Interactive Brokers Group, Inc.

Hello, and thank you for standing by. Welcome to Interactive Brokers Group second quarter 2024 earnings call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask the question during this session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. I would now like to turn the call over to Nancy Stubbe. You may begin.

Thank you. Good afternoon, and thank you for joining us for our second quarter 2024 earnings call. Joining us today are Thomas Pederphy, our founder and chairman, Milan Galic, our president and CEO, and Paul Brody, our CFO. I will be presenting Milan's comments on the business, and all three will be available on 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. This quarter, world markets began to move in divergent ways as stock markets, central banks, and geopolitical cross-currents played out. The S&P 500 rose this quarter, while other previously strong markets, such as Europe, Canada, Japan, China, and Australia, all declined after positive first quarter market results. Further differences were seen on the central bank front, as the U.S. Federal Reserve chose to maintain benchmark rates this quarter, while in other developed countries, like Canada, Europe and Switzerland, central banks started to cut rates, beginning with 25 basis points. One ongoing fact that has not changed, however, is the popularity of investing, with global interest from investors who increasingly want broad portfolios and international access. The secular global investment trend remains that investors allocate some of their portfolio to securities in their home markets, but a more significant portion to overseas securities, particularly in the U.S. Product-wise, industry options contract volumes were ahead of last year, though down against a blistering industry record first quarter. Similar to options, CME futures volumes, though up 14% versus last year, were down 2% in the quarter for the industry, primarily on investors trading less actively using interest rate futures on the direction of interest rates than they had in the first quarter. On the equities front, U.S. industry volumes, though up versus last year, were down a fraction of a percent in the quarter. In equities, the Magnificent Seven once again were the main drivers of U.S. market performance, contributing nearly all of the S&P's gains this quarter, and with just two stocks, Nvidia and Apple, responsible for three-quarters of that. As in prior recent quarters, We see investors holding onto their positions and not looking to make changes like selling them and buying new names. Industry equities volumes were flat to down again as a result. Against this backdrop, all our volumes are up for both the quarter and the year as our clients remained active in all product categories. The continuing trend towards global investing across countries and product type by all kinds of clients continues to show up in our numbers. We saw strong account growth as we added more investors to our platform, both institutional and individual, across all geographies. We added 178,000 new accounts this quarter, behind only the mean stock days of the first quarter of 2021 and the first quarter of this year. New accounts meant more cash in those accounts, which helped raise our client credit balances to a record $107.1 billion, even as our volumes show that our clients put their money to work in the markets. Our client equity was up 36% over last year to $497 billion, which was just shy of half a trillion dollars in total client assets, a figure we ended up exceeding this month. Rising equity markets and the anticipation of lower rates have led clients to feel more comfortable with taking on risk, so they took on more assertive positions, which increased our exposure fee revenue, and took on more leverage to bolster their positions, increasing both our margin loans which reached a record $55 billion this quarter, and our margin interest income, all of which translated into strong financial results. Commission revenue was second only to the meme stock spike of the first quarter of 2021, and net interest income reached a record, as did total net revenues. We maintained our focus on expenses, meaning our pre-tax income also reached a record, and our reported pre-tax profit margin reached an industry-leading 72%, with adjusted pre-tax margin of 73%. In terms of how the business looked on the client front, our accounts and client equity once again grew fastest in Europe and Asia, similar to what I mentioned earlier, growing numbers of investors worldwide, wanting access to international and particularly U.S. markets. Of our five client segments, the fastest account growth was seen with individuals, with introducing brokers and proprietary traders not far behind. On the client equity side, financial advisors once again grew the fastest, followed by iBrokers and individuals. Commission growth was fastest for our proprietary traders, while net interest income growth was led by hedge funds, followed by introducing brokers and individuals. Speaking of introducing brokers, our pipeline of potential clients remains healthy. We were pleased that HSBC publicly announced their HSBC World Trader Offering, powered by Interactive Brokers, in June. There are several other opportunities, about a couple dozen of them, at various stages. Some are in the testing stage. Others have started onboarding so-called friends and family accounts, where they test the waters and make sure that everything is working, while others are in the prospect stage to figure out the optimal way for them to interface with us. As we mentioned and as bears repeating, This can take time since we offer a variety of ways for an introducing broker to come onto our platform, some quicker than others, and all dependent on what the broker wants. So while we expect growth to continue in this area, predicting the timing of it is not something we can do. In terms of new product introductions, we had a busy quarter. We strengthened our ATS by adding new liquidity providers and order types. Each quarter we are executing more trades on our ATS, connecting our client orders with liquidity providers and helping them save on execution costs. IBKR Trader Workstation remains our premier product for professional clients, yet we understand that different client types have different