Interactive Brokers Group, Inc. — 2018 Form 10-K
Reporting period: Year ended December 31, 2018. The filing is annual; fourth-quarter figures are separately identified below. Amounts are U.S. dollars unless stated otherwise.
Business context
IBKR provides automated global electronic brokerage, execution, clearing and custody services across more than 120 exchanges and market centers. Electronic brokerage generated 96% of combined segment net revenues in 2018. The company continued winding down its options market-making business after transferring U.S. operations to Two Sigma in 2017; remaining activity was limited. IBG, Inc. consolidated IBG LLC despite owning approximately 18.1% of it; the remaining 81.9% was reported as noncontrolling interest.
Financial performance
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Total net revenues | $1.903 billion | $1.702 billion | +12% |
| Net interest income, as stated in MD&A | $929 million | $683 million | +36% |
| Commissions | $777 million | $647 million | +20% |
| Trading gains | $39 million | $40 million | -3% |
| Other income | $158 million | $332 million | -52% |
| Non-interest expenses | $707 million | $653 million | +8% |
| Income before income taxes | $1.196 billion | $1.049 billion | +14% |
| Net income | $1.125 billion | $793 million | +42% |
| Net income available to common stockholders | $169 million | $76 million | +122% |
| Diluted EPS | $2.28 | $1.07 | +113% |
Pre-tax margin was 63%, versus 62% in 2017. Higher customer balances and benchmark rates drove interest income; higher options and futures activity supported commissions. The 2018 average Federal Funds effective rate was 1.83%, compared with 1.00% in 2017. Other income fell mainly because currency diversification produced a $19 million loss versus a $110 million gain in 2017, and the prior year included a $93 million Tax Receivable Agreement remeasurement gain. The 2017 Tax Act effects reduced earnings by approximately $84 million, including transition tax and deferred-tax remeasurement, partly offset by the agreement-liability gain.
Fourth-quarter results
| Metric | Q4 2018 | Q4 2017 |
|---|---|---|
| Total revenues | $634 million | $593 million |
| Interest expense | $142 million | $78 million |
| Net revenues | $492 million | $515 million |
| Income before income taxes | $309 million | $364 million |
| Income tax expense | $19 million | $200 million |
| Net income available to common stockholders | $43 million | $(2) million |
| Diluted EPS | $0.57 | $(0.02) |
Quarterly net revenues and pre-tax income declined year over year, while lower tax expense sharply improved common-stockholder earnings versus Q4 2017, which included the Tax Act charge.
Cash flow, balance sheet and capital
- Operating cash flow was $2.356 billion, up from $1.065 billion in 2017; investing cash outflow was $57 million and financing cash outflow was $399 million.
- At year-end, total assets were $60.547 billion, liabilities $53.391 billion and total equity $7.156 billion. Management considered approximately $60.2 billion, or 99.5% of assets, liquid; much of the balance sheet reflects customer-related cash, securities and collateralized receivables.
- Cash, cash equivalents and short-term investments were $26.937 billion. Cash, cash equivalents and restricted cash were $10.1 billion, including $7.503 billion segregated for regulatory purposes.
- Short-term borrowings were $17 million; the company reported no variable-rate debt outstanding. Customer payables and securities-lending obligations are substantial operating liabilities, not equivalent to ordinary corporate debt.
- Aggregate excess regulatory capital was $5.8 billion, and all regulated operating companies were in compliance with their requirements.
- Customer accounts increased 24% to approximately 598,000; customer equity rose 3% to $128.4 billion. Total customer DARTs increased 25% for the year. The board’s stated dividend intention was $0.10 per share quarterly.
Material changes, outlook and risks
- Market-making revenue and activity continued to contract as the company exited most options market making. Management expected approximately $40 million of annual net expenses associated with the discontinued activity to move to electronic brokerage; about 98% of related resources had transferred by year-end, with most of the remainder expected to transfer in 2019.
- Management cited higher 2018 volatility and rising U.S. rates as supportive of brokerage trading and net interest income, while noting that results remain sensitive to trading volumes, interest rates, customer activity, competition and regulatory change. The filing provides no specific earnings or revenue guidance.
- A small number of customers held concentrated positions in one U.S.-listed security that subsequently fell sharply. Through February 27, 2019, IBKR recognized an aggregate loss of approximately $47 million; the stated maximum loss was approximately $59 million if prices fell to zero and no debts were recovered. Collection efforts and the ultimate loss remained uncertain.
- The company’s GLOBAL currency basket declined 1.14% in U.S.-dollar value during 2018; management said the strategy reduced comprehensive earnings by $99 million.
- Other risks include customer margin defaults during rapid market moves, technology or third-party service failures, cybersecurity, regulatory penalties and litigation. Systems were not fully redundant globally, and disaster-recovery trading support was then limited to U.S. markets. Regulatory inquiries covered multiple compliance areas; the timing and amount of potential fines were not predictable.
- Pending matters included patent litigation, with a trial scheduled for February 2020 on four patents, and a customer class action in which negligence claims remained pending after other claims were dismissed. Litigation reserves were not material at year-end. A separate 2015 Swiss-franc event had produced cumulative net losses of $116 million; debt collection continued.
- The company expected to recognize approximately $136 million of right-of-use assets and lease liabilities upon adoption of the new lease standard in 2019. Contractual obligations included $167 million of operating-lease payments, $171 million payable under the Tax Receivable Agreement and $56 million of transition-tax liability.
Important facts for investors to verify
- Reconcile the $47 million customer-position loss recognized through February 27, 2019 with subsequent recoveries, liquidation results and the disclosed $59 million maximum exposure.
- Track whether customer growth, trading activity and net interest income persist if volatility or benchmark rates decline; note that interest expense also rose substantially.
- Assess the quality and recurring nature of earnings, particularly currency-basket gains and losses, other income, and the unusually high 2017 tax expense.
- Review progress and costs from the market-making wind-down, including the transfer of expenses and any earn-out income from Two Sigma.
- Monitor regulatory inquiries, patent and customer litigation, customer margin concentration, and the adequacy of operational and disaster-recovery controls.
- Consider the controlled-company structure, founder voting control, 81.9% noncontrolling interest, potential future share issuance for member redemptions, and Tax Receivable Agreement payments.