Interactive Brokers Group, Inc.

Good day, and thank you for standing by. Welcome to the Interactive Brokers Group Quarter 2 23 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker's 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 keypad. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1 1 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Nancy Stubbe. Please go ahead.

Thank you. Good afternoon, and thank you for joining us for our second quarter 2023 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 Gallick, 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. our robust operating metrics once again translated into strong financial results this quarter. In fact, but for a substantial addition to reserves for legal contingencies, we would have posted record adjusted pre-tax income. Our account growth remained strong at 19%, while our client equity was up 24%. Margin loans have increased over the course of 2023, as investors are feeling more confident in the markets after a down year in 2022. Our net interest income reached a record, as did our total adjusted net revenues, which were over $1 billion this quarter. On the other hand, trading volumes dropped this quarter, and with that, dropped our commissions by 10% from the first quarter. Lower commissions prevailed across the board. Option commissions decreased the least, then came futures, and stock commissions dropped the most. I do not expect the situation to reverse. Our clients are most heavily weighted in the Magnificent Seven, where they luckily have huge unrealized gains that they are not likely to want to realize. As a result, I expect a lot of calls to be written in the coming quarters in these stocks. When the stocks rise further, the calls will be repurchased, and when they fall, they will lapse. In this way, our option commissions will benefit, and our stock commissions will continue to suffer. Investors voted to put their money into big tech stocks, rather than keeping it at banks at near-zero returns. As usual, we do not know how well our advertising worked. Telling everyone about our 4.58% return on immediately available qualified cash may have prevented more and larger withdrawals, but it barely helped to increase customer cash, which grew only by a little more than 2% over the first quarter. As I have mentioned before, I still believe inflation is going to stay with us, And while there may be a pause in rate hikes, this is not a short-term state of affairs that will soon result in rate cuts. The debt has increased by a trillion dollars since Congress raised the debt limit. Interest on U.S. debt cost over $650 billion over just the past nine months. Annualized, this comes close to a trillion dollars a year. This increased spending will drive inflation, which will lead to higher rates, which will in turn increase spending, and so on. In terms of our client segments, our strongest ones for account growth have been individuals, proprietary traders, and hedge funds. These have also shown the strongest growth in 12-month commissions revenue, while individuals, prop traders, and financial advisors have been the strongest drivers of net interest income. We are still looking to onboard the first of the two large introducing broker accounts this year, hopefully in the third quarter. It will start slowly, and we hope to see it completed within a few months of its start. Our dates are slipping with respect to the second large introducing broker, but we are still hoping to begin onboarding them before year end. Our developers have been extremely busy with new products and tools and have a full plate for the remainder of the year. One area we have focused on is delivering specific tools to specific customer types. For financial advisors, we introduced customized indexing, making it easy to build stock portfolios modeled on ETFs that are customizable for tax efficiency and investment goals. Customized indexing clients will own fractional shares of each component stock, so the advisor can adjust weighting, capitalize on gains or losses for tax purposes, or exclude specific stocks or sectors, personalizing as their clients need. We also introduced a tax harvesting tool, a streamlined CRM, and now offer our RIAs research from ISI Evercore. We do not require minimums, we have no ticket charges, and charge no custodial, technology, software, platform, or reporting fees. For individuals and introducing broker clients, we expanded overnight trading in U.S. stocks and ETFs and now have over 10,000 names available. This has been particularly attractive for our clients in those time zones where investing during regular U.S. trading hours is difficult. For our more sophisticated clients and funds, we introduced our securities lending dashboard, which allows them to access the same expanded securities lending data and key metrics for U.S. equities that historically were only available to banks, broker dealers, and large institutional investors. Internationally, we added the Taiwan Stock Exchange, NASDAQ Copenhagen, and the Prague Stock Exchange to our platform, while fractional share trading will soon be available for Canadian stocks and ETFs. We remain committed to having the most informed clients, wherever they are in their investing journey. Our IBKR campus educational website has the courses, webinars, podcasts, and market commentaries to assist our clients in learning more about trading, the economy, and financial markets, from the most basic educational fundamentals to sophisticated strategies and market commentary. They can learn more about interactive brokers' trading tools and how to use them. Our Learn and Earn program lets clients who are new to a particular securities product earn commission credits for each bundle of courses they complete. We remain very optimistic about what our business model, international market access, strong and secure balance sheet, multiple features and tools at low prices and high interest paid on cash balances, offers to clients and potential clients around the world. We are extremely disappointed that we did not achieve a new record in the second quarter, and we were determined to redouble our efforts and get there in the third. 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 start with our revenue items on page three of the release. We followed on our strong first quarter performance, recording net revenues of $1 billion in the current quarter. With ongoing customer account and balance sheet growth, we continue to build a strong base for both commission and interest revenues in the future. Commissions were $322 million, level with the year-ago quarter, despite industry-wide declines in volumes for futures and especially for equities. Our futures and options volumes came in at in near their quarterly highs, while stock share volumes declined from last year's quarter, once again driven by a drop in trading of lower-priced stocks. Net interest income was a quarterly record $694 million, reflecting higher interest on margin loans and segregated cash from both increases in benchmark rates and larger segregated cash portfolios. U.S. benchmark rates have moved from an average effective rate of 77 basis points in the second quarter of last year to 499 basis points this quarter. These gains were partially offset by the higher interest we paid on customer credit balances, as our longstanding policy is to pass through rate hikes above 50 basis points to our customers on their qualified funds. Other fees and services generated $47 million. with the biggest contributors being market data fees of $18 million, risk exposure fee revenue of $10 million, and options exchange liquidity payments of $7 million. The increase in risk exposure fees from the prior year quarter was driven by more risk on positioning of customers, which led to a $4 million rise in these fees. Other income was a loss of $63 million and 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 a $1 million gain for the quarter. Turning to expenses, execution, clearing, and distribution costs rose 21% versus last year, led by higher volumes and options, which carry higher fees, the non-recurrence of last year's $3 million OCC clearing fee rebate, and a $1 million increase in market data fees, as well as lower liquidity rebates. We find it useful to measure what we call gross transactional profit, which is commissions less execution and clearing costs directly related to trading, which excludes primarily market data distribution fees. 