Interactive Brokers Group, Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. The unaudited consolidated statements include IBG LLC, although Interactive Brokers Group, Inc. owned approximately 15.7% of IBG LLC; the remaining 84.3% was held by noncontrolling interests. The company operates electronic brokerage and market-making businesses, supported by corporate activities.
Financial performance and position
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total net revenues | $359 million | $171 million | $918 million | $835 million |
| Income before income taxes | $202 million | $40 million | $331 million | $432 million |
| Net income | $182 million | $31 million | $294 million | $393 million |
| Net income available to common stockholders | $22 million | $3 million | $32 million | $37 million |
| Diluted EPS | $0.35 | $0.05 | $0.52 | $0.65 |
| Pre-tax profit margin | 56% | 23% | 36% | 52% |
- Revenue mix: Q3 trading gains were $87 million (prior year $42 million), commissions and execution fees $167 million ($133 million), and interest income $122 million ($123 million). Other income was a loss of $1 million versus a loss of $102 million. Nine-month commissions rose to $473 million from $394 million and interest income to $356 million from $306 million; other income was a loss of $78 million versus a loss of $25 million.
- Expenses: Non-interest expenses were $157 million in Q3, up from $131 million. For nine months they were $587 million, versus $403 million, including $145 million of customer bad-debt expense versus $2 million. Q3 customer bad-debt expense was $7 million.
- Cash flow: Nine-month operating cash flow was $627 million, compared with $39 million in 2014; investing cash flow was negative $26 million versus positive $64 million; financing cash flow was negative $248 million versus negative $242 million. Cash increased $319 million to $1.588 billion. Management notes operating cash flows are materially affected by trading positions and customer balances.
- Balance sheet at September 30: Total assets were $47.226 billion, liabilities $41.944 billion, and total equity $5.282 billion. Cash and cash equivalents were $1.588 billion; cash and securities segregated for regulatory purposes were $20.911 billion. Short-term borrowings were $4 million, down from $34 million at December 31, 2014. Customer receivables were $15.879 billion and customer payables $35.315 billion. The company reported $3.4 billion of aggregate excess regulatory capital; all regulated operating companies were compliant.
- Liquidity: Management classified approximately $46.8 billion, or 99.2% of assets, as liquid and said operating cash flows, available cash and borrowing capacity should meet liquidity needs for more than 12 months. The filing cautions that some non-U.S. cash is intended for local operations and is not readily available for U.S. operations.
Material changes and operating trends
- Q3 net revenues rose 110% year over year and pre-tax income rose to $202 million, driven by lower currency-strategy losses, higher trading gains, increased commissions and lower interest expense. Higher market volatility and late-August trading activity lifted market-making results.
- Electronic brokerage Q3 pre-tax income increased 19% to $184 million; customer accounts grew 18% to 322,000, customer equity increased 13% to $62.1 billion, and customer DARTs rose 28% to 683,000. Nine-month brokerage pre-tax income was nearly flat at $423 million versus $422 million, affected by Swiss-franc customer losses.
- Market-making Q3 pre-tax income increased to $46 million from $7 million. Nine-month pre-tax income rose 4% to $103 million, while net revenues were essentially unchanged at $229 million.
- Nine-month diluted EPS fell to $0.52 from $0.65 despite higher net revenues. Management attributed the decrease primarily to currency-diversification losses and losses from customer positions following the Swiss-franc move. Excluding those effects, management reported core consolidated pre-tax income of $636 million, up 24%, and a 59% pre-tax margin, versus 56% on the same basis in 2014.
- In July 2015, the company issued 2.77 million Class A shares in exchange for an equal number of IBG LLC membership interests, increasing its ownership from 15.0% to 15.7%. Covestor was acquired in May 2015. The company paid three quarterly dividends of $0.10 per share and declared another $0.10 dividend after quarter-end.
Outlook, risks and unusual items
- Swiss-franc event: The January 15, 2015 currency move caused losses exceeding customer deposits. The company estimated its loss, net of hedging, at approximately $119 million and was pursuing collection. Management’s nine-month discussion reports $137 million of bad-debt expense associated with the event and an $18 million hedging gain. The ultimate recovery and financial impact remained uncertain.
- Currency strategy: The company holds its net worth in a 16-currency basket called GLOBAL. Management said the strategy reduced nine-month results by $220 million and that the U.S.-dollar value of GLOBAL declined about 7.1% year over year. Q3 comprehensive earnings were reduced by $76 million, with approximately 58% of equity denominated in currencies other than the U.S. dollar.
- Market and credit risks: Results depend on volatility, actual versus implied volatility, trading volumes, interest rates, exchange rates and competition. Margin lending and customer short positions can expose the company to losses exceeding collateral, particularly during fast markets or illiquid conditions. Management uses automated monitoring and liquidation controls but notes these may not work in every circumstance.
- Contingencies: Trading Technologies patent litigation resumed and moved into discovery after a stay was lifted in July 2015. The company intends to defend itself; outcome is uncertain and litigation reserves were not material. Clearing-house guarantees and certain customer settlement obligations are also disclosed, with potential exposure not quantifiable; management considers the likelihood of payments under clearing-member guarantees remote.
- Interest rates and capital: The company had no variable-rate debt outstanding. It warned that rate changes can affect net interest income and the market value of government securities. No specific earnings guidance was provided; management stated liquidity should be adequate for more than 12 months and expects to fund technology-related capital expenditures from operations and cash on hand.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The filing states there were no material changes to the company’s previously disclosed risk factors.
Most important facts for investors to verify
- Progress and recoveries from the Swiss-franc customer receivables, including the reconciliation of the $119 million estimated net loss, $137 million bad-debt expense and $18 million hedging gain.
- Currency-strategy losses and the sensitivity of reported earnings and equity to GLOBAL exchange-rate movements.
- Whether brokerage account, trading-volume and commission growth persists, and how customer balances and margin borrowing affect net interest income.
- Quality and volatility of market-making earnings, including the effect of volatility and the actual-to-implied volatility relationship.
- Customer credit exposure, collateral sufficiency, regulatory capital availability and developments in the Trading Technologies litigation.