Interactive Brokers Group, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016; unaudited. Unless noted otherwise, financial amounts are in U.S. dollars and millions. The consolidated statements include IBG LLC, but IBG, Inc. owned only 16.2% of IBG LLC at quarter-end; the remaining 83.8% was reported as noncontrolling interests.
Business context
Interactive Brokers is a global electronic broker and market maker, operating in electronic brokerage and market making, with centralized corporate activities. It reported 1,169 employees and served customers in more than 190 countries. Management described brokerage as the growing business and noted continuing competitive pressure on market making.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total revenues | $387 | $405 | $894 | $592 |
| Net revenues, after interest expense | $369 | $387 | $858 | $559 |
| Income before income taxes | $213 | $240 | $550 | $129 |
| Consolidated net income | $200 | $221 | $510 | $112 |
| Net income attributable to IBG, Inc. common stockholders | $27 | $23 | $60 | $10 |
| Diluted EPS | $0.40 | $0.37 | $0.91 | $0.17 |
| Pretax margin | 58% | 62% | 64% | 23% |
- Quarterly revenue and earnings: Q2 net revenues fell 5% year over year. Trading gains declined 49% to $34; commissions and execution fees fell 3% to $152. Higher net interest income, up 17% to $126, partly offset the declines. Pretax income fell 11%.
- First-half comparison: Net revenues rose 53% and pretax income rose substantially from the prior-year period. This comparison benefited from a $278 swing in other income, including currency-diversification gains of $101 versus a $162 loss a year earlier, and from the absence of the prior-year Swiss-franc-related customer bad-debt charge. Management’s adjusted comparison, excluding currency-strategy effects, U.S. government securities mark-to-market gains and the prior-year Swiss-franc losses, showed net revenues up 2%, pretax margin of 56% versus 57%, and pretax income of $396 in the current period.
- Segment trends: Electronic brokerage Q2 net revenues increased 8% to $310 and pretax income edged up 2% to $191; customer accounts grew 15% year over year to 357,000, customer equity rose 12% to $73.7 billion, and total customer DARTs increased 5% to 648,000. Market-making Q2 net revenues fell 40% to $43 and pretax income dropped 83% to $5. For the first half, electronic brokerage pretax income was $426 versus $239, while market-making pretax income was $25 versus $57.
- Cash flow: First-half operating cash flow was $12, versus cash used of $99 in 2015; investing activities provided $18, versus using $17. Financing used $208, principally reflecting distributions to noncontrolling interests, dividends, employee tax-withholding share repurchases and Tax Receivable Agreement payments. Cash and cash equivalents decreased $158 to $1,443.
- Balance sheet and liquidity: At June 30, total assets were $51,829, liabilities $46,137 and total equity $5,692. Cash and securities segregated for regulatory purposes were $25,257. Customer receivables were $15,137 and customer payables $39,319. Short-term borrowings were $8; the filing does not present material conventional long-term debt. Securities loaned were $3,270 and are part of securities-financing operations. Management considered 99% of assets liquid and stated that available cash, operating cash flow and borrowings should meet liquidity needs for more than 12 months.
- Regulatory capital: Operating companies had $3,953 of excess regulatory capital and were compliant with applicable requirements at quarter-end.
Changes, outlook, risks and unusual items
- Quarterly market-making results were pressured by mixed trading volumes and reduced trading opportunities around the U.K. Brexit vote, despite higher average VIX and a higher actual-to-implied volatility ratio. Management also cited first-quarter divergence in individual stock price behavior as a factor in first-half trading gains.
- Customer margin loans were down 21% year over year amid economic uncertainty, while higher customer cash balances supported brokerage net interest income. Average commission per cleared customer DART declined 9% in Q2.
- The 2015 Swiss-franc shock caused customer losses exceeding deposits. The company reported $138 of customer bad-debt expense in the first half of 2015 and estimated cumulative losses of approximately $119, net of hedging and collection efforts; it continues to pursue collections, so the ultimate outcome remains uncertain.
- Management gave no specific earnings or revenue guidance. It planned continued investment in technology infrastructure, expected to fund capital expenditures from cash on hand and operations, and retained flexibility to adjust spending. It said there were no definitive agreements for a material acquisition.
- Key risks include market-making spread and competition pressure, unpredictable trading activity and volatility, foreign-exchange and interest-rate exposure, customer margin and counterparty credit risk, and potential off-balance-sheet losses on futures and other obligations. The company noted margin-credit exposure may be unquantifiable in severe market conditions and that automated liquidation may not work where markets are illiquid or systems are unavailable.
- Other notable matters: the company changed its currency-diversification basket effective at quarter-end by adding offshore renminbi, removing the Korean won and Brazilian real, and adjusting U.S. dollar and yen weights; management said the change did not affect Q2 results. It declared a $0.10-per-share dividend payable in September. A patent case was stayed pending patent reviews; a customer class-action matter over margin liquidations remained pending. Litigation reserves were not material, but outcomes are uncertain.
Important facts for investors to verify
- Whether first-half earnings growth persists after separating currency-diversification gains, securities mark-to-market effects and the prior-year Swiss-franc charge.
- Whether brokerage account and customer-equity growth can offset lower commissions per trade and reduced trading activity per account.
- Whether market-making performance improves from Q2’s $5 pretax income and whether competitive and volatility conditions support sustainable results.
- The recoverability of Swiss-franc-related customer receivables and any material developments in the patent, class-action or regulatory matters.
- The accessibility and composition of liquidity, including regulatory-segregated funds, subsidiary cash and excess regulatory capital; these resources are not all freely interchangeable.
- The parent-company earnings distinction: consolidated net income substantially includes noncontrolling interests, while common-stockholder net income was $27 in Q2 and $60 for the first half.