Interactive Brokers Group, Inc.

Hello, thank you for standing by and welcome to the Interactive Brokers Group Third Quarter Earnings Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1-1 on your telephone. Please be advised that today's conference may be recorded. I would now like to hand the conference over to your speaker today, Nancy Stubbe, Director of Investor Relations. Please go ahead.

Thank you. Good afternoon, and thank you for joining us for our third quarter 2022 earnings conference call. Once again, Thomas is on the call, but asked me to present his comments on the business. Also joining us today are Milan Galick, our CEO, and Paul Brody, our CFO. After prepared remarks, we will have a 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. This quarter showed the strength of the Interactive Brokers business model. automating substantial parts of the brokerage business in order to keep costs low and global product offerings and opportunities high, even as unfavorable market conditions continued to extend into this quarter and beyond. While we were able to maintain our commission income, just barely, it is understandable that in these mostly one-way markets, only very few retail clients feel any urge to open new brokerage accounts. This has a large and unfavorable implication for the growth of our business, and we expect this to continue into the early part of next year. In spite of that, by this time next year, we expect that our accounts will be about 30% higher than today due to some new, larger introducing broker relationships we have mentioned earlier. Preparing to onboard these accounts is a very slow process, and it is unlikely that any sign of these will show before the spring. Account number growth comes on the retail end from direct and introducing broker customers. But much of our commission income comes from hedge funds and proprietary trading groups. An average hedge fund account generates 67 times as much revenue as an average individual account. And for prop trading accounts, this multiplier is around 10. Hedge funds and proprietary trading accounts are less affected by the direction of the markets and are therefore our emphasis has turned more in their direction lately. As most recent Preckin statistics illustrate, for the past three consecutive years, the number of hedge funds on our platform has grown faster than at any other leading bank or broker. IBKR is now the sixth largest provider of prime brokerage services by number of funds, and we feel fairly confident about moving to be number four in the current year, right behind Morgan Stanley, Goldman, and JP Morgan. This growth in hedge fund accounts is happening even though we still do not provide some of the products hedge funds use, like non-exchange listed products outside of cash forex, or first-hand research and organization of meetings and introductions to corporate CEOs or CFOs. Our reversion toward non-exchange listed products is due to our fear of taking on counterparty credit risk that often turns out to be the source for existential difficulties in the business. But these products also create opportunities for outsized trading gains, is they are usually exchange-listed options dressed in different cloth, i.e., different custom-made terms, but they are always, ultimately, hedged by exchange-listed products. Since their terms are unique, they cannot be directly compared to anything to ensure reasonable pricing. While we are not going to change our stance with respect to OTC products, we do not feel the same way about other products, like research and corporate introductions. And as we continue to grow in this business, That is something we may consider in the future. The point is that ever since we started in the brokerage business, we said that we'll build our platform for the most demanding investors and we automate it so that we can easily make it available for anyone who may care to use it. We were often told that that was not a realistic approach. You must choose your target audience. Relying on our growing hedge fund customer base, we are now able to turn this logic around and market the platform to the more sophisticated individual investors by saying to them, to get better results, get a better platform. The best informed investors choose interactive brokers. We are planning to use this as our tagline in our branding efforts. Another welcome development during the quarter was the growth of our bond platform. For many years, this platform has been growing very slowly, recording about 1,000 trades a day. Suddenly, with more active bond market volumes, this now reaches 3,000 transactions a day. Given the relevance of bonds, our Bonds Marketplace has a search tool where you can scan by maturity date, yield to worst, and duration to analyze and compare issuers and save your scan to run again at any time. Many of our customers realize that they can achieve better execution prices by sending us limit orders between the prevailing bids and offers. We go out to numerous other platforms to show these orders, but if no trade occurs and we get an offsetting order, we match the two. We also have order types that instruct us to keep the order internally and wait for a match. This way, the client is not driving the quote in the market against yourself. Despite the slower growth in accounts, we welcomed our two millionth customer in September. less than two years after adding our one millionth customer, and ended the quarter with a record 2,012,000 accounts, an increase of 