Interactive Brokers Group, Inc.

Good day and thank you for standing by. Welcome to the Interactive Brokers Group for Q23 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, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would not like to hand the conference over to your speaker today, Nancy Stubbe. Director of Investor Relations.

Good afternoon. Happy New Year, and thank you for joining us for our fourth quarter 2023 earnings call. Thomas is on the call and 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. In 2023, we added over 470,000 net new accounts. Our client equity at year-end was up 39% to $426 billion, an increase of over $100 billion from last year. We earned over $4 billion in net revenues and over $3 billion in pre-tax income, both for the first time. Our pre-tax margin was 71% for the full year, by far the highest in the industry. In fact, very few public companies in any industry have that kind of profit margin. If market conditions continue as they are, even with the three interest rate cuts being predicted, I see no reason why we wouldn't be able to maintain pre-tax margin at the 70% level. We saw stronger markets in 2023 with the same focus on options and on the magnificent seven names that we have seen for a year now. We see options being traded actively both traditionally as a means to offset risk and a standalone zero data expiry. Regarding interest rates, we are not willing to argue with the market. If the market believes that long-term rates will be under 4%, we don't think it's our business to dispute it. However, there are several long-term trends that, in my opinion, call for higher inflation and higher rates in the long run. First is deglobalization. Over the past few decades, where goods are manufactured has been reallocated around the globe, often far from consumers as containerization reduced shipping expenses and manufacturing went where it's cheapest. Prices of some goods were driven down 50 to 90%. But now, as we have been predicting, geopolitical uncertainty has driven transportation costs up, with insurance for transport rising every day as vessels are attacked and routes become unsafe. To start producing closer to consumers, where labor is, often more expensive, means higher costs and prices. Second is demographics. For the most part, skilled labor is produced in developed countries, like the US and Europe, and to some extent in Asia. Population growth, however, is occurring in those countries where skilled labor is not produced. Birth rates and population growth have dramatically reversed in developed countries to decreasing instead of growing, meaning that skilled labor will cost more and more over time. Third are deficits. Deficits contribute to inflation, as interest payments get funded through deficit spending, which then means bigger deficits and higher interest, which gets added on to the deficit, on and on, so it is unclear to me how inflation can substantially decrease as the deficit grows. Fourth, the ever-increasing demand for spending on environmental projects will continue to become more and more expensive. Combining these factors, it is hard to see how inflation will subside over the long term. even if in the next several months it may ameliorate somewhat. These trends are inescapable, and while you may see long-term rates at 4% for now, they could go back to 5%, 6%, 7% or more as costs, deficit spending, and the national debt keep increasing. Turning to our business, our client accounts and client equity grew fastest in Europe and Asia as more and more people worldwide want to access international markets, invest in securities they feel offer the most upside, regardless of what type of security it is or where it is traded, and hold what they perceive as safer currencies. In 2023, individuals saw the fastest account growth among our five client segments and the second highest commission and net interest growth. Proprietary traders had the fastest client equity and commission growth. Introducing brokers had the highest net interest growth, followed by individuals and financial advisors, all well over 50%. While we saw growth in hedge fund accounts and significantly higher client equity, it showed a smaller increase in commission and interest activity than our proprietary traders or individuals. This is likely due to so many funds holding the same magnificent seven names, but as many of you are on the call, maybe you can expand on this. We had one of our busiest years ever of programming. During 2023, we added a wide range of features and capabilities, including those for financial advisors, and enhanced IBKR mobile, portfolio analyst, our CRM, and student training lab, plus added comprehensive new content at our Traders Academy, Quant blog, and Traders Insight. Our new Discover tool lets you see technical insights using actionable analysis and alerts, with a market buzz bubble map to identify the companies most in the news, allowing clients to go more in-depth analytics and sentiment, and has proven quite popular. For our long-short hedge fund of proprietary trading clients, we added features like a securities lending dashboard, which gives an expanded universe of securities lending data like borrower and lender depth, among other items. For financial advisors, we are significantly less expensive than competitors, To give an idea of the value add we offer to financial advisors, when an advisor buys a mutual fund for his or her clients at Interactive Brokers, we charge a maximum of $14.95 for the entire trade and nothing for allocating the mutual fund among any number of clients after the trade. In contrast, competitors charge $45 per account to allocate a trade. Our biggest issue is that FAs do not believe us when we tell them that they can save thousands of dollars each time they update their customers' portfolios. For our options traders who do