Interactive Brokers Group, Inc. (IBKR) Q2 2011 Earnings Report, Transcript and Summary

Thomas Peterffy – Chairman, CEO and President Paul Brody – CFO, Treasurer and Secretary Deborah Liston – Director, IR

Good day, everyone, and welcome to the Interactive Brokers Second Quarter 2011Earnings Results Conference Call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Ms. Deborah Liston, Director of Investor Relations. Please go ahead.

Thank you. Welcome, everyone, and thank you for joining us today. Just after the close of regular trading, we released our second quarter financial results. We’ll begin the call today with some prepared remarks on our performance that complements the material included in our press release and allocate the remaining time to Q&A. Our speakers are Thomas Peterffy, our Chairman and CEO, and Paul Brody, Group’s CFO. At this time, I just like to remind everyone that today’s discussion might include forward-looking statements. These statements represent the company’s belief regarding future events that by the nature are not certain and outside the company’s control. The company’s actual result and financial condition may differ possibly materially from what’s indicated in these statements. For a discussion of some of the risk and factors that could affect the company’s future results, please see the description of those factors in our filings made with the SEC. I’d also direct you to read the forward-looking disclaimers in our quarterly release. With that, I’ll turn the call over to Thomas Peterffy.

Good evening. Before I get into the quarterly results, I would like to start regarding the GLOBAL effect on OCI out of the way. In the past quarter downward movement of the US dollar against our basket of currencies the GLOBAL had a favorable impact on our earnings to the tune of $50 million. This was counterbalanced by OCI or Other Comprehensive Income. That deducted $56 million of reported earnings but not from comprehensive income or net earnings. Had none of this had happened, our pre-tax earnings for the quarter would have been $155 million instead of $149 million reported. So this is one of those rare quarters in which the currency effects almost balance each other, our and reported earnings are fairly close to the actual operating results. Pre-tax profit from our Brokerage segment increased by 23% year-over- year. Although lighter trading volumes on global exchanges kept commissions at roughly the same level. We had an increase in the net interest income which rose 109% over the prior year and now accounts for nearly a third of Brokerage net revenues. This is directly related to the 111% increase in customer margin balances that have grown in response to our extremely low financing rates, which currently range from half of 1% to 1.6%. Customer account growth remains strong and steady growing 21% year-over-year to 176,000 accounts. The equity our customers hold grew by 57% to 25.7 billion. We typically see account growth slow in the second quarter and dip in June, which was the case this quarter. Still our growth rates continue to exceed our peers by a wide margin and the reason is quite simple. We offer our customers an unrivaled value by allowing them to trade a multitude of asset classes globally in several currencies using sophisticated trading…

Thank you, Thomas, and thanks, everyone for joining the call. As usual, I’ll review first our summary results and then give segments highlights before we take questions. The net revenues are driven by increases in trading gains and net interest income this quarter. Despite the continuing low interest rate environment, net interest income grew on a 52% increase in customer cash credit balances, and 117% increase in margin debit balances over the year ago quarter. The increase in trading gains was largely a reflection of currency translation effect, which negatively impacted the year ago quarter’s earnings and are reported in the results of the Market Making segment. The other driver of pre-tax income was a 4% reduction in non-interest expenses as lower volume levels drop down the variable cost of execution and clearing. Before we discuss our results further, I’d like to briefly explain the new accounting presentation known as comprehensive income. In prior periods, we discussed the currency translation as an item that we view as material to our operating results. Historically, the reporting of our currency translation gains and losses under GAAP arbitrarily shifted a portion of our currency hedging results from the income statement to the balance sheet. More specifically, the amount shifted was the change in dollar value of our foreign subsidiaries, also known as other comprehensive income. We included this item in our non-GAAP reporting of income so as to give a clearer presentation of the state of our operating businesses. Under the new GAAP guidance, the portion of the currency translation gains and losses reported as other comprehensive income is now reportable in the statement of comprehensive income. That’s a new statement which replaces the traditional income statement. The GAAP guidance requires this method to be applied starting January 1, 2012 and as permitted,…

Thank you. (Operator instructions) Our first question comes from Niamh Alexander from Keefe, Bruyette & Woods. Niamh Alexander – Keefe, Bruyette & Woods: Hi, thanks for taking my questions. Congrats on a good quarter. If I could expand on the brokerage a little bit, Thomas, you’ve been making inroads with the RIA community the registered advisors. Help me understand and what is it particularly that attracts those to your platform, because I understand it’s more of a custodian service they are looking for, it’s kind of a lot of the extra services on top of the platform that the existing brokerage there pretty embedded and it’s hard to move over to another. So can you help me understand how you’ve been successful, and what else we should look for going forward?

