Interactive Brokers Group, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Unaudited consolidated results include IBG LLC, although IBG, Inc. directly owned approximately 18.1% of IBG LLC; most consolidated earnings were attributable to noncontrolling interests.
Business context
Interactive Brokers is a global electronic broker, executing and clearing trades across more than 120 exchanges and market centers. Its two segments are electronic brokerage and market making. The company was winding down most options market-making activities following the 2017 transfer of its U.S. options business and exit from most non-U.S. options market making.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenues | $558 million | $487 million | $1.732 billion | $1.334 billion |
| Net revenues | $439 million | $426 million | $1.411 billion | $1.187 billion |
| Income before taxes | $276 million | $268 million | $887 million | $685 million |
| Net income | $258 million | $247 million | $835 million | $629 million |
| Net income available to common stockholders | $39 million | $31 million | $126 million | $78 million |
| Diluted EPS | $0.51 | $0.43 | $1.71 | $1.10 |
- Q3 net interest income was $244 million, up 34%; nine-month net interest income was $686 million, up 43%. Higher benchmark rates and larger customer credit and margin-loan balances were the main drivers. Interest expense also rose substantially: to $119 million from $61 million in Q3, and to $321 million from $147 million year to date.
- Commissions rose 2% in Q3 to $167 million and 20% for the nine months to $572 million. Other income fell to $21 million from $70 million in Q3 and to $121 million from $205 million year to date, largely reflecting weaker currency-diversification results and nonrecurring prior-year gains.
- Non-interest expenses were $163 million in Q3, up 3%, and $524 million for the nine months, up 4%. Q3 general and administrative expense increased 67% to $25 million, primarily due to professional services and legal and regulatory costs.
- Pre-tax margin was 63% in Q3, unchanged year over year, and 63% for the nine months versus 58%. Electronic brokerage pre-tax margin improved to 66% in Q3 from 61%, and to 64% for the nine months from 60%.
- Electronic brokerage Q3 net revenue grew 21% to $444 million; customer accounts rose 26% year over year to 576,000, customer equity increased 23% to $142.5 billion, and total customer DARTs increased 10% to 763,000. Market-making income before tax was $7 million in Q3 versus $11 million, and $25 million for the nine months versus a $35 million loss.
Balance sheet, cash flow and capital
- At September 30, total assets were $62.1 billion and total liabilities $55.2 billion. Total equity was $6.9 billion, including $5.7 billion of noncontrolling interests; stockholders’ equity attributable to IBG, Inc. was $1.2 billion.
- Cash and cash equivalents were $3.1 billion, with a further $7.5 billion segregated for regulatory purposes. The company described approximately $61.7 billion, or 99.4% of assets, as liquid, but much of its balance sheet consists of customer-related, collateralized or regulated balances and is not equivalent to unrestricted corporate cash.
- Short-term borrowings were $28 million, versus $15 million at year-end 2017; securities sold under repurchase agreements were zero, down from $1.3 billion. The company reported no variable-rate debt outstanding.
- For the nine months, operating cash flow was $2.764 billion, investing cash flow was negative $43 million, and financing cash flow was negative $341 million. Cash, cash equivalents and restricted cash increased $2.306 billion to $10.585 billion. The filing cautions that operating cash flows largely reflect changes in customer balances and trading positions.
- Aggregate excess regulatory capital was $5.5 billion; all regulated operating companies were in compliance with their capital requirements. Management said available cash, operating cash flow and borrowings should meet liquidity needs for more than 12 months.
Material changes, outlook and risks
- The currency-diversification strategy produced a $24 million Q3 loss in other income, versus a $26 million gain a year earlier; management said the strategy reduced Q3 comprehensive earnings by $27 million. For the nine months, the strategy’s reported result was a $7 million loss versus a $104 million gain.
- Management expects approximately $40 million of annual expenses associated with the exited options market-making business to be absorbed by electronic brokerage. About 95% of the related resources had been transferred by September 30, with most of the remainder expected to transfer in Q4 2018. The Two Sigma agreement provides possible future earn-out income tied to business performance.
- There was no quantified earnings or revenue guidance. Management cited customer growth, trading activity and higher interest rates as business drivers, while noting that trading volumes are unpredictable and rate, market and currency movements can affect results.
- Risks include customer margin lending and liquidation exposure, market and foreign-exchange volatility, interest-rate changes, competitive pricing, regulatory scrutiny and potentially unpredictable trading losses. The company noted that margin-related exposure can be significant and is not quantifiable, especially in illiquid or rapidly moving markets.
- Pending matters include a patent dispute in which the company says ten of twelve asserted patents were found unpatentable, with appeals concerning the remaining two; and a customer class action whose negligence claims were remanded for further proceedings after other claims were dismissed. Management said litigation reserves were not material, but outcomes remain uncertain. The company also expects significant and increasing regulatory fines over time, although their amount and timing are unpredictable.
- The Tax Act reduced the U.S. corporate tax rate to 21%. The company recorded a provisional $62 million transition-tax obligation and reported a $4 million one-time Q3 tax expense related to remeasurement of deferred tax assets. It said the tax accounting remained subject to further analysis.
- Effective January 2019, new lease accounting was expected to increase reported assets and liabilities; management did not expect the balance-sheet gross-up to be material.
Most important facts for investors to verify
- Whether growth in net interest income persists as rates, customer cash balances, margin loans and the cost of interest paid to customers change.
- How much reported earnings depend on currency diversification, investment marks and other non-core items, and how those effects reconcile to comprehensive income.
- Whether customer-account and equity growth converts into durable trading activity and commission revenue, given lower commissions per DART and weaker sequential DARTs.
- The timing and actual cost of transferring the remaining market-making resources, plus any earn-out income from Two Sigma.
- The distinction between regulated or customer-related liquidity and unrestricted corporate funds, and the continued adequacy of excess regulatory capital.
- Developments in the customer negligence remand, patent appeals, regulatory inquiries and potential fines, as well as final Tax Act accounting.