Interactive Brokers Group, Inc. (IBKR) Q Earnings Conference Call January 21, :30 PM ET - PDF

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Interactive Brokers Group, Inc. (IBKR) Q Earnings Conference Call January 21, :30 PM ET Executives Chairman, Chief Executive Officer and President Paul J. Brody Chief Financial Officer, Treasurer,
Interactive Brokers Group, Inc. (IBKR) Q Earnings Conference Call January 21, :30 PM ET Executives Chairman, Chief Executive Officer and President Paul J. Brody Chief Financial Officer, Treasurer, Secretary Deborah Liston Director of Investor Relations Analysts Sean Brown Teton Capital Group, LLC Richard H. Repetto Sandler O'Neill & Partners LP Macrae Sykes Gabelli & Company, Inc. Niamh Alexander Keefe, Bruyette & Woods, Inc. Fang Li Baleen Capital Management LLC Operator Good day, everyone, and welcome to the Interactive Brokers' Fourth Quarter 2013 Earnings Results Conference Call. This call is being recorded. At this time, for opening remarks and introduction, I would like to turn the call over to Ms. Deborah Liston, Director of Investor Relations. Please go ahead. Deborah Liston Thank you, operator and welcome everybody. Hopefully, by now you ve seen our fourth quarter earnings release, which was released today after the market closed, and which is also available on our website. Our speakers today are, our Chairman and CEO and Paul Brody, our Group CFO. Today, we ll start the call with some prepared remarks about the quarter and then we'll take questions. Today's call may include forward looking statements, which represent the Company's belief regarding future events and by the nature are not certain and outside the Company's control. Our actual results and financial condition may differ possibly materially from what's indicated in these forward looking statements. We ask that you refer to the disclaimers in our press release. You should also review a description of the risk factors contained in our financial reports filed with the SEC. I'd now like to turn the call over to. Good afternoon everyone and thanks for joining us to review our fourth quarter performance. We ended 2013 on an upbeat note with strong performance from our Brokerage business which continues to steal the spotlight from the Market Making segment and drive the Company s growth. Despite the typical seasonal slowdown we would normally see at the end of the year, we added more Brokerage accounts in the fourth quarter than each of the prior three quarters giving further credence to our growth momentum and the ability to outperform our industry peers in the long term. This rising trend can be attributed not only to the steady flow of positive word of mouth referrals we received from our expanding customer base, but also through the success of our latest initiatives including segment focused marketing campaigns and our determination to continue bolstering the value of our platform with new technological innovations. Case in point, in the second half of 2013 we ve rolled out a number of exciting new option trading tools that not only complement the extensive suite of tools we currently have, but that further solidify our reputation as the premier broker and the only options broker for the investors who are concerned with execution prices which we know is an important determinant of overall investment performance. To briefly review the operating environment of the fourth quarter we were pleased to see higher trading volume, driven in part by rising investor confidence, allowing us to record our highest quarterly commissions ever. Persistently low interest rates also encouraged customers to take advantage of our industrial marginal lending rates, which currently range from 0.5% to 1.58% depending upon the size of the loan, driving our margin balances to a record high. While we witnessed rising volatility levels early in the quarter fueled yet another debt ceiling debate, this spike quickly dissipated and volatility levels settled down throughout the rest of the period. Before I get into the segment details, let me give you an overall picture of fourth quarter results before any unusual items and currency or tax effects. For the quarter, we reported pretax income of $39 million. Excluding currency effects and unusual items, it was $144 million composed of $113 million Brokerage and $37 million Market Making and a loss of $6 million in corporate. For the full year, we reported pretax income of $451 million. The corresponding numbers excluding currency effects and unusual items are $613 million of pretax income comprised of $455 million of Electronic Brokerage and $161 million for Market Making, and a loss of $3 million for corporate. The total per share impact of both the currency effect and the unusual item is a negative $0.16 for the quarter and a negative $0.25 for the therefore eliminating those, our normalized EPS is about $0.23 this quarter and $0.98 this year. Now I will explain these items in further detail. The unusual item is a $73 million loss we have reported on our books for the Singapore