We do not find it difficult to make inroads in that segment. What attracks these folks in addition to our extremely low commissions and financing charges and better executions is the fact that our software is more capable of managing bunch of accounts by one or more individual, individuals namely, our allocation software is far superior, we are told to anything else that’s out there. Niamh Alexander – Keefe, Bruyette & Woods: And are you finding the existing customers that you’ve got on board are they using more of your services, are you kind of cross-selling some services?

Specifically, many of these registered financial advisors who are on an option overlay portfolio for their clients, like what we have to offer because they can basically come in and buy some securities and write options over them in blocks and then have our software allocated among the clients. And as the options then come, you’d roll them forward so for them it’s only one trade and it can go into 10, 20, 30, 100 accounts. Niamh Alexander – Keefe, Bruyette & Woods: Okay, it’s pretty neat. All right, that’s helpful. We can follow-up after. And if I can touch back on the Market Making a little bit here, because you indicated you thought some market participants pull away and you’re looking to see if some of the rules have an impact. How do you feel, do you feel like we’re kind of getting towards the end of the negative impact of some of those rule changes and new participants coming into the market and of course, impacting the spreads negatively?

Yes, I feel that the Market Making environment has stabilized, so there is still that one rule, the naked access rule that’s hanging out there and then, of course, I have no idea about the fallout from the Dodd Frank, which is still yet to come. I can’t tell what that will be, but for the time being I feel comfortable that the environment or Market Making is pretty stable and we will be able to go forward and generate a modest return. Niamh Alexander – Keefe, Bruyette & Woods: Still a business you very much want to be in?

Yes. Niamh Alexander – Keefe, Bruyette & Woods: Okay, thanks. Thanks for taking my questions.

Thank you. Our next question comes from Ed Ditmire from Macquarie. Ed Ditmire – Macquarie: Good afternoon.

Hi, Ed. Ed Ditmire – Macquarie: I just want to ask a little bit about your efforts to in terms of the capital introduction program. Sounds like a relatively unique program and I just wondered how difficult is it to get a hedge fund to commit to a program where they would only be able to get investments through your capital introduction program from people that were already Interactive brokerage client, is that something that is a stumbling block or is it something that would supplement other capital introduction efforts you might be undertaking?

I would like to make a correction. I didn’t mean to say that they are only allowed to take funds from current Interactive brokerage clients. What I said was that we, at this time, insist that all the funds that they are managing be with Interactive Brokers so that we can make sure that we don’t get into a Madoff situation, right? We can see how much money the fund has and how much money it earns and we can see all the trades and anything we need to look up. Ed Ditmire – Macquarie: Great. And I have a follow-up question on the RIA effort. Do you guys serve both RIAs and independent brokers?

Yes, we also do business for introducing brokers. Ed Ditmire – Macquarie: Not introducing brokers but independent brokers meaning independent financial advisors that are Series 7 commission-based sales people.

Series 7 commission-based people. Well, yes, our registered advisors can either mark up our small commission to limited extent or can charge fee, which we also regulate as to how much the fee can be. Ed Ditmire – Macquarie: Okay. Can you speak about the number of these kinds of financial advisors on your platform or maybe how many you add in a given quarter?

I’m sorry to say that I do not know the number. What I do know is that 18% of our accounts are financial advisor accounts. So it’s 18% of 176,000 and that 24% are customer deposits belong to those accounts and 16% of the commissions are generated by those accounts. Ed Ditmire – Macquarie: And one last question, do you guys charge a fee-based revenue at all in those accounts or is it all of the revenue model based on a net interest spread and commissions?

No, we only charge a commission. Ed Ditmire – Macquarie: Okay, thank you.

Thank you. Our next question comes from Rich Repetto from Sandler O’Neill. Rich Repetto – Sandler O’Neill: Good evening, Thomas. First, I want to congratulate in your top number one position on the DARTs.

Thank you. Rich Repetto – Sandler O’Neill: And my first question is when you’re going to achieve the second goal, that’s the profits?

I said within five years. Rich Repetto – Sandler O’Neill: You broke out the category of brokerage customers in the five categories and you’ve given us some transparency on what you’re working on as far as the hedge fund platform etc., But, which one is growing the fastest of the five broad categories?