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 at 22% this quarter for a gross transactional profit margin of 78%. Market data expense, a pass-through item, is included in execution, clearing, and distribution fees line item, while the corresponding market data revenue is reported in other fees and services rather than in commissions. For this purpose, in the second quarter, we exclude $15 million in market data expense. Compensation and benefits expense rose 21% over the prior year quarter on a combination of staffing increases and inflation. While up in dollar terms for the quarter, comp and benefits expense remained at 13% of our adjusted net revenues versus 16% last year and somewhat below its historical level. Our headcount at quarter end was 2,908. G&A expenses roughly doubled versus last year's second quarter, largely attributable to a substantial increase in reserves related to the previously disclosed regulatory investigation into the use of unapproved electronic messaging and the firm's recordkeeping requirements. Without that increase, G&A expenses would be down slightly year on year. Our adjusted pre-tax margin was 67%, up from 63% in the year-ago quarter. While higher interest rates benefit us, automation remains our key means of maintaining consistently high margins. Income tax expense of $51 million reflects the sum of the public company's $30 million and the operating company's $21 million. Moving to our balance sheet on page five of our release, Our total assets were $121 billion at the end of the quarter, with growth over last year driven primarily by increases in our segregated cash and securities. We maintain a balance sheet aimed at supporting our growing business and providing ample financial resources during volatile markets, with maximum flexibility and short-term liquidity. We have no long-term debt. The duration of our investment portfolio as of June 30th was 40 days. Turning to our operating data on pages 6 and 7, our contract volumes for all customers were strong, reaching their fourth highest quarterly level in options, up 9% over the year-ago quarter. Futures contract and stock share volumes were down 3% and 28% respectively. Options and futures volumes were generally in line with industry volumes. And in stocks, the drop-off was largely attributable to investors moving to higher quality stocks as trading in Pink Sheet and other very low-priced stocks was impacted most. On page seven, you can see that our account growth remains robust with over 95,000 net account ads in the quarter and total accounts at 2.3 million, up 19% over the prior year. Total customer darts. were 1.9 million trades per day, down 14% from the stronger prior year quarter. Our cleared IBKR Pro customers paid an average of $3.11 commission per cleared commissionable order, up 14% from last year as our clients' volume mix included higher per order contributions from nearly all product categories, particularly from options and futures. Page 8 presents our net interest margin numbers. Total GAAP net interest income nearly doubled to $694 million on the year-ago quarter, reflecting stronger earnings on segregated cash and margin loans partially offset by higher interest expense on customer cash balances. After a series of seven target rate increases in 2022, the Federal Reserve has raised interest rates by 25 basis points three times this year. and many other central banks also raised this quarter. This group includes the UK, Canada, Australia, and Hong Kong, as well as the Eurozone and Switzerland. Net interest on segregated cash was $700 million, primarily due to Federal Reserve rate hikes, but also to our managing to short duration on invested funds, which has allowed us to more closely match asset and liability maturities and to pick up benchmark rate increases quickly. At June 30th, our US portfolio duration was 40 days, so the investments have rolled over into new higher rates with a fairly short lag time. A 21% increase over the year-ago quarter in average segregated cash and securities balances also drove interest income higher. Margin loan interest rose to $547 million, up significantly from $197 million last year. despite average margin loan balances declining 11% from last year's second quarter. Higher rates in the U.S. and internationally have driven higher margin interest income. Securities lending net interest was $79 million, down from the year-ago quarter due to a dynamic we have noted previously. While securities lending opportunities maintained a relatively strong pace, it's also the case that as benchmark rates rise, a greater portion of the revenue generated by securities lending for which we receive cash collateral that we invest as segregated funds is reflected as interest on segregated cash. We estimate this impact to be about $40 million for the quarter versus last year. In other words, without this shift in reporting line items, net interest from securities lending would be $119 million, up 3% from 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 balances as we passed through rate increases. We paid $774 million to our customers on their balances in the second quarter. Fully rate sensitive balances were roughly unchanged at about $20 billion. We consider our policy offering clients a full pass-through of all rate hikes after the first 50 basis points on their qualified cash, a significant component in our success and one that continues to set us apart. We believe this leads to clients choosing to keep their cash with us, especially active clients who do not want to use sweep programs that prevent them from immediately accessing their cash to invest. Now, for our estimates of the impact of increases in rates, given market expectations of possibly one or more rate hikes to come, we estimate the effects of increases in the Fed funds rate to produce an additional annual net interest income of approximately $49 million for each 25 basis points increase in the benchmark. Note that our starting point for these estimates is June 30th, with the Fed funds effective rate at 5.08%. and also based on balances at that date. About 25% of our customer cash balances is not in U.S. dollars, so estimates of U.S. rate change, in fact, exclude these currencies. We estimate increases in all the relevant non-USD benchmark rates to produce additional annual net interest income of $26 million for each 25 basis point increase in the benchmarks. In conclusion, the company performed well in the second quarter in a complex and uncertain environment, reflecting our continued ability to grow our customer base and deliver on our core services to customers, all at a low cost and while offering meaningful cash interest as we manage the business effectively with strong controls over risk and operating expenses. And with that, we'll turn it over to the moderator, and we will take questions.