incident that we discussed we disclosed in October. As a reminder, certain of our brokerage customers took large positions in a few related stocks listed on the Singapore Stock Exchange last year. In the beginning of the fourth quarter, these stocks lost over 90% of their value in a very short period of time and we are able to liquidate only a small portion for the exchange of the trading. We are pursuing legal actions to recuperate our loss base and have secured freeze orders in Malaysia and Singapore, but this process will take a long time. We said in October, that the maximum loss would be $84 million. However, because we were able to take the stocks onto our books at a value of about $20 million to offset the margin call, we have a $64 million that has been recorded in bad debt in the Brokerage segment. These stocks have lost about half their value, so we ve also recorded a loss of $10 million in the Corporate segment bringing the total impact to $74 million. As I explained in the last earnings call, this event was an anomaly. Our real time risk management controls would normally kick in and start liquidating the positions to prevent such a large loss, but in this case our hands were tied because the exchange halted trading almost immediately. So after this loss occurred, we took swift action to modify our margin lending methodology, specifically on stocks that rapidly appreciate in value like these did to prevent similar event in the future. I will now explain the currency effects that I also excluded from normalized results. As you know we keep our total equity of $5.1 billion in our self defined basket of 16 currencies we call the GLOBAL in order to minimize the currency risk that we would otherwise be exposed to as an internationally diversified firm trading products in 25 different countries. In the fourth quarter, the value of the GLOBAL declined by half of 1% of the U.S. dollar which resulted in a decrease in our comprehensive earnings for about $25 million, this was $31 million is reflected in trading gains, offsetting gain of $6 million reported below the line in Other Comprehensive Income or OCI. For the full year, the large swing we saw in translation gain and loss from quarter toquarter netted to roughly $116 million decrease is comprehensive earnings due to the strengthening of the U.S. dollar during the year, which equates to about 2% of our total equity capital. And now I ll review the performance of our Brokerage segment. We achieved many important milestones in Early in the year we received the distinction for the second year in a row being named the number one Online Broker from Barron s in their annual review of Electronic Brokers with IB scoring highest in several categories including Best International Trading, Best for Frequent Trader, Best Portfolio Analysis Report and having the widest range of offerings. This recognition has boosted our exposure to professional traders, our credibility with institutions and has helped to further expand our customer base. We added mainly 30,000 customer accounts during the year finished 2013 with 239,000 accounts. This represents a 14% increase year over year. We have a diversified customer base with over 40% of our accounts being institutions including hedge and mutual funds and proprietary trading desks, in addition to accounts of independent financial advisors and introducing brokers. The remainder is comprised of individual traders and investors. Our customer base is also geographically diversified, with our customers residing in nearly 200 countries and over 60% of new accounts coming from outside the United States. The 30,000 newly added accounts are the result of about 60,000 new accounts opening and 30,000 accounts closing. One of the top reasons why people close accounts is that they are irked by the monthly minimum commission requirement of $10. In any one month in which an account pays less than 10 dollars of commission, we charge them the difference and this seems to anger people to a point as they move their accounts elsewhere and do not recommend us to others. Bending to popular demand, starting this year we have decided to eliminate this $10 minimum commission requirement for accounts with a net liquidating value over $100,000. Customer equity has grown to $45.7 billion, a 39% increase over the prior year. Additionally, since they are attracting more institutional accounts, the average equity per customer account has expanded 22% this year to an average of over 190,000 per account. Our prime brokerage business has taken off since we first started targeting this segment. Today we have over 1,300 hedge fund clients, an increase of 8% over the last year. These funds range from start up managers with a few hundred thousand dollars to larger, multi billion dollar funds. The value proposition when comparing IB to the large investment banks is clear. Our customers get superior price execution, since we don t internalize or sell their order flow, but quite the opposite, we invest a great deal of our resources into the maintenance, and