basis points, the spread rises. The $102 million run rate includes the reinvestment of all of our present holdings at the new assumed rate, but does not take into account any change in how we may manage our segregated cash. A 25 basis point unanticipated fall in rates would produce a decline in net interest income of $32 million over the next four quarters and $32 million as well for the yearly run rate. As a reminder, about a quarter of our customer credit balances are not in U.S. dollars. and so changes in rates that occur in the US do not apply to all of our balance. Turning to the income statement, we define non-core items as those not part of our fundamental operating results. Non-core adjusting items versus the year-ago quarter are as follows. Our currency diversification strategy swung from a gain of $16 million a year ago to a loss of $9 million this quarter for a comparative decrease in income of $25 million. Investment gains and losses rose from a gain of $13 million to a gain of $113 million this quarter for a comparative increase of $100 million. And the market-to-market on U.S. government securities went from a $13 million loss to about zero this quarter, a comparative increase of $13 million. The net effect of these items increased pre-tax income by $104 million this quarter, a positive shift of $88 million over last year's quarter. Net revenues were a reported $754 million for the quarter, up 40% versus last year's second quarter. Excluding non-core items, net revenues were up 24% to $650 million. Commission revenue rose 11%, on higher volumes year-on-year, particularly in stocks and options. Net interest income rose 40% to $274 million despite continued low benchmark interest rates. Thanks to growth in our balance sheet, higher margin loan balances, and our successful securities lending efforts, our growth in net interest was robust. Other fees and services revenues, which include market data, exposure, account activity, FDIC bank suite program and IPO facilitation fees, as well as order flow income from options exchange mandated programs, rose 38% to $55 million. The top three contributors were risk exposure fees, which were up $6 million, market data fees, which were up $5 million, and liquidity payments from options exchanges, which rose $2 million. Other income, which includes gains and losses on our investments and currency diversification strategy, as well as principal transactions, showed a gain of $118 million, up from a gain of $27 million in last year's quarter. Ex non-core items, other income, increased 27% to $14 million. Non-interest expenses were $213 million for the quarter, down 33% from last year's quarter. Larger exchange liquidity rebates, lower futures volume, and a $6 million clearing fee rebate drove a 29% reduction in execution, clearing, and distribution fees to $54 million, despite the higher stock and options volume. As mentioned, a portion of exchange liquidity rebates are passed through to our clients and are reflected in reduced commissions. Fixed expenses were $158 million, down 34%, driven by a 73% decrease in G&A expenses. Last year's G&A included a $103 million in costs associated with the WTI oil futures event. At quarter end, our total headcount stood at 2,429, a 34% increase over last year. We continue to hire aggressively in client services to support the influx of new accounts, as well as in software development. Note, too, that Brexit required that we open offices in Europe, which are now fully operational in Hungary as well as in Ireland. Customer bad debt expense was $1 million, well contained for a highly active trading period. Reported pre-tax income more than doubled from last year's quarter to $541 million, for a 72% pre-tax margin. And excluding non-core items, pre-tax income rose 41% to $437 million, a 67% pre-tax margin. Diluted earnings per share were $1 for the quarter versus 40 cents for the same period in 2020. And ex-non-core items, diluted earnings per share were 82 cents versus 57 cents as adjusted last year. Now, to help investors better understand our earnings, taxes, and the split between public shareholders and non-controlling interests, the second quarter numbers are as follows. Starting with our pre-tax income of $541 million, we remove $1 million income at the holding company. Then we deduct $12 million for income taxes paid by our operating companies, which are mostly foreign tax.