Interactive Brokers Group, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; unaudited. The company is an automated global electronic broker and market maker, reporting electronic brokerage and market making segments, supported by corporate activities. IBG, Inc. owned approximately 16.6% of IBG LLC; the remaining 83.4% was reported as noncontrolling interests.
Financial results
| Metric ($ millions, except per-share data) | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net revenues | 345 | 359 | 1,203 | 918 |
| Income before income taxes | 183 | 202 | 733 | 331 |
| Net income | 168 | 182 | 678 | 294 |
| Net income available to common stockholders | 20 | 22 | 80 | 32 |
| Diluted EPS | $0.30 | $0.35 | $1.20 | $0.52 |
| Pretax margin | 53% | 56% | 61% | 36% |
Q3 revenue mix included trading gains of $38 million (down 56%), commissions and execution fees of $144 million (down 14%), interest income of $157 million (up 29%), and other income of $27 million versus a $1 million loss. Nine-month trading gains were $124 million (down 43%); commissions and execution fees were $462 million (down 2%); interest income was $446 million (up 25%); and other income was $228 million versus a $78 million loss.
Non-interest expenses were $162 million in Q3, up 3%, and $470 million for nine months, down 20%. Nine-month expenses included $6 million of customer bad debt, compared with $145 million in 2015, largely reflecting the non-recurrence of losses related to the Swiss franc event. Interest expense was $21 million in Q3 and $57 million for nine months.
Segments and operating measures
- Electronic brokerage: Q3 net revenue was $288 million and pretax income $162 million, down 4% and 12%, respectively. For nine months, net revenue was $945 million and pretax income $588 million, up 8% and 39%; the comparison benefited from the absence of the prior-year Swiss franc-related bad debt expense. Customer accounts grew 15% year over year to 370,000 and customer equity rose 33% to $82.7 billion. Q3 customer DARTs declined 11% to 609,000.
- Market making: Q3 net revenue was $43 million and pretax income $7 million, down 52% and 85%. Nine-month net revenue was $145 million and pretax income $32 million, down 37% and 69%. Management cited lower trading volumes, lower volatility and a weaker actual-to-implied volatility ratio.
Cash flow, balance sheet and capital
- At September 30, 2016, total assets were $55.1 billion, liabilities $49.2 billion and total equity $5.9 billion. Cash and cash equivalents were $1.55 billion, versus $1.60 billion at year-end 2015. Cash and securities segregated for regulatory purposes were $25.25 billion; these are not equivalent to unrestricted corporate cash.
- Customer receivables were $18.2 billion and customer payables $42.5 billion. Short-term borrowings were $24 million, compared with none at year-end 2015; management reported no variable-rate debt outstanding. Securities loaned were $3.6 billion.
- For the first nine months, operating cash flow was $114 million, versus $627 million in 2015; investing cash flow was positive $11 million, versus negative $26 million; and financing cash flow was negative $198 million, versus negative $248 million. Cash decreased $51 million. Management noted operating cash flows are affected by trading positions and changes in customer balances.
- Aggregate excess regulatory capital was $4.231 billion, and regulated operating companies were in compliance with requirements. Management stated that cash, operating cash flows and available borrowings should meet liquidity needs for more than twelve months; it estimated 98.9% of assets were liquid, while noting it maintains liquidity cushions and collateral.
Material changes, outlook and risks
- Nine-month results were materially affected by the currency diversification strategy: other income included a $112 million gain in 2016, compared with a $186 million loss in 2015. The company also reported net mark-to-market gains on its U.S. government securities portfolio for the nine-month period; such gains or losses may reverse if securities are held to maturity.
- The January 2015 Swiss franc shock caused customer losses exceeding deposits. The company estimated cumulative losses, net of hedging and collections, at approximately $118 million and continued collection efforts; the ultimate effect depends on recoveries.
- Q3 market making faced a less favorable environment: average VIX fell to 13.3 from 19.2, and the actual-to-implied volatility ratio averaged 74% versus 109%. Management said market making profitability is sensitive to volatility, trading volumes and market structure. Competition, regulatory scrutiny, customer activity and interest-rate movements are additional risks.
- The company changed its 15-currency GLOBAL basket in June 2016, adding offshore renminbi and removing the Korean won and Brazilian real. Approximately 54% of equity was denominated in currencies other than the U.S. dollar at quarter-end.
- No specific earnings or revenue guidance was provided. Management expects continued technology-infrastructure investment and stated capital expenditures can be adjusted to operating performance. A 0.25% rate increase was estimated to raise annualized net interest income by about $52 million; a 0.25% decrease was estimated to reduce it by about $68 million. Fixed-rate securities may create offsetting mark-to-market effects.
- Patent litigation brought by Trading Technologies was stayed pending patent reviews; the USPTO had found it more likely than not that nine asserted patents were invalid. A customer class action was dismissed on September 28, 2016, though appeal or refiling remained possible. Management said other legal matters were not expected to materially affect financial condition, but could affect results in a particular period. Clearing-house guarantees are unquantifiable, with payment considered remote; futures and customer settlement activities also create off-balance-sheet exposure.
Important facts for investors to verify
- How much of reported nine-month earnings growth reflects recurring brokerage economics versus currency gains and the absence of the 2015 Swiss franc bad-debt charge.
- Whether trading volumes, volatility and market-making profitability recover, and whether brokerage account growth translates into higher activity and commissions.
- Progress and recoveries on the estimated $118 million Swiss franc-related customer losses.
- The quality and availability of liquidity, including the distinction between unrestricted cash and regulatory-segregated assets, and the effect of customer balance movements on cash flow.
- Developments in Trading Technologies litigation, regulatory inquiries and other contingencies, as well as the interest-rate and foreign-currency sensitivities disclosed by management.