further development of our order routing technology to secure the best execution prices for our customers orders. In addition, we provide state of the art trading technology, sophisticated algorithms, broad global trading access and securities financing, all of the fraction of the costs charged by these large banks. Not to mention our Hedge Fund Capital Introduction Program has seen tremendous success since we first launched it in Of the funds that were participating in IB s Capital Introduction program as of January 1, 2014 and had been in the program for at least three months, approximately 60% of them have been seen at least one investment from an investor through this program. In addition to Capital Introduction, hedge funds value our premier securities lending and financing. IB customers not only benefit from our deep inventory of equities available to borrow, but also our very competitive lending rates, and informational tools we provide for locating hard to borrow stocks. Currently we are able to source about 60% to 75% of borrows internally and we are connected to about 60 counter parties including agents, lenders and brokers for sourcing other hard to borrow items. Our pre borrow program give customer the convenience of locating borrows in anticipation of a short sale and helps mitigate the chances of both buy ins and close outs. As I mentioned earlier, customer margin balances are at a record high, growing 38% this year to $13.5 billion. This has contributed to 25% increase in net interest income over the prior year. Margin as a percentage of customer equity has stayed pretty consistent with about 30%. In the Brokerage space, one of our biggest advantages over the competition has always been the fact that we are first and foremost the technology firm with emphasis on building systems and applications. As a result, we are constantly working to maximize the value of our platform by actively rolling out new product development, trading tools and tradable products and markets while at the same time keeping our costs at the lowest possible level. As I mentioned earlier, we have introduced a number of exiting new tools this year, especially focused on option trading. In the fourth quarter, we rolled out the Options Strategy Lab and the Probability Lab, the latter of which have been marketing very heavily through print and television advertisements. The Options Strategy Lab gives traders the ability to input their price or volatility forecast for any U.S. or a foreign equity into the strategy scanner and receive suggested simple or complex options strategies which can be compared and analyzed based on lowest costs, highest reward to risk ratio, largest gain on lowest maximum loss. The Probability Lab takes this to the next level by utilizing the same technology and giving the trader a visual tool to think about options trading without complicated mathematics. With the Probability Lab, the trader can view the probability distributions for any U.S. or foreign equity, currency or future contract as implied by the prevailing option prices. If their opinion of this distribution differs from what the market is implying they can manually adjust the distribution curve and then receive options trade sorted by the highest Sharpe ratio based on that difference. In addition to the marketing efforts I just mentioned, we have also been highlighting valuable uses for the Probability Lab through daily commentary posted by our traders and market participants to the IB Traders Insight, which, by the way is also a new service we have initiated during the past quarter and which you can access from the homepage of our website. I believe that with the use of options, we will continue to grow as more and more investors come to understand the benefit of using options as part of building and managing their portfolio. The latest tools we have developed will help our customers find more opportunities to trade options which will in turn increase our market share and further improve our execution quality beyond the high level we already achieve. I do believe that options are a critical component of our continued success. Now I will review the performance of our Market Making segment. Market Making pretax profit of $6 million, fell 61% from a year ago quarter and 92% from the prior quarter. However, if we back out the currency effects, we have a clearer picture of our performance. As I mentioned earlier, this period s trading gains were negatively impacted by a translation loss of $31 million. After backing this out, pretax Market Making profits totaled $37 million compared to $46 million in the year ago quarter and $41 million in the prior quarter. For the full year we reported pretax Market Making profits of $72 million this year compare to $189 million in After backing out the currency effects, pretax profit of in Market Making were $161 million in 2013 compare to $227 million in The environment for Market Making remain tepid with volatility levels remaining at historic lows for much of 2013 and competition remaining strong keeping