Interactive Brokers Group, Inc. — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010; unaudited. IBG, Inc. is a holding company that owned approximately 10.8% of IBG LLC, the operating group. The consolidated results include IBG LLC, with the other owners’ share reported as non-controlling interests. Amounts below are in millions unless stated otherwise.
Business context and results
The company operates electronic brokerage and market-making businesses across more than 80 exchanges and trading venues. Q3 results improved year over year, while nine-month earnings declined substantially, mainly due to lower market-making trading gains.
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Total net revenues | $299.1 | $271.5 | $735.8 | $899.9 |
| Income before taxes | $161.9 | $133.3 | $298.9 | $492.3 |
| Net income, consolidated | $148.7 | $120.1 | $273.2 | $442.1 |
| Net income available to common shareholders | $11.0 | $8.4 | $18.8 | $33.9 |
| Diluted EPS | $0.26 | $0.20 | $0.44 | $0.81 |
| Pre-tax margin | 54% | 49% | 41% | 55% |
Q3 total net revenues rose 10%; nine-month net revenues fell 18%. Q3 trading gains increased 9% to $168.7, while nine-month trading gains decreased 41% to $326.9. Commissions and execution fees rose 1% in Q3 and 10% year to date. Net interest income increased 78% in Q3 to $26.4 and doubled year to date to $71.1, reflecting higher customer cash and margin balances.
Q3 non-interest expenses decreased 1% to $137.2, largely from lower execution and clearing costs. Nine-month non-interest expenses rose 7% to $436.9, including higher compensation and execution costs. The reported consolidated earnings substantially exceed earnings attributable to IBG, Inc.’s common shareholders because most IBG LLC earnings belong to non-controlling owners.
Segments and operating trends
- Market making: Q3 pre-tax income increased to $104.0 from $74.6, and margin rose to 61% from 50%; currency movements and lower execution costs helped. For nine months, pre-tax income fell to $113.3 from $334.3 and margin declined to 34% from 61%, amid tighter spreads, difficult market conditions and adverse currency effects.
- Electronic brokerage: Q3 pre-tax income was $63.5 versus $62.1; nine-month income increased to $200.2 from $169.6. At September 30, customer accounts were approximately 151,000, up 18% year over year, and customer equity was $18.9 billion, up 41%. Q3 total DARTs rose 4% to approximately 355,000.
Management cited intense high-frequency-trading competition, historically tight bid/offer spreads and low volatility as market-making headwinds. Q3 spreads were reported approximately 33% narrower than a year earlier. A weaker U.S. dollar benefited Q3 reported market-making earnings; the filing also reports $164.8 million of translation losses for the first nine months. Currency effects are material and may affect reported results differently across periods.
Cash flow, balance sheet and liquidity
- Nine-month cash flow: Operating cash flow was $773.3, versus $280.1 in 2009; investing cash use was $14.5 and financing cash use was $309.2. Cash and cash equivalents increased $485.2 to $1.292 billion. Operating cash flow is significantly affected by customer balances and trading-related assets and liabilities.
- September 30 balance sheet: Total assets were $29.66 billion and total equity was $5.11 billion. Cash and securities segregated for regulatory purposes were $7.62 billion; these are not equivalent to unrestricted corporate cash. Management classified approximately 98% of assets as liquid, principally marketable securities, customer cash and collateralized receivables.
- Debt and liquidity: Senior notes payable were $219.6 million, including $174.2 million at 7% and $45.4 million at 5%, with 15- or 18-month maturities. Short-term borrowings were $148.1 million. The $100 million two-year secured revolver had no balance outstanding; the company reported compliance with its covenants. Management said available cash, operating cash flow and the facility should meet liquidity needs for more than twelve months.
- Regulatory capital: Aggregate excess regulatory capital was $3.39 billion, and all operating companies were reported in compliance with applicable requirements.
Outlook, risks and contingencies
No specific earnings or revenue guidance was provided. Management anticipated gross capital expenditures to remain around the first nine months’ level in the near term, while technology infrastructure investment could increase over time; spending was expected to be funded from cash on hand and operations. No definitive agreement for a material acquisition was reported.
Key sensitivities include market volumes, volatility, bid/offer spreads, competition, customer activity, interest rates, foreign exchange rates, margin lending and the ability to liquidate customer collateral. The company reported $5.42 billion in customer margin credit and stated that losses from margin and short-sale exposures could be significant and were not quantifiable. Futures activity also creates off-balance-sheet risk. Clearinghouse guarantees may be unquantifiable, although management characterized the likelihood of payment as remote.
Pending litigation and regulatory matters arise in the ordinary course; reserves were not material, and management did not expect a material adverse effect on financial condition, though a period’s results could be affected. The filing also identifies the Dodd-Frank Act and potential derivatives-market rules as regulatory developments; management viewed them as broadly favorable but noted proposals under consideration.
Important facts for investors to verify
- How much of consolidated income is attributable to IBG, Inc. common shareholders, given the approximately 10.8% ownership of IBG LLC.
- Whether market-making earnings recover from nine-month spread, volatility and currency pressures, and how currency translation affects reported trading gains.
- Whether brokerage account, customer-equity and trading-activity growth can offset pricing pressure, expenses and low interest rates.
- The composition and availability of liquidity, including the distinction between unrestricted cash and customer or regulatory-segregated funds, and the treatment of short-term borrowings.
- Developments in margin-credit, futures, clearing guarantees, litigation and regulatory exposures, and any changes to capital or market rules.