Business context and reporting period
Interactive Brokers Group, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2019. It operates a global electronic brokerage business and a substantially wound-down market-making business. IBG, Inc. owns approximately 18.5% of IBG LLC; the remaining 81.5% is reported as noncontrolling interests, so consolidated net income substantially exceeds income attributable to IBG, Inc. common stockholders.
Financial performance and condition
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total net revenues | $466 million | $439 million | $1.437 billion | $1.411 billion |
| Income before taxes | $281 million | $276 million | $845 million | $887 million |
| Net income | $261 million | $258 million | $795 million | $835 million |
| Net income attributable to common stockholders | $36 million | $39 million | $117 million | $126 million |
| Diluted EPS | $0.45 | $0.51 | $1.52 | $1.71 |
| Pre-tax margin | 60% | 63% | 59% | 63% |
- Revenue drivers: Q3 commissions rose 12% to $187 million and interest income rose to $468 million, while interest expense increased to $177 million. Reported net interest income was $291 million, up $47 million year over year. Nine-month commissions fell 6% to $538 million; net interest income rose 16% to $796 million.
- Expenses: Q3 non-interest expenses increased 13% to $185 million. Nine-month expenses increased 13% to $592 million, including $45 million of customer bad-debt expense versus $2 million a year earlier.
- Cash flow: Operating cash flow was $2.178 billion for the nine months, compared with $2.764 billion in 2018. Investing cash outflow was $77 million and financing cash outflow was $358 million. Cash, cash equivalents and restricted cash increased $1.729 billion to $11.829 billion. Operating cash flow reflects significant changes in customer balances and other brokerage-related accounts.
- Balance sheet and liquidity: Total assets were $67.804 billion and total liabilities $60.151 billion at September 30, 2019. Total equity was $7.653 billion, including $6.248 billion of noncontrolling interests. Cash and cash equivalents were $3.035 billion; $8.794 billion was segregated cash for regulatory purposes. Customer receivables included $25.970 billion of margin loans. Short-term borrowings were $15 million; management reported no variable-rate debt outstanding. The company said 99.1% of assets were considered liquid and reported $6.177 billion of excess regulatory capital; regulated subsidiaries were in compliance.
Material changes versus the prior comparable period
- Q3 net revenues increased 6%, but income available to common stockholders and diluted EPS declined. Management attributed the modest increase in pre-tax income principally to stronger net interest income and commissions, partly offset by lower other income and higher expenses.
- For the first nine months, net revenues increased 2% while pre-tax income declined 5%. Higher net interest income was offset by lower commissions and trading gains, lower other income, increased expenses, and customer credit losses.
- Customer accounts rose 16% year over year to 666,000 and customer equity rose 10% to $156.6 billion. Q3 total customer DARTs increased 13% to 859,000.
- The company adopted lease accounting guidance in January 2019, recognizing $122 million of right-of-use assets and $126 million of lease liabilities at quarter-end. It reported $62 million of capital expenditures for the nine months, versus $23 million in 2018.
Outlook, management commentary, risks and unusual items
- No formal earnings guidance was provided. Management stated that operating cash flows, available cash and borrowing capacity should meet liquidity needs for more than the next 12 months. It expects to fund technology-related capital expenditures from operations and cash on hand.
- Management cited greater Q3 volatility and higher trading activity, but noted that trading volumes are unpredictable. Federal Reserve rate cuts and a flat or inverted yield curve may pressure future net interest income; the company shortened the duration of its U.S. government securities portfolio.
- A small number of customer accounts with concentrated positions incurred an approximately $42 million net loss during the first nine months. The estimated maximum loss is approximately $51 million if the security becomes worthless and no debt is recovered; collection efforts and ultimate losses remain uncertain.
- Currency diversification reduced Q3 comprehensive earnings by $75 million, compared with $27 million in the prior-year quarter. The reported Q3 loss in other income included a $47 million currency-strategy loss and a $13 million mark-to-market loss on Tiger Brokers; the nine-month period included a $16 million Tiger Brokers mark-to-market gain.
- Risks include customer margin lending and collateral concentration, foreign-exchange and interest-rate exposure, market volatility, regulatory change, and Brexit-related uncertainty. The company was providing information to FINRA, the SEC, the CFTC and the Department of Justice regarding anti-money-laundering and Bank Secrecy Act practices; outcomes were not predictable. Pending litigation includes a customer margin-liquidation class action and a patent dispute, with a trial in the patent matter scheduled for May 2020. Management said litigation outcomes could affect results in a given period, though it did not expect a material effect on business or financial condition.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Track whether the $42 million customer margin-loss incident is recovered, and whether losses approach the disclosed $51 million maximum.
- Assess the sustainability of net interest income as benchmark rates, customer cash balances, margin loans and securities-lending demand change.
- Separate consolidated results from the much smaller amount attributable to common stockholders, given IBG, Inc.’s approximately 18.5% ownership of IBG LLC.
- Monitor foreign-currency strategy effects, including the substantial Q3 impact on comprehensive earnings, and mark-to-market changes in investments.
- Follow regulatory inquiries, litigation developments, Brexit implementation and the maintenance of excess regulatory capital and customer-asset protections.