not absolutely need an immediate fill, we built a facility to trade at the mid-price against our marketable order flow. Option orders and frequently traded options have a very good chance of being filled within a few minutes. A growing percentage of our options order flow gets successfully executed through this facility. This is in addition to our similar facility for equities, which we've had for some time now and which we continue to build. As we onboard more and more institutional clients, we get more and more liquidity in our ATS, especially for institutions willing to rest orders for a brief period of time. Ultimately, we believe that the most a broker can do for its customers who trade frequently is to give them the best possible execution prices. This has always been the most important consideration as we have developed our platform over the years. In 2024, we have another active year of programming projects planned, and you will see further upgrades to our platform with more features and capabilities. We are also adding new countries where our clients can trade. I will not say more to avoid tipping off our competitors. Finally, we are well aware that we have now reached $14 billion in equity on our balance sheet. We are considering possible opportunities in the space that would help us grow the business. Our public float is small, so we are unlikely to buy back shares. And personally speaking, I would hope that an opportunity presents itself, as raising the dividend is not something I think helps the company grow in the long run. There is much to look forward to. The Interactive Brokers platform is built with the purpose of bringing investors and marketplaces together to interact with each other all over the world, optimizing the allocation of capital and resources. It is our job to educate current and beginning investors, to develop the best tools and capabilities to facilitate their investing journey. We are as busy programming as we've ever been. This and our much lower cost structure is what sets us apart and will continue to do so in the years ahead. With that, I will turn the call over to Paul Brody. Paul?

Thank you, Nancy. Good afternoon, everybody, and thanks for joining the call. I'll review the fourth quarter results, and then we'll open it up for questions. Starting with our revenue items on page three of the release, we're pleased with our financial results this quarter, roughly matching the record adjusted net revenues and pre-tax income of the prior quarter. And for the full year 2023, we achieved record results in every major financial measure. Commissions rose versus last year's fourth quarter, reaching $348 million. For the full year, commissions were $1.4 billion, up 3% from 2022. In 23, we saw higher trading volumes in options and futures coming from our large base of sophisticated and active traders, investors, and advisors. Net interest income of $730 million for the quarter and a record $2.8 billion for the year reflected a risk on environment that led to steadily higher margin lending as well as higher yields on our margin loans and segregated cash portfolio. This is partially offset by the higher interest paid to our customers on their cash balances as Interactive Brokers passes through to them all rate hikes above the first 50 basis points on their qualified funds, which differentiates us in an environment where many competitors pay little to nothing to their customers. Other fees and services generated $55 million for the quarter and $197 million for the year. The increase from the prior year quarter was driven by the risk on positioning of customers, which led to a rise in risk exposure fees to $17 million, as well as higher FDIC suites fees, which rose to $6 million this quarter. Market data fees at $17 million and exchange liquidity payments of $8 million were the other factors in this category. 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. Without these excluded items, other income was $16 million for both the quarter and the full year. Turning to expenses, execution, clearing, and distribution costs were $100 million in the quarter and $386 million for the year, up versus last year primarily due to higher volumes in options and futures which carry higher fees. As a percent of commission revenues, execution and clearing costs were at 23 percent in the fourth quarter for a gross transactional profit margin of 77 percent unchanged from last quarter. We calculate this by excluding from execution and clearing $20 million of costs, predominantly market data, without a direct commission revenue component. Compensation and benefits expense was $136 million for the quarter for a ratio of compensation expense to adjusted net revenues of 12%, unchanged from last year. For the year, this ratio was also 12% down from 14% in 2022. We are always focused on expense discipline while improving our strong top line. Our headcount at year end was 2,932. G&A expenses were $45 million down from the year-ago quarter. For the full year, recall that 2023's numbers is inflated due to a previously disclosed regulatory settlement in the second quarter. Without that, full-year G&A would have been even with 2022. Our pre-tax margin was 72% for the quarter and 71% for the year. Automation and expense control, along with thoughtful management of our balance sheet, remain our key means of maintaining high margins while we invest in the future of our business. Income taxes of $77 million reflects the sum of the public company's $45 million and the operating company's $32 million. The public company's taxes included a decrease in the deferred tax asset, which reflects an annual remeasurement of future tax benefits. Together with some other items, These had an $8 million impact on income taxes. In removing these one-time non-cash items, the public company's adjusted effective tax rate was 17.9% within