31% from last year. We saw account growth in all client segments and all geographic regions, with particular strength, 43% and 31%, in Europe and Asia, which together represent the majority of our accounts. Account growth, once again, occurred in all five of the client types that we serviced. Individual account growth was fastest at 38%, followed by proprietary traders at 28%, introducing brokers at 20%, financial advisors at 14%, and hedge funds at 13%. Commission per DART continues to rise as our clients continue to be active in options and especially in futures, which carry a higher commission, although the bulk of that goes to exchange fees. In equities, higher commission per DART was driven by a mix with fewer penny stock orders, where we limit our commissions not to exceed 1% of trade value. Higher futures commissions include very high exchange and regulatory fees, which in part explain our higher execution and clearing direct expense. An advantage of providing many product types to worldwide customers is the ability to capture opportunities when one product or another becomes active. This quarter, while stock share volumes were below those of last year, Options and particularly futures volumes remain strong. We are always looking to find opportunities to grow our business. We've been letting investors know that Interactive Brokers pays its clients 2.58% on their cash balances. And if the Federal Reserve raises rates again by 75 basis points, then their rate will also rise by 75 basis points to 3.33%. We recently introduced our options wizard a tool where you can enter your outlook about the future of the underlying price movement, and the wizard will provide some standard strategies that can be filtered by aggressiveness or by probability of profit. Or you can set up your own strategy. Continuing high inflation is a catalyst that convinces people that holding onto their money as cash will not earn them any return. Investing in securities worldwide will be necessary for a chance to earn a positive rate of return. which is why we have focused on investor educational materials like our Traders Academy courses, our webinars, podcasts, and blogs to inform our customers and make our platform the platform of choice for successful investors, the two million we have and the millions more we hope to have. 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, and thanks, everyone, as usual, for joining the call. We'll review the third quarter operating results and then we'll open it up for questions. Starting with our revenue items on page three of the release, we recorded another strong quarter with record net revenues and pre-tax income on an adjusted basis. With customer account growth at 31% year-over-year, we continue to expand our potential for both commission and interest revenues in the future. Commissions were strong, reaching $320 million despite weak equity markets worldwide. Futures volume outpaced the third quarter of 2021. Options volume was roughly unchanged. And while stock share volumes declined from the last year's quarter, the drop in notional dollar value of stock trades was generally in line with the drop in regional equity indices around the world. Net interest income of $473 million reflected higher margin loan interest despite lower balances thanks to increases in benchmark rates and higher interest earned on our segregated cash portfolio as U.S. rates have moved from an average effective rate of 9 basis points last year to 218 basis points in this year's quarter. These gains were partially offset by higher interest we paid on customer credit balances as we pass through rate hikes above 50 basis points to our customers on their qualified funds. Other fees and services generated $45 million, with biggest contributors being market data fees of $19 million unchanged, and options exchange liquidity payments of $9 million, down 18% from the prior year. Risk exposure fee revenues were $5 million, down 38% in the current risk-off environment. Other income includes gains and losses on our investments, our currency diversification strategy, and principal transactions. Note that many of these non-core items are excluded in our adjusted earnings, and without these excluded items, other income was $9 million for the quarter. Turning to expenses, execution, clearing, and distribution costs rose 41% from last year, led by lower liquidity rebates, higher futures volumes, which carry higher fees, and an increase in the SEC fee rate on U.S. stocks and options. As a percent of commission revenues, execution and clearing costs, which are driven by a combination of trading volume, exchange rebates, and changing fee schedules, were 21 percent this quarter versus 18 percent in the second quarter. Note that market data expense, a pass-through item, is included in execution, clearing, and distribution fees, while the corresponding market data revenue is reported in other fees and services rather than in commissions. So, to align the volume-driven expenses with commissions, we look at pure execution and clearing costs, excluding market data expense. Compensation and benefits expense rose $14 million, or 14 percent, over the prior year, in line with hiring. While up in dollar terms for the quarter, comp and benefits expense fell to 13% of our adjusted net revenues, somewhat below its historical level. Our headcount at quarter end was 2,752. G&A expenses were down $7 million, or 16%, versus last year's third quarter on lower legal expenses from a higher than typical