Interactive Brokers Group, Inc.

Good day, and thank you for standing by. Welcome to the Interactive Brokers Group Third Quarter 2023 Earnings Conference 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. You will then hear an automated message advising your hand is raised. To ask a question, please press star 1-1 again. I would like to advise that today's conference call is being recorded. I would now like to turn the conference over to your speaker for today, Nancy Stubbe. Please go ahead.

Thank you. Good afternoon, and thank you for joining us for our third 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. Our account growth remained strong at 21%, while our client equity was up 29%. Net interest income reached a record, as did our total adjusted net revenues, which were over $1 billion for the third consecutive quarter. On the other hand, markets were down in nearly every country in the quarter, and trading volumes dropped. Low market volatility, customers moving to higher-priced stocks of companies with greater capitalization and overwhelming competitive strengths, and a geopolitical environment that is increasingly uncertain all led to lower darts. This meant that while we were able to increase our commission revenue slightly, reaching its fourth-highest level in our history, it is still the case that investors are holding on to the same seven equities and not trading others actively. However, options volumes continue to be strong, and option commissions were up the most this quarter. Then came futures, while stock commission revenue dropped. As I've said previously, I do not expect this situation to reverse. There are several competing cross-currents in the markets. If you are a long-term investor, I'm looking 10 years out, what you want most is stability and not to lose a lot of money. You want to put your assets in a politically, currency, and inflation-wise stable place. While historically that has been the U.S., the U.S. will look less stable politically as the election approaches, and inflation will look worse because of wage increases and union issues, as well as the increasing cost of carrying U.S. government debt. As apparent U.S. political stability weakens, people are less likely to invest in equities. On the other hand, there is the tax liability for U.S. taxpayers on substantially appreciated stock prices. should that gain be realized. This background explains what we have been seeing lately in the markets. Our customers' top stock holdings, the Magnificent Seven, haven't changed much, but corresponding options activity has increased. In addition, we are seeing more and more investors getting into U.S. Treasuries. Generally, activity on our government and corporate bond platform has picked up appreciably. We do not see inflation coming down substantially, and still see interest rates staying at elevated levels for a long time, which will in turn increase spending to pay the interest on this debt, adding to inflationary pressures. It remains the case that investors globally are looking to the markets to stay ahead of inflation and uncertainty. More people want to invest in securities markets, hold their choice of currency in their accounts, and gain exposure to different countries, particularly the U.S., as a way to build wealth and security. We continue to advertise and closely watch which outlets work the best for us. We have built an automated advertising system where we measure the yield and use an algorithm to adjust spending on each channel where we advertise. Telling everyone about our 4.83% return on immediately available qualified cash may have prevented withdrawals, but it barely helped to increase customer cash, which grew only by a little more than 2% from the prior year. In terms of our client segments, our strongest ones for account growth have been individuals and proprietary traders, which have also shown the strongest growth in 12-month commission revenue, while financial advisors, individuals, and introducing brokers have seen the strongest growth in net interest income. Geographically, Europe has seen the fastest account growth, followed by Asia, then the Americas. I would like to talk about our introducing broker segments. I spoke of two large accounts coming. I regret that now because the timing of these accounts is out of our control, and with the larger of the two, it is difficult to put an exact time on it. But we have so much else going on that I feel it is a disservice to focus only on when, when, when for this one client when we have so many other promising items lined up. First, the smaller of the two iBrokers successfully began onboarding their approximately 52,000 accounts. So far, more than half of them are with us, and we expect the bulk of the rest by the end of the year. Next, a couple of other introducing brokers are joining us. All this is to say, when that other iBroker starts to onboard, I will let you know. Until then, I cannot put a date on it. I have been wrong on the date for a while now, so it is unclear to me why you would want me to keep giving one. But unfortunately, it is not only the date I have been wrong on. I have also mis-estimated the size of these operations. They now both appear to be smaller than I originally expected, and accordingly, I need to reduce my estimate of long-term account growth from 30% to the low 20% area. On the hedge fund side, the most recent Preckin statistics show us moving into the number five position in terms of number of hedge funds for which we serve as prime broker. We were once again the fastest growing of the top prime brokers this year. We plan to be number four next year, behind only Goldman Sachs, Morgan Stanley, and JP Morgan. Our developers have been extremely busy with new products and tools and have a full plate for the remainder of the year. This quarter, we introduced fractional shares trading for Canadian stocks and ETFs, launched a securities lending dashboard for our more sophisticated clients to be able to assess short selling activity for specific securities and inform their decision making, introduced the next generation IBKR desktop trading platform, launched the Discover tool to help clients find opportunities based on their own customized settings and trading preferences, started our Sense of Security podcast designed to help improve financial literacy for newer investors, and introduced long-term investment accounts in Hungary. We remain very optimistic about what our business model, international market access, a strong and secure balance sheet, and multiple features and tools, all at low prices with high interest paid on cash balances, offers to clients and potential clients around the world. In an increasingly uncertain world, the greater degrees of freedom our clients have to manage their portfolios as they wish, the better their ability to educate themselves as events change and economies increasingly fluctuate and diverge, the better off they will be. 