its usual range. For the year, taxes of $257 million are the sum of the public company's $142 million and the operating company's $115 million. Moving to our balance sheet on page five of the release, Our total assets end of the year 12% higher at $128 billion, with growth driven by higher customer cash and margin loan balances from both new and existing customers. We maintain a balance sheet geared towards supporting our growing business and providing sufficient financial resources during volatile markets. We have no long-term debt. Our ample capital base is deployed primarily in running our current business, and our liquidity positions us to support our customers during periods of high market stress. It also helps us win new business by showing the strength and depth of our balance sheet to current and prospective clients and partners. In our operating data on pages six and seven, our contract volumes in options for all customers rose 21% over the prior year quarter, well above industry growth. Futures contract volumes rose 4%, while stock share volume declined for us as it did across the industry. For the full year, options and futures contract volumes rose 12% and 1% respectively. The decrease in stock share volume is largely attributable to lower trading in pink sheet and other very low-priced stocks. Notional value of brokerage shares traded, however, was up in most markets, particularly in the U.S., as clients gravitated to larger, higher-quality names. On page 7, you can see the total customer darts were 1.9 million trades per day, up 2% from the prior year and reflecting a more risk-on period for investors. Commission per cleared commissionable order of $3.19 was up slightly from last year, driven by increases in futures volume and average trade size. Options contributed higher volume, but a lower average trade size, and stock trade volume and average trade size both declined. Page 8 shows our net interest margin numbers. Total GAAP net interest income was $730 million for the quarter, up 29%, and $2.8 billion for the year, up 68%. Our net interest margin net interest income, as displayed in our NIM, was $9 million higher, worth $739 million. as we include income here that, for GAAP purposes, is classified as other fees or other income, but that we feel is more appropriately considered interest. These results reflect strength in margin loan and segregated cash interest partially offset by higher interest expense on customer cash balances. Most central banks around the world, including the Federal Reserve, held interest rates steady this quarter, with only Australia increasing its benchmark rate slightly. The Federal Reserve raised interest rates four times over the year, raising the average U.S. Fed funds rate for the fourth quarter to 5.33% from 3.65% in the prior year. Our segregated cash interest income rose 67% on a 4% increase in average balances, while margin loan interest rose by 50% on a 9% increase in average balances. The average duration of our portfolio remained at under 30 days. With the U.S. dollar yield curve inverting further over the fourth quarter, we have been maximizing what we earn by capturing higher short-term yields rather than accept the significantly lower yields of longer maturities. In this rate environment, this strategy allows us to maintain a relatively tight maturity match with the rate we pay our customers. Securities lending net interest has not been as strong as in prior quarters for two main reasons. First, overall customer demand for shorting stocks has fallen. There are fewer hard-to-borrow names industry-wide which, with the market's low volatility, are the drivers of securities lending. Second, as we have noted on previous calls, higher average interest rates versus prior periods means more of what we earn from securities lending is classified as interest on segregated cash. To more accurately compare our securities lending revenue with the year-ago quarter, we estimate that if the interest earned on this cash collateral fell under securities borrowed and loaned, it would have been $18 million higher, or $61 million. Interest on customer credit balances, the interest we pay to our customers on the cash in their account, rose on both higher rates than nearly all currencies and higher balances from new account growth. As we've noted many times in the past, the high interest rates we pay on customer cash, currently 4.83% on qualified U.S. dollar balances, is a significant driver of new customers. Fully rate-sensitive balances were about $18 billion this quarter. Now for our estimates of the impact of changes in rates. Given market expectations of rate cuts in 2024, we estimate the effect of such changes in the Fed Fund's rate to be a $56 million reduction in annual net interest income for each 25 basis point decrease in the benchmark. Note that our starting point for these estimates is year end. The Fed Fund's effective rate is 5.33% and average balance is as of December 31st. Any growth in our balance sheet and interest earning assets would reduce this impact. About 25% of our customer cash balances is not in US dollars. so estimates of a U.S. rate change exclude those currencies. We estimate the effect of decreases in all the relevant non-U.S. dollar benchmark rates would further reduce annual net interest income by $18 to $20 million for each 25 basis point decrease in those benchmarks. In conclusion, we had a financially strong quarter to close out a record year in net revenues and pre-tax margin. reflecting our continued ability to grow our customer base and deliver on our core value proposition to customers while scaling the business. This highlights the attractiveness of our strategy, automating as much of the brokerage business as possible, and expanding what we offer while minimizing what we charge. And with that, we'd like to open it up for questions.