Interactive Brokers Group, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; financial statements are unaudited. IBG, Inc. is a holding company that owned approximately 18.5% of IBG LLC, with the remaining 81.5% recorded as noncontrolling interests. The company operates a global electronic brokerage business; it discontinued separate segment reporting this quarter as its market-making activity had become less significant.
Financial performance
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Total net revenues | $532 million | $558 million | Down 5% |
| Net interest income | $256 million | $246 million | Up 4% |
| Income before income taxes | $308 million | $339 million | Down 9% |
| Net income | $290 million | $324 million | Down 10% |
| Net income attributable to common stockholders | $46 million | $49 million | Down 6% |
| Diluted EPS | $0.60 | $0.64 | Down 6% |
| GAAP pretax margin | 58% | 61% | Down 3 percentage points |
Commissions rose 55% to $269 million as market volatility drove higher activity. Customer options, futures and stock volumes increased 64%, 59% and 24%, respectively, year over year; total customer DARTs rose 71% to 1.45 million. Other fees and services increased 9% to $38 million.
Other income swung to a $31 million loss from $104 million of income, primarily reflecting an $8 million mark-to-market loss on the Tiger Brokers investment versus a $103 million gain a year earlier, and a $49 million loss from the currency diversification strategy versus a $19 million loss. Net interest income benefited from higher customer balances and securities-lending income, but lower benchmark rates weighed on yields. Reported net interest margin was 1.45%, versus 1.67%.
Non-interest expenses rose 2% to $224 million. Higher execution and clearing costs, compensation, and general and administrative expenses were partly offset by customer bad debt expense declining to $7 million from $43 million. The prior-year bad debt related to customer margin loans against a security that rapidly lost value. Management’s non-GAAP adjusted diluted EPS was $0.69 versus $0.55; adjusted net revenues were $581 million versus $468 million. These measures exclude specified currency effects, investment marks and, where applicable, unusual bad debt.
Balance sheet, cash flow and liquidity
- Total assets were $75.8 billion and total liabilities $67.7 billion at March 31, 2020; total equity was $8.1 billion, including $6.7 billion of noncontrolling interests. Customer payables were $62.7 billion.
- Cash and cash equivalents were $3.1 billion; cash segregated for regulatory purposes was $14.3 billion and regulatory-segregated securities were $30.2 billion. Customer receivables, primarily margin loans, were $20.1 billion, down from $31.3 billion at year-end 2019.
- Short-term borrowings were $14 million; securities sold under repurchase agreements were zero, versus $1.9 billion at year-end. Management reported that approximately 99.2% of assets were liquid and expected cash flows, available cash and borrowing capacity to cover liquidity needs for more than 12 months.
- Operating cash flow was $5.2 billion, compared with $603 million in Q1 2019; cash, cash equivalents and restricted cash increased $5.1 billion to $17.4 billion. The company attributed the operating cash flow largely to customer balance movements, including customer margin loans falling $11.2 billion and customer credit balances rising $6.5 billion. Thus, the cash-flow increase should not be read as equivalent to earnings or recurring free cash flow.
- Capital expenditures were $12 million. Aggregate excess regulatory capital was $6.4 billion, and all regulated operating subsidiaries were in compliance with capital requirements.
Material changes, outlook and risks
- COVID-19: Exceptional market volatility and trading activity supported commission growth, while near-zero rates, customer deleveraging and valuation movements affected interest income and investment results. Customer accounts increased 22% year over year to 760,000; customer equity was $160.7 billion, up 9% year over year but down 8% from year-end 2019. Management said the pandemic’s future financial impact could be significant but could not be quantified. No specific earnings or revenue guidance is provided.
- Post-quarter oil-market loss: On April 20, 2020, negative WTI futures prices caused losses for customers holding long positions in related cash-settled contracts. IB fulfilled clearinghouse variation-margin requirements and revised its estimated aggregate loss to approximately $104 million after deciding to compensate certain customers. The company said it did not expect a material effect on financial condition.
- Currency exposure: The currency diversification strategy reduced comprehensive earnings by $87 million in Q1 2020, comprising a $49 million loss in other income and a $38 million translation loss in other comprehensive income. Approximately 29% of equity was denominated in currencies other than the U.S. dollar.
- Customer credit and market risk: Margin lending and customer positions can expose the company to losses beyond customer account equity, particularly during rapid market moves or in illiquid or concentrated positions. The filing cites a maximum approximately $50 million loss on the prior security-related customer deficits if its price fell to zero and no debt was collected; approximately $42 million of aggregate loss had been recognized for the quarter, with collections uncertain.
- Regulatory and legal matters: The company was discussing settlements with FINRA, SEC and CFTC concerning historical anti-money-laundering and Bank Secrecy Act procedures; it expected monetary payments and an independent consultant, and had established a reserve it considered adequate. A related Department of Justice inquiry continued. The Trading Technologies patent matter included a district-court trial scheduled for November 2020; a customer class-action negligence claim and other ordinary-course litigation also remained unresolved. Management could not quantify some litigation losses or ranges.
- Operations and reporting: Management said its technology infrastructure withstood elevated volumes and that remote work had not materially affected internal controls. The company changed income-statement presentation and discontinued segment reporting, with prior-period presentation adjusted for comparability.
Key facts for investors to verify
- Whether elevated trading activity and account growth persist as market volatility changes, and how lower rates affect net interest income and margin.
- The outcome and final cost of the April 2020 negative-oil-price customer losses, including any further compensation or collections.
- The valuation and subsequent performance of Tiger Brokers and other investments, and the continuing effect of the currency diversification strategy.
- The adequacy of the reserve and eventual terms for AML/BSA regulatory settlements, the DOJ inquiry, and material litigation developments.
- Whether customer balance movements, regulatory segregation requirements and excess regulatory capital continue to support liquidity through volatile markets.