needs. We see that many financial advisors find their needs met by a more streamlined, targeted web platform. The IBKR Financial Advisor Portal has been enhanced with a new portfolio summary screen and a specialized order allocation tool. Further, our portfolio analyst online performance analysis tool added a retirement planner for FAs as well as for individuals and introducing brokers to better serve our clients' long-term plans. We added several trading venues, including Korean derivatives trading on Eurex, CBOE European derivatives, and overnight trading in U.S. corporate and government bonds. We launched securities lending for Swedish stocks, made our crypto offering available in the U.K., and launched recurring investment in Canada. We also introduced conditional orders on our mobile platform, a much requested feature that can be set to initiate or cancel an order based on a variety of triggers. AutoFX is now the default setting for clients with cash accounts wishing to trade securities in a currency different from their accounts. With AutoFX, clients can place an order for a security without manually performing a foreign currency conversion. we handle the FX transaction automatically. Although we are not the only broker offering this feature, IBKR's implementation offers significant advantages for cost-conscious and active traders. First, we only charge three basis points compared to up to a full percent by our competitors. And second, we charge only if a trade that a client makes results in a negative currency balance. This means that clients who trade multiple times daily can significantly reduce their costs because IBKR does not charge FX conversion on every trade, while other brokers do. Our high-touch prime brokerage service, which we announced last quarter, has also gotten off to a good start. Clients benefiting from this service have commented that they have an easier time interfacing with us and appreciate having their own point person and specialized attention to their particular issues. As one of our new high-touch clients said, this service makes the decision to disregard pitches from other prime brokers easier we are considering other improvements to make our prime brokerage offering even more compelling i look forward to continuing the work on the many projects we have lined up much is planned for the rest of 2024 and beyond which we are eager to develop test and introduce we have a healthy pipeline of new business and new initiatives and are eager to share these with you as they come to fruition with that i will turn the call over to paul brody paul

Thank you, Nancy, and welcome everyone to the call. Thanks for joining. Starting with our revenue items on page three of the release, we're pleased with our financial results this quarter as we again produced record net revenues and pre-tax income. Commissions rose versus last year's second quarter, reaching $406 million, second only to that of the pandemic-era first quarter of 2021. This quarter, we saw higher trading volumes from our growing base of active customers with options setting a new quarterly volume record and futures reaching their second highest volumes ever. Then interest income also reached a quarterly record at $792 million, despite only modestly higher benchmark rates in most major currencies and a recent taste of rate cuts in a few others. A more pronounced risk on environment in the quarter led to a significant increase in margin borrowing and higher yields on our margin loans and segregated cash portfolio on a year-over-year basis provided tailwinds to these results. These increases were partially offset by the higher interest paid to our customers on their cash balances. Interactive Brokers passes through to them all rate hikes above the first 50 basis points on their qualified funds, which makes us attractive compared to other brokers and banks and competitive with money market funds. Other fees and services generated $68 million, up 45% from the prior year, driven by the risk on positioning of customers in the quarter. As we report in the financial highlights on page one of our earnings release, the primary factor was an increase in risk exposure fees with contributions from payments for order flow from exchange mandated programs and FDIC sweep fees as well. 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, our other income was a $24 million gain for the quarter. Turning to expenses, Execution, clearing, and distribution costs were $115 million and a quarter, up 24% over the year-ago quarter, predominantly from a $9 million increase in the SEC regulatory fee rate that began on May 22nd, and on higher volumes in options and futures, which carry higher fees. The SEC fee is a pass-through to customers, so it does not impact our profitability. as a percent of commission revenues, execution, and clearing costs were 23% in the second quarter for a gross transactional profit margin of 77%. We calculate this by excluding from execution, clearing, and distribution $20 million of non-transaction-based costs, predominantly market data fees, which do not have a direct commission revenue component. The compensation and benefits expense was $146 million for the quarter for a ratio of compensation expense to adjusted net revenues of 11%, down from 13% in last year's quarter. We remain focused on expense discipline as reflected in our slowing the staff increase to 1% over the prior year. The year-over-year increase included a decrease in compliance staff as we went into full operational mode with our in-house developed compliance system, offset by increases in client-facing and software development roles. Our headcount at June 30th was 2,951. G&A expenses were $52 million, down from the year-ago quarter. Without last year's unusual legal reserve G&A was up 33% or $13 million, primarily on higher advertising and partly on legal expenses. Our pre-tax margin was 72% for the quarter as reported and 73% as adjusted. Income taxes of $71 million reflect the sum of the public company's $36 million and the operating company's $35 million. Public companies adjusted effective tax rates was 16.5%, slightly below its usual range. Moving to our balance sheet on page five of the release, our total assets ended the quarter 13% higher than the prior year quarter end at $137 billion, with growth driven by margin lending to both