Good day, ladies and gentlemen. And welcome to the Interactive Brokers Group fourth quarter financial results conference call. At this time, all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference is being recorded. I would now like to hand the floor over to Nancy Stuebe, Director of Investor Relations. Please go ahead.

Thank you, operator. And welcome, everyone, to our fourth quarter earnings call. Our earnings were released after the market closed and are also available on our website. Our speakers today are Thomas Peterffy, our Chairman and CEO, and Paul Brody, our Group Paul Brody CFO. We will start the call with some prepared remarks about the quarter and then we will take your questions. As a reminder, today’s call may include forward-looking statements, which represent the company’s beliefs regarding future events, which, by their nature, are not certain and are outside of the company’s control. Our actual results and financial condition may differ possibly materially from what is 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 risk factors contained in our financial reports filed with the SEC. And now, I’d like to turn the call over to Thomas Peterffy.

Thank you for joining us for our final 2016 earnings conference. We finished the year with some surprises in the otherwise usually seasonally subdued holiday quarter. The results of the election surprised many investors, and people who read the New York Times and did not watch my interview on CNBC on October 3 may have mistaken its likely impact on the markets. Kidding aside, the night and days following the election brought some welcome trading volume to the markets in an otherwise lackluster quarter. Our pretax income for the quarter was $28 million and for the full year $761 million. Correcting for the unfavorable currency fluctuations, these would have been $181 million for the quarter and $801 million for the full year. 2016 was an unusually slow year for the markets. Aside of a few days of sudden spurts of activity following the BREXIT and the US general election votes, there was very little activity in the markets and volatility was at historic lows. Indeed, our commission revenue declined from $617 million in 2015 to $612 million in 2016. This in spite of the number of accounts having increased by 16% to 385,000 and our customer assets increased by 27% to $85.5 billion. Continuing with the trend of the previous years, Market Making pretax income diminished to $44 million from the previous year’s $130 million, while brokerage has increased 41% from $536 million to $756 million, although the 2015 number was diminished by $140 million differentially greater bad debt expense due to the Swiss franc debacle. Without that, pretax profits from brokerage would have increased by 12%. As I said earlier, commission income decreased for the year, so that this overall income increase is mostly due to $98 million increase in interest income. As previously indicated, this week we are…

Thank you, Thomas. Thanks, everyone, for joining the call. I’ll start with our summary results and then move on to segment highlights before we open it up to questions. The fourth-quarter operating results reflected a solid performance in Brokerage, led by gains in net interest income and a positive swing in mark-to-market value of investments on US government securities versus the prior year quarter. These were largely offset by currency translation losses and lower earnings in the Market Making segment. Full-year results showed strength in core brokerage and continued decline in Market Making. Our pretax income of $761 million represented a return on average equity of 13% and a profit margin of 55%. Excluding currency translation effects and Treasury marks, our profits were $775 million with a similar pretax margin. Overall operating metrics reflected a somewhat better trading environment, but still sluggish market volatility. While we saw an increase in activity around the US presidential election in November, the subsequent decline in December activity led to quarterly total DARTs at about 3% below the average for the year. Average overall daily trade volume for the quarter was 1.32 million trades per day, even with the fourth quarter of 2015 and up 5% sequentially as the average VIX level declined 18% and rose 6% respectively over the same time period. We continued to see strength this quarter in asset gathering and margin balances and brokerage as I’ll describe in my comments on that segment's performance. Electronic Brokerage metrics showed solid increases in the number of customer accounts and customer equity, up 16% and 27% respectively. Total and cleared customer DARTs were unchanged and up 2%, respectively, from the year-ago quarter even in the face of low volatility. Orders from cleared customers who clear and carry their positions in cash with us…

Thank you. [Operator Instructions] Our first question comes from the line of Conor Fitzgerald from Goldman Sachs.

Good evening. A couple on your net interest income. I guess, leaving rates aside for a moment, you mentioned growing your stock lending business, can you help us get a sense of how much additional net interest income upside there is for you as you continue to kind of grow that part of your business?

