Interactive Brokers Group, Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Figures are unaudited and in U.S. dollars; financial amounts are in millions unless stated otherwise. IBG, Inc. is the public holding company and owned 17.1% of IBG LLC at quarter-end; most consolidated earnings are attributable to noncontrolling interests.
Business context
Interactive Brokers operates an automated global electronic brokerage and market-making business. Electronic brokerage provides execution, clearing, custody, and related services; market making trades principally in exchange-listed products. The company served customers through more than 120 exchanges and market centers and reported 1,206 employees.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenues | $438 | $387 | $847 | $894 |
| Interest expense | $51 | $18 | $86 | $36 |
| Net revenues | $387 | $369 | $761 | $858 |
| Income before taxes | $204 | $213 | $417 | $550 |
| Net income | $187 | $200 | $382 | $510 |
| Net income available to common stockholders | $23 | $27 | $47 | $60 |
| Diluted EPS | $0.32 | $0.40 | $0.67 | $0.91 |
| Pre-tax profit margin | 53% | 58% | 55% | 64% |
Revenue and cost drivers: Q2 trading gains fell 62% to $13; commissions rose 5% to $160; and interest income rose to $206 from $144, while interest expense increased to $51 from $18. Net interest income increased 23% to $155 in Q2 and 17% to $297 for the first half. First-half trading gains fell 83% to $15, commissions declined 1% to $314, and other income declined 33% to $135. Non-interest expenses rose 17% to $183 in Q2 and 12% to $344 for the first half; general and administrative expense included market-making exit costs.
Segments: Q2 electronic brokerage pre-tax income was $198, up from $191; market making recorded a $24 pre-tax loss versus $5 income. First-half electronic brokerage pre-tax income declined to $383 from $426, while market making recorded a $46 loss versus $25 income.
Balance sheet, liquidity, and cash flow
- At June 30, total assets were $57.6 billion, total liabilities $51.4 billion, and total equity $6.2 billion. Cash and cash equivalents were $2.1 billion, up from $1.9 billion at December 31, 2016.
- Customer receivables, primarily margin loans, were $22.8 billion; customer payables were $46.0 billion. Securities segregated for regulatory purposes totaled $24.2 billion.
- Short-term borrowings were $9 million, down from $74 million at year-end. The company reported no variable-rate debt outstanding. These figures should be considered alongside the large customer-related financing balances on the brokerage balance sheet.
- Management stated that 99.3% of assets were liquid and that available cash, operating cash flows, and borrowings should meet liquidity needs for more than 12 months. Aggregate excess regulatory capital was $4.9 billion; all regulated operating companies were compliant.
- For the first half, operating activities provided $300 million, investing activities used $10 million, and financing activities used $161 million. Cash increased $190 million, including a positive $61 million foreign-exchange effect.
Material changes, outlook, and risks
- Options market-making exit: The company announced a global wind-down of options market making and agreed to transfer its U.S. options market-making operations to Two Sigma Securities, subject to closing conditions; closing was expected in Q3 2017. It estimated up to $25 million of one-time restructuring costs, with $23 million recognized in the first half. Management expected approximately $39 million of annual net expenses to shift to electronic brokerage as the wind-down proceeded.
- Trading conditions: Management cited historically low volatility and declining market-making activity. Average VIX was 11.4 in Q2 versus 15.6 a year earlier; the actual-to-implied volatility ratio averaged 64% versus 87%. Market-making results are also exposed to competition, market structure, and trading-volume changes.
- Brokerage growth and rates: Customer accounts increased 20% year over year to 428,000, customer equity rose 42% to $104.8 billion, and Q2 customer DARTs increased 3% to 669,000. Higher benchmark rates and customer balances supported net interest income. Management estimated that a 0.25 percentage-point rise in U.S. dollar rates would add about $12 million to first-year net interest income; a comparable decline would reduce annualized net interest income by about $16 million, based on stated assumptions.
- Currency strategy: The company manages equity against a 14-currency basket, with about 30% of equity denominated outside the U.S. dollar. The strategy increased Q2 comprehensive earnings by $66 million; currency movements can materially affect reported results.
- Contingencies: Losses from the 2015 Swiss-franc event were estimated at approximately $117 million, net of hedging and collection efforts; recovery remains uncertain. The company disclosed pending litigation, including patent and customer class-action matters, and said litigation reserves were not material. Exchange and clearinghouse guarantees are not quantified and are not accrued because management considers payment remote. Certain futures and other transactions may create off-balance-sheet exposure.
- No specific earnings or revenue guidance was provided. Management said it expected continued phase-out of options market making and identified technology investment and opportunistic strategic acquisitions as ongoing priorities. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Key facts for investors to verify
- Progress, closing status, final costs, and timing of the options market-making wind-down and Two Sigma transaction.
- Whether electronic brokerage growth and higher rates can offset lower market-making revenue, higher interest expense, and rising operating costs.
- Cash-flow quality and liquidity in light of customer-related balances, regulatory segregation requirements, and the company’s stated liquidity assessment.
- Collection outcomes for Swiss-franc-related customer losses and developments in disclosed litigation and contingent guarantees.
- Effects of currency-basket movements and interest-rate changes on net income, comprehensive income, and reported margins.
- The distinction between consolidated earnings and earnings attributable to IBG, Inc. common stockholders, given the 17.1% ownership of IBG LLC at quarter-end.