I think the financial advisors have grown the fastest lately, but not by much. Slightly faster than the others. Rich Repetto – Sandler O’Neill: Right. And then super impressive the margin loan growth and we all know how profitable it is. I’m just trying to think of anything, anytime you grow that fast, is there any other impacts or after, I know there’s capital requirements on margin lending. Are you more putting more safeguard as collateralized loan but as far as losses or anything like that, but is this growth just as smooth as it appears in the outside?

It seems to be as smooth on the inside as it will be outside. Rich Repetto – Sandler O’Neill: Good for you. Last question is on the Market Maker, you made the comments that it didn’t achieve the 10% hurdle this quarter and you’ve been very transparent with the strategy there. I guess the question is though at some point, and this probably been asked before, is there a minimum capital level like you couldn’t just let it, not that it’s going to eat in again, but if they got to 2 billion or 1.5 billion couldn’t, at some point the Market Maker globally can’t be effective, I would assume?

If it’s not making money or substantially underperform our targets then obviously we would shrink it and close it. We will not run our business that doesn’t make money, but as I’ve said, as long as we can make 10% we will do it. Rich Repetto – Sandler O’Neill: Okay. Then very last question. On a naked access that’s been delayed, so you perform all checks, so your customers will see no… or should see no impact on the speed or difference because you’re already performing, you’re not providing a service like that, is that correct?

See, whenever a customer sends in an order, we assume that the order had been executed and reevaluate the customer position with that additional position and see if the margin requirements are still met. If they are then we execute the order and if they aren’t we reject the order. We’ve always done this, because I think it’s suicidal to go into the brokerage business without such a check. And I do not understand how people with substantial monies are willing to close their eyes and do this business without check. Rich Repetto – Sandler O’Neill: That makes a lot of sense. Thanks and we’ll talk to you soon.

Thank you.

Thank you. Our next question comes from Mac Sykes from Gabelli & Company. Mac Sykes – Gabelli & Company: Good evening, gentlemen. Just two quick questions here. First, assuming that ETrade did get purchased by another competitor, can you explain how that might affect your business?

Well, if ETrade were to be purchased by Ameritrade I guess for a few quarters we would again not be the first broker by DARTs. But, I think it would just set us back not too many quarters I would hope Mac Sykes – Gabelli & Company: Okay, just at a higher level just because of your experience, Thomas –

I would like to say that in addition of course, if ETrade went to Ameritrade or to any other existing broker, I think that we would get some customers would rub off, and hopefully, the larger more sophisticated ones of those would come to us. Mac Sykes – Gabelli & Company: Fair enough. Just to get your thoughts on stuff that’s going on in Washington these days, given your experience, I was just curious that what you might think some of the fallouts from a US downgrade might be, how much that impacted derivatives market in general? And then are you taking any actions with Timber or your counterparties in advance stocks deadline?

We had some years ago decided to keep our cash balance in all of our capital basically in GLOBAL, so we are diversified in that way. Personally, I would not attribute a great deal of significance to not raising the debt ceiling and so I don’t think that there will be any substantial fallout whichever way it goes. Mac Sykes – Gabelli & Company: Okay, I appreciate it, thank you.

Thank you. Our next question comes from Ed Ditmire from Macquarie. Ed Ditmire – Macquarie: I apologize if you’ve already said this, but did you guys say how much equity is in the brokerage unit first quarter?

I don’t think we said it, but I have not been again saying it. Do you know, Paul? I would guess it’s $1.4 billion. Ed Ditmire – Macquarie: And then one follow-up question to someone else’s question. Do you think that if ETrade was sold to another broker and was no longer owned by the largest shareholder being Citadel your key competitor, do you think you would market make more of their customers' orders than you do today?

I don’t believe, so you know, because these guys like to sell their customer order, order flow to people who are willing to pay for it and fool around with the orders. We are not in that business. We are extremely safe, we want to give the best execution to our customers and we know that and that will work for us and we will not play those games. Ed Ditmire – Macquarie: Okay, thank you.

Thank you. I’m showing no further questions at this time.

Wonderful, thank you very much.

Thanks, everyone for joining us. And just a reminder, that a copy of this webcast will be available on our Web site. Thanks and have a great evening.

Ladies and gentlemen, thank you for participating in today’s conference. This concludes our program for today. You may now disconnect and have a wonderful day.