Interactive Brokers Group, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Amounts are in U.S. dollars; financial statement amounts below are in millions unless noted. The company operates electronic brokerage and market-making businesses. IBG, Inc. owned approximately 14.1% of IBG LLC; most consolidated earnings were attributable to noncontrolling interests.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total net revenues | $171.0 | $326.3 | $835.2 | $826.3 |
| Income before income taxes | $39.5 | $196.4 | $431.8 | $412.5 |
| Net income | $31.7 | $186.0 | $393.6 | $381.3 |
| Net income available to common stockholders | $3.2 | $16.4 | $37.4 | $33.4 |
| Diluted EPS | $0.05 | $0.32 | $0.65 | $0.67 |
| Comprehensive income (loss) available to common stockholders | $(7.6) | $20.1 | $28.5 | $29.7 |
- Revenue drivers: Q3 trading gains were a loss of $75.7, versus a gain of $123.3 a year earlier. Commissions rose 10% to $132.6 and interest income rose to $122.4, but interest expense also increased, to $24.1. Nine-month net interest income increased 39% to $252.9; commissions increased 4% to $393.5.
- Expenses and margins: Q3 non-interest expenses were $131.6, up slightly year over year; pretax margin fell to 23% from 60%. Nine-month non-interest expenses declined 3% to $403.4 and pretax margin improved to 52% from 50%.
- Segment results: Electronic brokerage pretax income increased 41% to $152.4 in Q3 and 22% to $418.1 for nine months. Market making recorded a Q3 pretax loss of $111.8, compared with $87.5 income; nine-month pretax income fell to $22.8 from $66.1.
Financial position, cash flow and liquidity
- At September 30, total assets were $41.61 billion, liabilities $36.42 billion and total equity $5.19 billion, compared with $37.87 billion, $32.78 billion and $5.09 billion, respectively, at December 31, 2013.
- Cash and cash equivalents were $1.01 billion, down from $1.21 billion at year-end. Customer receivables were $17.26 billion versus $13.60 billion; customer payables were $29.97 billion versus $26.32 billion. These brokerage balances largely reflect customer activity and should not be read as unrestricted corporate cash or conventional debt.
- Nine-month operating cash flow was positive $39.2 million, compared with negative $127.5 million in 2013. Investing activities provided $63.8 million; financing activities used $242.1 million. Cash declined $202.5 million, including a $63.4 million adverse effect from exchange-rate changes.
- Short-term borrowings were $59.4 million, versus $24.6 million at year-end. The company reported no variable-rate debt and terminated its $100 million revolving credit facility on August 8, 2014; it reported no borrowings under the facility at September 30.
- Management described approximately 99% of assets as liquid, primarily customer cash, collateralized receivables and marketable securities. Aggregate excess regulatory capital was $3.25 billion, and regulated operating companies were in compliance with their capital requirements.
Material changes, outlook and risks
- Foreign currency effects: Management attributed much of the Q3 deterioration to the stronger U.S. dollar and the company’s 16-currency “GLOBAL” equity strategy. Currency translation reduced Q3 trading gains by $133.0 million, versus a $46.2 million gain in the year-ago quarter. Management said this reduced comprehensive diluted EPS by approximately $0.38; Q3 comprehensive diluted EPS was a loss of $0.13. The GLOBAL’s U.S.-dollar value declined about 4% year over year, and approximately 61% of equity was denominated in currencies other than U.S. dollars.
- Market making: Excluding currency translation, Q3 market-making pretax income was $21.2 million versus $41.3 million a year earlier. Management cited competition, lower volatility and an approximately $16 million trading error. The VIX averaged 13.0, down 9% year over year. For the first nine months, market-making pretax income excluding translation effects was $119.7 million versus $123.4 million.
- Brokerage growth: Q3 total customer DARTs increased 13%, customer accounts increased 18% to 272,000, and customer equity increased 33% to $54.9 billion. Customer margin loans reached $17.3 billion, up 36% year over year. Management noted that margin balances and revenue depend on customer activity and market conditions.
- Guidance: The filing provides no specific earnings or revenue guidance. Management expected 2014 gross capital expenditures to exceed 2013 levels, primarily for network, data-center and backup-facility expansion, funded from operating cash and cash on hand. It believed available cash and operating cash flows would meet liquidity needs for more than 12 months.
- Contingencies: A small group of customers’ concentrated positions in four Singapore-listed stocks collapsed in October 2013. The company had recognized cumulative losses of approximately $82 million through September 30, 2014; maximum aggregate loss was estimated at $84 million if prices fell to zero and no debts were recovered. Collection efforts were ongoing. Pending litigation reserves were not material; management could not quantify potential losses for certain proceedings.
- Other risks: The filing identifies market, foreign-exchange, interest-rate, customer-margin-credit and counterparty risks. Customer margin exposure was $17.26 billion; losses in extreme market conditions may exceed collateral, and off-balance-sheet exposures are not fully quantifiable. A 0.05% decrease in benchmark rates was estimated to reduce annualized net interest income by about $14.3 million.
- Governance and controls: Management reported effective disclosure controls and internal control over financial reporting as of September 30, 2014, with no material control changes during the quarter. The company declared a $0.10-per-share dividend payable December 12, 2014. Subsequent to quarter-end, it issued 1,358,478 Class A shares to Holdings for IBG LLC interests, increasing IBG, Inc.’s ownership of IBG LLC to approximately 14.5%.
Investor verification priorities
- Reconcile reported Q3 earnings with the substantial currency-translation impact, including the distinction between net income available to common stockholders and comprehensive income.
- Track market-making results excluding currency translation, and assess the persistence of competitive, volatility-related and trading-error impacts.
- Review the Singapore customer-debt recovery progress and exposure relative to the stated $84 million maximum loss.
- Monitor growth and credit quality of customer margin loans, collateral sufficiency and the associated off-balance-sheet risks.
- Confirm the effects of the post-quarter share-for-membership-interest exchange, dividend obligations, regulatory capital levels and planned infrastructure spending.