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. Welcome, everyone, to the call as usual, starting with our revenue items on page 3 of the release. We followed on our strong first and second quarter performances with net revenues reaching over $1.1 billion. With ongoing customer account and balance sheet growth, we continue to build a strong base for revenue growth in the future. Commissions were $333 million, up 4% from the year-ago quarter, despite industry-wide declines in equities volume. Our options volumes, in particular, came in at a quarterly high, doubling the pace of industry volume growth. Stock share volumes declined from last year's quarter, once again driven by a drop in trading of lower-priced stocks, but also reflective of lower industry volumes. Net interest income was a quarterly record $733 million, reflecting higher interest and margin loans than segregated cash. 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 $52 million, with the biggest contributors being market data fee revenue of $17 million, risk exposure fee revenue of $13 million, and options exchange liquidity payments of $8 million. The $8 million overall increase in risk exposure fees from the prior year quarter was driven by more risk on positioning of customers. Other income was $27 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 $20 million for the quarter. Turning to expenses, execution, clearing, and distribution costs rose 14% versus last year, led by higher volumes and options, which carry higher fees than equities. We measure the profitability of our commissions by looking at gross transactional profit, which is commission revenue less execution and clearing costs. This measure excludes market data expense, which is a pass-through. In the third quarter, execution and clearing costs were 23% of commission revenue for a gross transactional profit margin of 77%. Compensation and benefits expense rose 14% over the prior year quarter on a combination of a 5% increase in average headcount and also on inflation. Compensation and benefits expense was 11% of our adjusted net revenues versus 13% last year and below its historical level. Our headcount at quarter end was 2,927. G&A expenses returned to a more typical level this quarter after we recorded a reserve in the second quarter for regulatory matters, which have since been settled. Versus the prior year quarter, increases were related to advertising and legal expenses, partially offset by a reduction in consulting fees. Our adjusted pre-tax margin was 73 percent, up from 68 percent in the year-ago quarter. Income tax expense of $68 million reflects the sum of the public company's $36 million and the operating company's $32 million. Moving to our balance sheet on page five of the release, our total assets were $121 billion at the end of the quarter. with growth over last year driven primarily by increases in our margin lending and securities lending businesses. We maintain a balance sheet aimed at supporting our growing businesses and providing ample financial resources during volatile markets with maximum flexibility and short-term liquidity. We have no long-term debt, and the duration of our U.S. investment portfolio at September 30th was 26 days. In our operating data on pages six and seven, our contract volumes for all customers were strong, with options reaching their highest quarterly level, up 18% from a year ago. Futures contract volumes were down slightly, in line with industry volumes. And in stocks, the drop off of 22% was largely attributable to investors moving to higher quality stocks, as trading in pink sheet and other very low priced stocks declined the most. On page seven, you can see that our account growth remains robust with over 140,000 net account ads in the quarter and total accounts at 2.4 million of 21% over the prior year. Total customer darts were 1.9 million trades per day, down slightly from the prior year quarter. Our cleared IBKR Pro customers paid an average of $3.11 commission per cleared commissionable order. up 5% from last year, as our clients' volume mix included higher per-order contributions from options and futures. Page 8 presents our net interest margin numbers. Total GAAP net interest income rose 55% to $733 million from the year-ago quarter, reflecting stronger earnings on segregated cash and margin loans, partially offset by higher interest expense on customer cash balances. With one more 25 basis point hike in the latest quarter, the average federal funds rate was over 300 basis points higher this year than last. Many other central banks also raised this quarter. This group includes the UK, Canada, Hong Kong, and the Eurozone. Net interest earned on segregated cash was $728 million, up $500 million from last year, primarily from global rate hikes. Maintaining a short duration on our invested funds continues to allow us to closely match asset and liability maturities and pick up benchmark rate increases quickly. As I said, at September 30th, our US portfolio duration was 26 days, so the investments have rolled over into new higher rates with a fairly short lag time. A 5% increase over the year-ago quarter in average segregated cash and securities balances also helped drive interest income higher. Margin loan interest rose $623 million, nearly doubling the prior year quarter, despite average margin loan balances rising only slightly. Higher rates in the U.S. and internationally have driven higher margin interest income. Securities lending net interest was $66 million, down from the year-ago quarter, due both to lighter overall demand for so-called hard-to-borrow stocks and to a rate dynamic we have noticed previously. Namely, as benchmark rates rise, a greater portion of the revenue generated by lending securities for which we receive cash collateral that we invest as segregated funds is categorized as interest on segregated cash. We estimate this impact to be about $28 million for the quarter versus last year. In other words, without this shift in reporting line item, Net interest from securities lending would have been $94 million versus $114 million in 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 and qualifying balances as we passed through rate increases. We paid $832 million to our customers on their balances in the third quarter. Fully rate sensitive balances were up about 5% from the second quarter at $21 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, increases and decreases, given market expectations of near-term rate hikes and further out rate reductions, we estimate the effects of both increases and decreases in the Fed funds rate on our net interest income. We estimate increases in the Fed funds rate to produce additional annual net interest income of approximately $56 million for each 25 basis point increase in the benchmark. Symmetrically, decreases in the Fed funds rate should reduce annual net interest income by approximately $56 million for each 25 basis point decrease in the benchmark. Note that our starting point for these estimates is September 30th with the Fed funds effective rate at 5.33% and 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 effects exclude those currencies. We estimate increases in all the relevant non-USD benchmark rates to produce additional annual net interest income of approximately $20 million for each 25 basis point increase in the benchmarks. In conclusion, the company performed well in the third quarter. in a complex and uncertain environment, reflecting our continued ability to grow our customer base and deliver our core services to customers at low costs and competitive interest rates as we manage the business effectively with strong controls over risk and operating expenses. And with that, we'll turn it over to our moderator and happy to take questions.