new and existing customers. New account growth also helped drive our record customer credit balances, and we believe that our strong financial standing and competitive interest rates provide customers with an attractive place to hold their idle cash. We continue to have no long-term debt. Healthy profitability drove our 20% increase in firm equity over the prior year. We maintain a balance sheet geared towards supporting growth in our existing business and helping us win new business by demonstrating our strength to prospective clients and partners. In our operating data on pages six and seven, our customer contract volumes in options rose 35% over the prior year quarter, well above industry growth, and reached a new record high for IBKR. Futures contract volumes rose by 10%, reflecting our second highest volume ever, and stock share volumes rose by 26% as they did across the industry. Stock share volume generally increased in tandem with clients gravitating to larger, higher quality names, with relatively lower trading in Pink Sheet and other very low priced stocks in our largest markets. On page seven, you can see that total customer darts were 2.4 million trades per day, up 28% from the prior year, and especially strong in options, followed by stocks and futures. Commission per cleared commissionable order of $3.01 was down from last year due to a mix of smaller average order sizes in stocks and futures and lower average commission per contract in options. Volume and aggregate commissions were higher in all product classes, but the specific contracts traded by our customers have different size and commission characteristics. Page 8 shows our net interest margin numbers. Total GAAP net interest income was $792 million for the quarter, up 14% on the prior year, while our net interest margin net interest income was $805 million, or $13 million higher. In the NIM computation, we include some income that for GAAP purposes is classified as other fees or other income, but we believe is more appropriately considered interest. Our net interest income reflects strength in margin loan and segregated cash interest, partially offset by higher interest expense on customer cash balances. Only recently, a few central banks made 25 basis point cuts to their benchmark rates, including Europe and Canada. Switzerland cut its rates both this quarter and last. Others, including the Federal Reserve, had held interest rates steady. Reflecting a modest rise in benchmark rates over the year, our segregated cash interest income rose 6% despite a 2% decrease in average balances, while margin loan interest rose by 38% on a 31% increase in average balances. The average duration of our US Treasury portfolio remained at about 30 days. With the US dollar yield curve continuing to be inverted, we have been maximizing what we earn by focusing on higher short-term yields rather than except the significantly lower yields of longer maturities. This strategy allows us to maintain a relatively tight maturity match between our assets and liabilities. Securities lending net interest has not been as strong as in prior quarters for three main reasons. First, throughout the industry, overall demand for shorting stocks has fallen. An extremely strong stock market up in the US, well over 20% in the past year, means fewer people are looking to put on shorts when the overall market trend is so soundly upward. Second, there are fewer hard-to-borrow names industry-wide, not only because the overall market is rising sharply, but also due to a weakness in some of the drivers relevant to securities lending, including significantly fewer IPOs, low market volatility, and static merger and acquisition activity. Finally, as noted on previous calls, higher average interest rates versus prior year periods means more of what we earn from securities lending is classified as interest on segregated cash. To more accurately reflect all the income we earn from our securities lending business, we estimate that if the additional interest earned and paid on cash collateral were included under securities borrowed and loaned, then total net revenue related to our securities lending business would have been about $194 million for the quarter versus $190 million in the year-ago quarter and $167 million in the first quarter of 2024. This additional revenue would be reclassified from interest on segregated cash and interest paid on customer credit balances so it would have no effect on our overall NIM. Interest on customer credit balances, the interest we pay to our customers on the cash in their accounts, rose on both higher rates in many currencies versus last year and higher balances for new account growth. As we have noted 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 customer balances were about $18.6 billion this quarter versus $17.3 billion in the year-ago quarter. Together with firm equity, most of which consists of interest-earning assets, total fully rate-sensitive balances were approximately $30.7 billion. Now for our estimates of the impact of changes in rates, given market expectations of rate cuts sometime in 2024, We estimate the effect of a 25 basis point decrease in the benchmark Fed funds rate to be a $59 million reduction in annual net interest income. Note that our starting point for this estimate is June 30th with the Fed funds effective rate at 5.33% and balances as of that date. Any growth in our balance sheet and interest earning assets would reduce this impact. About 25% of our customer cash balances is not in U.S. dollars. So estimates of a U.S. rate change exclude those currencies. We estimate the effect of decreases in all the relevant non-USD benchmark rates would reduce annual net interest income by $18 million for each 25 basis point decrease in those benchmarks. At a high level, a full 1% decrease in all benchmark rates would decrease our annual net interest income by $307 million. This takes into account rate sensitive, customer balances, and firm equity. In conclusion, we posted another financially strong quarter 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. Our business strategy continues to be effective, automating as much of the brokerage business as possible continuously improving and expanding what we offer while minimizing what we charge. And with that, we will now open up the line for questions.