Interactive Brokers Group, Inc. — 2016 Form 10-K Summary
Business context and reporting period
Annual report for the year ended December 31, 2016; the filing also presents unaudited quarterly results. Interactive Brokers is a global electronic broker and market maker operating on more than 120 exchanges and market centers. Its two principal businesses are electronic brokerage and market making. IBG, Inc. consolidates IBG LLC, but owned approximately 16.6% of it at year-end; the remaining 83.4% was held by IBG Holdings LLC and is reported as noncontrolling interest.
Financial and operating results
| Metric | 2016 | 2015 |
|---|---|---|
| Total revenues | $1.475 billion | $1.256 billion |
| Net revenues | $1.396 billion | $1.189 billion |
| Income before income taxes | $761 million | $458 million |
| Net income | $699 million | $415 million |
| Net income available to common stockholders | $84 million | $49 million |
| Diluted EPS | $1.25 | $0.78 |
| Operating cash flow | $544 million | $725 million |
| Cash and cash equivalents at year-end | $1.925 billion | $1.601 billion |
Consolidated pre-tax margin rose to 55% from 39%. The year-end balance sheet reported $54.7 billion in assets, $48.9 billion in liabilities and $5.82 billion in total equity, including $4.85 billion of noncontrolling interests. About 99.1% of assets were considered liquid. Short-term borrowings were $74 million at year-end, versus none in 2015; the filing reports no variable-rate debt outstanding. Customer balances, securities lending and other brokerage-related balances make the balance sheet large and should not be read as conventional corporate leverage.
- Electronic brokerage: Net revenue was $1.239 billion, up 13%; pre-tax income was $756 million, up 41%, with a 61% pre-tax margin. Customer accounts grew 16% to 385,000, and customer equity rose 27% to $85.5 billion. Annual DARTs increased 2% to 660,000.
- Market making: Net revenue fell 36% to $190 million; pre-tax income declined 66% to $44 million, and margin fell to 23%. Trading gains dropped 39% to $163 million.
- Interest income: Net interest income increased 24% to $527 million; net interest margin rose to 1.11% from 1.03%. Growth reflected higher customer cash balances, securities lending income and a higher average federal funds rate.
- Trading and commissions: Commissions and execution fees edged down 1% to $612 million. Overall options and stock-share volumes declined 10% year over year, while futures volume rose 2%.
Fourth quarter: 2016 revenue was $215 million, net revenue $193 million, pre-tax income $28 million and net income attributable to common stockholders $4 million; diluted EPS was $0.07. In 4Q 2015, the corresponding figures were $289 million, $271 million, $127 million, $17 million and $0.25. The sharp year-over-year decline merits attention.
Material changes versus the prior comparable period
- Net revenue rose 17% and pre-tax income rose 66%, primarily reflecting a 24% increase in net interest income and the absence of the prior-year Swiss franc-related customer bad-debt charge.
- Non-interest expenses declined 13% to $635 million, mainly because customer bad-debt expense fell to $6 million from $146 million. The 2015 charge included $137 million of unsecured losses associated with the January 2015 Swiss franc event.
- Trading gains weakened substantially amid lower trading volumes, lower volatility and a lower actual-to-implied volatility ratio. Market making’s share of earnings and revenue continued to diminish relative to brokerage.
- Other income improved to $94 million from a $122 million loss. Currency-diversification losses were $40 million versus $206 million, while U.S. government securities recorded $26 million of net mark-to-market gains versus $33 million of losses.
- Cash from operations decreased to $544 million from $725 million, despite higher net income; management notes operating cash flow is materially affected by changes in customer balances and trading positions.
Outlook, risks, contingencies and unusual items
- No specific earnings or revenue guidance is provided. Management said cash flows, available cash and borrowing capacity should meet liquidity needs for more than 12 months. It planned to continue quarterly dividends of $0.10 per share for the foreseeable future; the board declared a $0.10 dividend in January 2017.
- Management cited trading activity, market volatility, interest rates, customer growth, competition and regulatory developments as important drivers. It warned that market-making earnings are unpredictable and that competition and tighter bid/offer spreads may pressure results.
- The company reported cumulative Swiss franc-event losses of approximately $118 million, net of hedging and debt collection efforts, and continues to pursue collection. The ultimate impact depends on recoveries.
- Currency diversification reduced 2016 comprehensive earnings by $65 million, compared with a $269 million reduction in 2015. Approximately 53% of equity was denominated in currencies other than the U.S. dollar at year-end; the GLOBAL currency basket was revised during 2016.
- Customer margin credit outstanding was $19.4 billion. Automated real-time margin monitoring and liquidation are key mitigants, but losses may exceed collateral in fast or illiquid markets. The company also disclosed off-balance-sheet futures exposure and guarantees to clearing organizations whose potential liability is not quantifiable; management considers payment under the guarantees remote.
- Pending matters include patent litigation brought by Trading Technologies and a customer class action concerning margin liquidations. The class complaint was dismissed, but plaintiff motions remained pending. The company also reported numerous regulatory inquiries, said it knew of no specific inquiry expected to have a material impact, and anticipated ongoing regulatory fines that cannot be predicted.
- Governance and capital structure: the founder and affiliates control approximately 83.4% of voting power through Holdings. The company is a controlled company and may issue additional shares over time in connection with member redemptions, creating potential dilution. Under the tax receivable agreement, 85% of realized tax savings from certain tax-basis increases is payable to Holdings; the recorded payable was $285 million.
- The financial statements received an unqualified audit opinion, and management and the auditor reported effective internal control over financial reporting as of December 31, 2016.
Most important facts for investors to verify
- Whether brokerage growth and higher net interest income can offset continuing declines in trading volumes, commissions per trade and market-making profitability.
- How much of 2016’s earnings improvement reflects recurring operating performance versus the non-recurrence of the Swiss franc loss and changes in currency and securities mark-to-market results.
- Subsequent recoveries on the approximately $118 million Swiss franc-related customer losses.
- Liquidity and risk exposures underlying the large customer-related balance sheet, $19.4 billion of margin credit and clearing-member guarantees.
- Potential outcomes and costs of the patent case, customer litigation and ongoing regulatory inquiries.
- Future share issuance and redemption activity, the 85% tax-receivable payments, and the implications of concentrated voting control.