I’m not sure we could quantify it looking forward, but it certainly grows in line with the growth of our balances naturally. To the extent that we’re successful in attracting more professional customers, more hedge funds, they seem to have an interest in the short side of the market, more than individuals. And so, to the extent that we can better our services there, so that that portion of interest revenue will thrive along with that part of the business. And we’re being pretty successful in that lately.

And then, Paul, I think I heard you say $45 million from the next Fed hike. I just wanted to clarify that. Not what the Fed did in September, but prospectively another 25 basis points higher.

Right. With the next 25 basis point move, we would expect in the numbers $41 million, in terms of interest rate sensitivity. As I said, further increases would produce smaller results because once we're into positive rate territory, which we now are, the interest spread is locked in. We give a very narrow spread to our customers on both the debit and credit side. And so, we would benefit on smaller balances and on things like short stock borrow opportunities. But other than that, it would basically rise with the rising balances.

Okay. I thought that your pricing model was 50 basis points of Fed funds; after that, you started sharing with the client. So, I just – the $41 million was a little higher than, I think, I and a couple of others would have guessed. So, I wanted to understand, I guess, why the Fed going up to, whatever, 90 basis points just was more asset sensitive than kind of 90 to 115, but that makes sense. And then on the employee compensation, I think you’ve mentioned some of the compliance costs coming in, are those fully in the run rate at this point?

I'm not sure we can answer that question. As our business grows, we add on different kinds of legal and compliance support services. So, we now have an entity called Greenwich Advisor Compliance Services, as Thomas mentioned. And these costs go into revenue-producing activities. They’re not all in the background. So, there's a mix. I’m not sure any of us know what the regulatory environment holds for us going forward. So, it’s some combination of expanding the size and complexity of the business, and the regulatory environment in general.

Conor, I said in my part that we do not pay interest to accounts with liquidating values under $100,000. And quite a few of our accounts are in that category.

That’s helpful. I think what I was just trying to understand is why that $41 million would then go to some de minimis amount if you're presumably not paying interest through the cycle on those smaller clients. But I’m just trying to understand why it goes to $41 million, and so that’s down to something de minimis and why it’s not more sustainable.

Well, because it’s not de minimis. There is a very substantial amount of money in those accounts.

That’s helpful. Thank you.

Thank you. And our next question comes from the line of Rich Repetto from Sandler O’Neill.

Yeah. Good evening, Thomas. Good evening, Paul. I just want to follow up on the comp question here a bit because it’s just – I know you've been adding people in the areas that you talked about, Paul, but if you look at the quarterly comp for the year, it was – the first three quarters at $58 million and then you jump up $10 million in the fourth quarter. And I thought you said the headcount didn't really – it was only a single-digit percentage, I thought, quarter-to-quarter. I guess the question is why the step up in comp in 4Q.

The reason is bonuses, actually. Bonuses.

So, most of it’s accrued, and then sometimes we have adjustments to true-up to actual at the end of the year.

So we paid higher bonuses than we accrued.

Right.

Okay. Because I'm looking back at prior years and that hasn't been a trend in the fourth quarter except for this year. Anyway…

It’s a very competitive world.

Okay. Okay. The next question is, on the net interest income, Paul, it was pretty flat quarter to quarter. And the balances, it looked like they grew either high-single-digit –more than what you would guess. So, I guess, was there – I’m just trying to see how you didn’t – realize a bigger increase in net interest income, given the growth in the balances quarter-over-quarter.

You mean sequential quarters?

Yes.

Not versus the prior year?

Right, correct.

Right, right. So, we had a 7% sequential increase in debit balances. Credits were roughly kind of flat. In fact, down very slightly. And sequentially, we had a 1% increase in net interest. Understand, partly – there’s a couple of effects here. One is that larger customers are going to get the best rates, meaning the smallest spread to us. That’s one effect. We’re happy to take in that business. It’s just perhaps incrementally at a smaller spread. And there are sometimes extra costs around – at end of period, especially around end of year when markets tighten up and things like the foreign currencies – and there are a number of currencies that are in negative interest-rate territory, like the Euro. And to the extent that we don’t pass on all of that cost to our customers, we absorb some of that.

