Interactive Brokers Group, Inc. (NASDAQ:IBKR) Q4 2022 Earnings Call Transcript

Interactive Brokers Group, Inc. (NASDAQ:IBKR) Q4 2022 Earnings Call Transcript January 17, 2023

Operator: Thank you for standing by, and welcome to Interactive Brokers Group's Fourth Quarter 2022 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. I would now like to hand the call over to Director of Investor Relations, Nancy Stuebe. Please go ahead.

Nancy Stuebe: Thank you. Good afternoon Happy New Year, and thank you for joining us for our fourth quarter 2022 earnings call. Thomas is on the call and asked me to present his comments on our business. Also joining us today are Milan Galik, 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.

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The good news about 2022 can be seen in our numbers. We now have over 2 million customers around the world. We earned $3 billion in net revenues for the first time. In the fourth quarter, our pre-tax margin reached 71% by far the highest in the industry. After two years of unprecedented investor interest in the markets overall we now see some retrenchment and more localized engagement in particular product segments like futures and options rather than across the board. Rising inflation and interest rates, as well as geopolitical uncertainty in places around the globe helped commodity, interest rate and stock index futures become more popular, while options were increasingly used to manage risk. Equity markets grew weaker as inflation and the impact of central bank policies took hold.

After years of persistent deficit spending with zero and negative interest rate policies around the world, I believe inflation is going to stay with us. It is likely to stay above 4% and the Federal Reserve will keep rates at this level or higher. And eventually we'll have to give up on getting inflation down to the current 2% target. We believe that the target will be raised. Higher inflation and lower equities markets impacted our industry. For us, our year-on-year account growth was 25% in 2022. While for many companies, this would be good news, we want to do better. Our natural account growth by word-of-mouth is 10% to 20%, when markets go down as they are now, that growth is closer to 10% and when the market goes up, that growth is more like 20%.

Our sales efforts also add another 10% to 20% on top of that. So in the short-term, that growth can be very lumpy. We still see the bulk of the onboarding of the two new introducing broker clients we have mentioned happening in the second and third quarters of this year. There's a lot of discussion today around market structure. An interactive broker's auction model for options offers customers a path to best execution. In a volatile market, options have continued to be a security of choice for investors, both to take on exposure to a security at a lower cost than buying the stock outright and as a way to mitigate risk. Industry listed U.S. options average daily volume was over 41 million contracts in 2022, up from under 40 million in the prior year.

We do not accept payment for order flow for IBKR Pro customer orders. Rather, we invite to the mid price orders by institutions and market makers to our ATS to trade with our retail orders. Somewhat similarly, we auction off each option order among 22 top market makers and other professional traders, who give their best vision offers for every order our customers enter. These options last something on the order of 100 milliseconds and the winner chooses which exchange it wants to use to trade with the order. We then post the order for a second option at the exchange and if nobody improves on the price, the original winner of the auction trades the contract at the previously agreed upon price. This all happens in a fraction of a second. All participants use automated processes and they automatically feed the amount of price improvement they are interested in competing on for any specific option contract at that specific time to trade with.

This competition to win the auction means our customers can take advantage of a leading edge system designed to get them the best available price. We are now going to enhance this system by enabling our own customers, who are selling client to participate in this process on the market maker side. We are going to give them an order type with which they can signify the option or options they want to buy or sell. And then when we receive an opposing order, we will bid or offer on their behalf along with the market makers. They will also tell us the price relative to the floating mid price, the middle of the bid offer spread that they are willing to pay up to and our software will do the bidding for them. We still have some minor details we must work out with this project, but we are hoping to be able to introduce this capability to our customers by the end of this month.

We are at the cutting edge of this best execution through auction process. We were the largest market makers in options for over 30-years, so we are very well versed in these processes. And we have been keeping them up to date over the years. With the potential for a new regulatory process in addition to new exchanges continuously involving new rule, we have a team of programmers regularly engaged in this activity. If some similar method becomes required, sophisticated mechanisms like the ones we use could take a long time and great expense for others to create. There's a lot of debate on this, but we will be good with whatever ends up being the outcome. By the way, we are always happy to welcome more market makers to our platform. We added another four this past year, so please get in touch if you'd like to join us.

We introduced more new products and expanded the capabilities of existing ones. Recognizing our global customers' reach, we introduced global trader, a streamlined version of our platform for mobile devices, which allows our clients to trade in over 90 stock markets worldwide. We continue to enhance our options trading tools from mobile options trading to our rollover options tool, strategy builder and probability lab. We will be upgrading our platform with more features and capabilities. We are introducing new tools for financial advisors once they have been asking for and that will set our offering apart as best in its class, as well as being among the lowest cost for an advisor to use. We are also adding new countries where our clients can trade.

We were pleased to receive our bank license in Hungary and plan to make it operational in 2023. Unlike in the U.S. customer funds on deposit with an EU broker may not be used to finance margin borrowings by other customers of the broker. Only banks can lend their customers' funds to other customers no matter what kind of collateral is involved. Our primary purpose with this EU Bank is to facilitate such financing. There is much to look forward to. The Interactive Brokers platform is built with the purpose of bringing investors and marketplaces together all over the world, optimizing the allocation of capital and resources. It is our job to develop the best tools and capabilities to facilitate that. 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. Paul?

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Paul Brody: Thank you, Nancy. Welcome everyone to the call. I'll review our 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 the record financial results we achieved this quarter. Commissions rose versus last year despite declining global market indices, reaching $331 million our third highest quarter ever. For the full-year, commissions were $1.3 billion, down only slightly from 2021 mean stock spike in trading. We saw higher trading volumes in futures and options in 2022 coming from our large base of sophisticated and active traders investors and advisors. Net interest income of $565 million for the quarter and $1.7 billion for the year reflected increases in benchmark rates worldwide.