number last year. Our adjusted pre-tax margin was a record 68 percent. Automation remains our key means of maintaining high margins, as well as continued expense control while we hire talented people and invest in the future of our business. Income taxes of $40 million reflect the sum of the public company's $23 million and the operating company's $17 million. Moving to our balance sheet on page five of the release, Our total assets were $115 billion at the end of the quarter, with growth over the last year driven by increases in our segregated cash and securities, partially offset by a reduction in customer margin loans. We maintain a balance sheet aimed at supporting our growing business and providing ample financial resources during volatile markets. We have no long-term debt. In our operating data on pages six and seven, our contract volume for all customers were strong, about even with the strong prior year quarter in options, and the third highest ever in futures, up 37%. Stock share volume was down significantly versus last year's active third quarter, and the drop-off is largely attributable to trading in pink sheet and other very low-priced stocks. Of note, the notional dollar value of shares traded dropped less than a number of shares traded. reflecting this shift away from low-priced stocks, which tends to raise the average commission per order. On page 7, you can see that our account growth remains robust, with nearly 90,000 net account adds in the quarter, and total accounts exceeding 2 million, up 31% over the prior year. Total customer darts were 1.9 million trades per day, down 15% from the strong prior year quarter. Our cleared IBKR Pro customers paid an average of $2.96 commission per cleared commissionable order, up 20% from the last year, as our clients' volume mix included higher per-order contributions from stocks and options. Page 8 presents our net interest margin numbers. Total GAAP net interest income was $473 million for the quarter, up 73% on the year-ago quarter. reflecting stronger margin loan and segregated cash interest, partially offset by higher interest expense on customer cash balances. The Federal Reserve raised interest rates twice in the quarter, by 75 basis points in late July and by a further 75 points in late September, with about a week left in the quarter. The latter raised had a minor positive impact in a 12-week quarter, but will have a fuller positive impact in the third quarter. Many other central banks also raised rates this quarter. This group includes the UK, Canada, Australia, and Hong Kong, as well as the Eurozone and Switzerland, which are now out of negative rate territory for the first time since 2014. Margin loan interest was up 125% to $317 million, despite average margin loan balances that were down 9% from last year's third quarter. Higher rates in the U.S. and internationally continue to bode well for our margin interest income. In interest on segregated cash was $228 million, primarily due to Federal Reserve rate hikes, but also to our managing to short duration on invested funds, which has allowed us to pick up benchmark rate increases quickly. At September 30th, our U.S. portfolio duration was 42 days so the investments roll over into new higher rates with fairly short lag time. Securities lending net interest was $114 million, down 7% from the year-ago quarter. It's worth noting that while securities lending opportunities maintain a relatively strong pace, it is also the case that as benchmark rates rise, a greater portion of the revenue generated by securities lending is reflected in interest on segregated cash because the cash collateral received is invested as segregated funds. We estimate this impact to be about $24 million for the quarter versus the year-ago quarter. Interest on customer credit balances or the interest we pay our customers grew as higher rates in many currencies led to our paying interest on qualifying accounts as we passed through rate increases. We pay $248 million to our customers on these balances in the third quarter. Now for our estimates of the impact of increases in rates. Given market expectations of more rate hikes to come, we estimate the effects of increases in the Fed funds rate to produce an additional annual net interest income as follows. At 25 basis points, an increase of $55 million. at 50 basis points, an increase of $110 million. At 75 basis points, an increase of $166 million. And at 100 basis points, an increase of $221 million. Note that our starting point for these estimates is September 30th, with the Fed Fund's effective rate at 3.08% and based on balances at that date. These estimates don't take into account any change in how we may adjust our investment strategy to take advantage of newly higher rates, or any change in our assets. About 20% of our customer segregated cash is not in U.S. dollars, so estimates of U.S. rate change impact exclude those currencies. We estimate a 25 basis point increase in all the relevant non-USD benchmark rates would produce an additional annual net interest income of $14 million and rising to about $56 million at a 100 basis point rate increase. In conclusion, the company generated another solid performance in the third quarter, reflecting our continued ability to grow our customer base, deliver on our core services to customers, while continuously adding new features and products, all at a low cost, and managing the business effectively with strong expense control. And with that, we will open it up for questions.