Okay. I guess, the last question, Thomas, is – and you sort of talked about this in the prepared remarks. But you got the agreement with Zions, and you got more potential there to do this other banks and brokers, I suspect. And, I guess, the question is, will the incremental customer that you’re getting from these introducing brokers or – and even these banks where you have the sort of the relationship with – like, will you get the same customer that has a level of trading activity that you've been accustomed to in the past, I guess is the question. It seems like you’re growing…

As I said, introducing broker customers are yielding us roughly half as much as regular customers do, all in. So, the commission they generate is about a third or maybe even less – they may be even less than that. Interest income is also less, but not that much less.

Okay. Okay. That's helpful. Thank you. I’ll get back in the queue if there are, I guess, more questions. Thanks.

Thank you. And our next question comes from the line of Chris Harris from Wells Fargo.

Thank you. I want to follow up on that last question regarding the introducing broker relationships. Do you guys handle all the customer service requests for those relationships as well?

No. No, no. The customer service is done by the introducing broker.

Got you, okay. I wanted to ask you sort of a hypothetical here, it might be hard to answer, but really wanted to talk to you a bit about tax reform here in the US. I imagine your taxes are a little bit more complicated than some of your peers. I think with some of the peers in the industry, we can just say, well, if there’s a 10% reduction in corporate tax rates, maybe that flows through exactly the same in the P&L. What do you think is going to be the impact on IBKR's P&L if we do see a lowering of the corporate tax rate by, say, 10%?

Paul?

Well, obviously…

I told you that you’re going to get this question.

Oh, yeah. Sure. No, I thought that you would respond. So, our taxes are – you are right. It’s not as simple as an individual. They fall into several streams, sort of. There are taxes paid via our foreign affiliates and that won’t change. To the extent it then flows on through to the US and then on to our IBKR, the public company, that portion will, obviously, benefit from the lower tax rate. The other effect, as you’ve seen probably some things written about, especially with some of the big banks, is that they have large deferred tax assets. We have a deferred tax asset that results from the structure that we created during the IPO. It's a reflection of tax benefits to be gained, over time, in the future. So, to the extent that rates go down, the estimated value of that deferred tax asset as well goes down, and accounting convention requires the firms take a write-down all at once. Our estimates show that it's not going to have a big material impact on us, the way it would on some of the larger banks that have been written about. But on an operating basis, obviously, the portion that flows through the public company will benefit from the lower tax rate.

So, if they cut our tax rate by a half, our income would rise by how much?

I can’t give specific numbers at this time. But we could try to put those out at another time. We have not done all the analysis on that.

Okay. Thank you, guys.

Thank you. And our next question comes from the line of Mac Sykes from Gabelli.

Just to jump on Chris' question. In terms of the actual makeup of the firm, owning that it’s public-private, have there been any talks in terms of some of the taxes for the partnership stuff causing any thoughts on maybe changing the structure of the overall entity?

No, we’re not thinking about changing the structure.

Okay. And then, what is driving the hedge fund lending? Is it overall desire for leverage, a closer focus on your competitive spread rates or active efforts by your sales people? I was just curious if we could dig into that a little bit more.

Well, they are all those, but, obviously, our sales force is a driving force. But one of the things that we do is we display our short availability and the rate at which our lending – that we would charge for lending those shares. And hedge funds can come to us and look it up online. And they do come to us and they look it up online and then they go back and beat up their prime brokers and say, how come Interactive Brokers is lending at that and you’re charging me this? The prime brokers usually succumb, except when the hedge fund is small and they say, well, we don’t care, go to Interactive Brokers.

And then my last question, on Treasury management, now that balances are pretty significant. Have you ever considered maybe starting a bank or perhaps like…?

Yeah, but we don’t want to take on the hassle. So, you see, we are a global broker and that goes with a lot of hassle, a lot of regulations. So, that is where we want to have our competitive fight, because we have relatively little competition on that because there are very few folks who do direct access brokerage globally. And so, that’s where our focus is.

Great. Thanks for taking my question.