U.S. rates have moved from an average effective rate of 0.08% in the fourth quarter of '21 to 3.65% in the fourth quarter of €˜22. This led to higher interest earned on margin loans and our segregated cash portfolio. These were 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. Other fees and services generated $43 million for the quarter and $184 million for the year. The drop from the prior year quarter was driven primarily by the risk off positioning of customers, which led to a reduction in risk exposure fees from $18 million to $6 million. FDIC sweeps fees rose to $3 million this quarter, while market data fees of $18 million and exchange liquidity payments of $9 million were both off 10%.

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 $19 million for the quarter and $39 million for the year. Turning to expenses, execution clearing and distribution costs were $90 million in the quarter and $324 million for the year. The increases were led by lower liquidity rebates and non-recurrence of 2021's options fee reduction and fee holidays from unusually high volumes throughout the industry, high 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 were 21% in the fourth quarter.

Note that we report market data expense, a pass through item in execution clearing and distribution fees, while the corresponding revenue item, market data revenue is included in other fees and services. To align the volume based costs with commission, we look at execution and clearing costs ex-market data expense. Compensation and benefits expense was $119 million for the quarter, or a ratio of comp expense to adjusted net revenues of 12%. For the year, this ratio was 14% unchanged from last year despite a 10% increase in headcount. We continue to focus on expense discipline, while improving our strong top line our headcount at year-end was 2,820. G&A expenses were up from the year ago quarter, primarily on higher legal expenses from relatively low numbers last year.

So for the full-year, they were down 6%, reflecting the non-recurrence of Brexit-related costs and a reduction in consulting expenses and bank fees. Our pretax margin was a record 71%. Automation and expense control along with prudent management of our balance sheet remain our key means of maintaining high margins, while we continue to hire talented people and invest in the future of our business. Income taxes of $56 million, reflects the sum of the public companies $31 million and the operating companies $25 million. For the year, taxes of $156 million are the sum of the public company is $87 million and the operating company is $69 million. Moving to the balance sheet on page five of the release. Our total assets ended the year at $115 billion with growth driven by higher customer cash balances, partially offset by lower customer margin lending.

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 not only deployed in running our current business, has helped us win new business by showing the strength and depth of our balance sheet to current and prospective clients and partners, and it positions us to capture numerous growth and investment opportunities we see worldwide. In our operating data on pages six and zeven, our contract volumes for all customers rose 23% over the prior year quarter and futures well above the industry growth. Options contract and stock share volumes declined versus unusually high volumes last year. For the full-year options and futures contract volumes rose 3% and 33% respectively.

The decrease in stock share volume was largely attributable to lower trading in pink sheet and other very low price stocks. On page seven, you can see that account growth remains robust with 415,000 net new account adds for the year. Total accounts broke through the 2 million mark in 2022 closing the year at 2.1 million, up 25% over the prior year. Total customer DARTs were 1.9 million trades per day, reflecting a risk off period for investors and down from last year's stronger market environment. Commission for a cleared commissionable order of $3.15 was up 32% from last year as our client's volume mix included fewer low priced stock trades and larger average trade size and option. Page eight, shows our net interest margin numbers. Total GAAP net interest income was $565 million for the quarter, up 92% and $1.7 billion for the year, up 45%.

These reflected strength in margin loan and segregated cash interest, partially offset by higher interest expense and customer cash balances. The Federal Reserve raised interest rates twice in the quarter by 75 basis points in November and a further 50 basis points in mid-December. These increases had a partial positive impact in the 12-week quarter, but will have a full impact in the first quarter of €˜23. Other central banks also raised rates this quarter including the U.K. Hong Kong, Canada, Australia, The Eurozone, and Switzerland. Higher interest rate led to margin loan interest income, up 32% over the third quarter and 182% over prior year quarter more than compensating for lower average balances in both periods. Securities lending net interest was not as strong as in the prior year for a few reasons.

First, while overall customer demand's for shorting stocks and borrowing shares rose, there were fewer hard to borrow names throughout the industry. Second, benchmark rates are rising. The interest we earn on cash collateral received in exchange for lending stock is also rising, that's good news. Because this cash collateral is invested as segregated funds, the interest earned on it falls under the heading net interest income on segregated cash in our net interest margin table rather than securities borrowed on loan. We estimate that the incremental interest earned on this stock loan cash collateral from rate increases was $42 million for the quarter. Interest on customer credit balances or the interest we pay to our customers increased, higher rates than nearly all currencies led to our paying interest and qualifying balances as we pass through these rate increases to our customers.

We paid $487 million to our customers on these balances in the fourth quarter and a total of $703 million for the year. Fully rate sensitive balances were about $20 billion this 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 additional annual net interest income as follows. A 25 basis points, an increase of $49 million at 50 basis points, an increase of $97 million at 75 basis points, an increase of $146 million and at 100 basis points, an increase of $195 million. Note that our starting point for these estimates is December 31, with the Fed funds effective rate at 4.33% and our balances at that date.

About 25% of our customers segregated cash is not in U.S. dollars, so estimates of U.S. rate change impacts exclude those currencies. We estimate a 25 basis point increase in all the relevant non-USD benchmark rate would produce additional annual net interest income of $25 million and rising to about $100 million at a 100 basis point rate increase. In conclusion, we had a financially strong quarter close out a record year of net revenues and pretax margin, reflecting our continued ability to grow our customer base and deliver on our core value proposition to customers. We've done this while highlighting the attractiveness of our strategy to automate for growth, expanding what we offer while minimizing what we charge. We do this at low cost, managing our growing business effectively and with strong expense control.

And with that, I'll turn it over to moderator and then we'll take some questions.

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