bid/offer spreads on exchange traded products very narrow. Volatility levels as you know are directly correlated with our Market Making trading gains. The average VIX this quarter totaled 14.2 consistent with the prior year quarter and 15% lower than the year ago quarter. And when comparing 2013 to 2012 the average VIX was 20% lower, which was a primary driver for the 30% drop in pretax profit. The ratio of actual to implied volatility, which measures our profit captured versus our cost of hedging was 73% this quarter compared to 63% in the prior quarter, 75% in the year ago quarter. According to data obtained from the exchanges we do business, exchange traded option volume increased 8% in the U.S. but decreased 2% globally for the fourth quarter. By comparison, our firm s total option volume increased by 1% and as a result our firm s market share was stable at 11.7% in the U.S. and increased from 8.7% to 9% globally. In the Market Making segment alone our option volume decreased by 6% during the fourth quarter, which drove our market share in that segment from 5.9% to 5.5% in the U.S. and from 5.3% to 5.1% globally. We continue to pay a $0.10 quarterly dividend for Market Making capital. This quarter we earned only about 1% return on equity, far below our 10% hurdle rate and as such we naturally decreased capital in this segment. We plan to continue monitoring the Market Making environment as we consider our future in this business, but in the meantime we have reduced our participation in less profitable markets and products and have been working to reduce our overhead costs in this segment as well. Thanks to the strong growth of our Brokerage segment combined with the shrinking of the Market Making segment, total capital in Brokerage has for the first time surpassed that of Market Making. And for 2013 Brokerage comprised over 85% of total pretax profits, but this number is really 75% if you back out the unusual and currency items. As we begin 2014, we have just launched a next phase our global market place we are building for institutional traders and investors. As you know we already have our Hedge Fund Marketplace also known as our Capital Introduction Program in place as well as our Money Manager marketplace which brings together Wealth Managers and Money Managers. This month we have also launched our Administrators Marketplace which allows third party administrators, auditors and legal counsel to market their services to hedge funds, advisors and prop trading accounts on our platform as well as have a single login to manage all their IB institutional client accounts they currently service. Our initiative to create this global marketplace has been very successful thus far in drawing institutions to our platforms and we believe this next step, will be very beneficial to our presence in the hedge fund space. I will now turn the call over to our CFO Paul Brody who can review the details of the financials. Paul J. Brody Thank you Thomas, good afternoon and thanks for joining the call, as usual I ll review our summary results, and then give segment highlights before we take questions. Fourth quarter results shows continuing strength in the brokerage business and tepid earnings in the Market Making segment. As compared to the year ago quarter net revenue for this quarter was driven by rising brokerage commissions and net interest income partially offset by declines in trading gains and a loss on the Singapore stocks event. Full year results showed similar strength in brokerage and thin Market Making profits further buffeted by adverse currency improvements. Our net pretax profits of $451 million represented a return on average equity of 9% and a profit margin of 42%. Our financial statements include the GAAP accounting presentation known as Comprehensive Income. Comprehensive Income reports all currency translation gains and losses, including those that reflect changes in the U.S. dollar value of the Company s non U.S. subsidiaries (known as Other Comprehensive Income, or OCI ). These are reported in the Statement of Comprehensive Income. The performance of the US dollar relative to other currencies was quite mixed in While certain of the larger components in the currency basket we call the GLOBAL strengthened against the US dollar, a number of other components weakened more than 10% against the dollar. In aggregate the GLOBAL, as expressed in US dollar terms, declined 0.5% for the 4th quarter and 2.4% for the year. OCI is a component of the total GLOBAL effect. Adding OCI to Net Income increased our reported diluted EPS by $0.02 for the quarter and decreased it by $0.06 for the full year. The unusual loss of about $74mm related to the Singapore stocks impacted EPS by an estimated $0.11. Overall operating metrics for the latest quarter were mixed. Volumes were up in futures and stocks and down in options vs. the year ago quarter. Average overall daily trade volume was just over 1 million trades per day, up 16% from the 4th quarter of Electronic Brokera
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