Thank you. And our next question comes from the line of Chris Allen from Buckingham.

Good afternoon, guys. Thomas, if I heard you correctly, you talked about no growth – the outlook for no growth in Market Making, but double digit growth in…

Speak into the phone please.

I'm sorry. Can you hear me?

Barely.

Is that better?

Yeah, much better.

Just the outlook for growth moving forward, you’re not expecting Market Making to grow, but you’re expecting Electronic Brokerage to grow double digits. Are you referring to the outlook for revenue growth or more accounts and customer equity growth? Any color there would be helpful.

All of the above.

And does that – for the revenue growth outlook, does that bake in a better environment from a volatility perspective?

No, no, no. It’s going to grow because our number of accounts are growing and our customer equity is growing. So, that is how it’s going to grow.

Got it. Okay. And then, I guess just a quick question on the Treasury marks, $11 million that was about $0.02 in EPS impact, is that correct, Paul?

For what time period? The quarter or the year?

The fourth quarter. Just the fourth quarter.

The Treasury marks are about $0.02, yes.

Okay. Thanks a lot, guys.

Thank you. And our next question comes from the line of Kyle Voigt from KBW.

Hi. Good afternoon. Just on the Greenwich Advisor Compliance Services, I think you started the rollout of this subsidiary in the third quarter. I just wanted to get an update here. Are you still adding significant functionality in headcount? And then, can you give us any indication as to whether you’re seeing more interest from FAs they are on-boarding or any feedback from the advisor community on the early rollout?

Yeah. So, the early rollout is very encouraging. Yes, we are definitely focusing on adding more capabilities and we have regularly – especially, registered investment advisors who had previously worked for the bulge bracket brokers, tend to come and ask about going independent and how they should do that.

Okay, thank you. Just one for Paul. Just to follow up on the comp expense again. Is there any way you can quantify, I guess, the true-up on the bonus comp in the quarter? Just trying to get a sense for the right run rate there going forward?

We don't have specific numbers on the true-up. However, if you looked at the annual, I think that's probably your accurate – is as accurate as you can get on the run rate.

Okay. Thanks for taking my question.

Thank you. And our next question comes from the line of Michael Trica from Oakum Bay Capital.

Good evening, guys. This is a question for, I think, Thomas, from the perspective of not only an investor, but a pretty active client as well. I had a question about the level and degree of iteration on improvements or changes on the TWS platform. Candidly, we’ve kind of experienced some latency in improvements and would even suggest maybe forming a roundtable of clients – larger clients, active clients of TWS of Interactive Brokers - to better communicate potential changes and speed up the iterations of those changes.

We would be happy to do that.

And certainly, we would love to participate.

Great. Good. That’s a good idea. But you are saying that you had experienced latency or it was – it is – is it getting better or worse?

Just the – we've been customers for – on and off for about a decade. And just the process of suggesting changes, I believe it's writing a ticket. And in terms of what we've done in the past, we've written tickets and not heard responses for weeks, small changes on TWS.

Address it to me and I tell you, you will get a response.

Certainly, I would gather a round table of large investors or large clients…

Yeah. That’s a great idea. We will do that. Thank you very much.

Thanks for your time.

Thank you. And our next question comes from the line of Doug Mewhirter from SunTrust.

Hi, good evening. Just had a question on the market maker. You talked about how you're looking for alternatives for it if you can't fix it. Of course, you're not in the best market right now with volatility being so low. Do you have the same general, I guess, plan? I know there's a lot of different options, joint ventures or sales. Are you leaning one way or another if that contingency has to happen?

We’re continuing to explore different possibilities for the market maker, yes.

Okay. And your commission per DART went up sequentially fairly nicely. I assume it was the business mix. Was there any unusual – I know that the futures volumes spiked with the election. Is that something that you think you could maintain going into this quarter and this year or is the business mix – or is the business mix going to sort of go back to a normal historical level?

It depends on the business mix. To the extent we get more hedge funds and large customers, our commissions per DART will go up. To the extent we get more introducing brokers, our commissions will go down. I mean, that’s commission per DART.

Okay. That's helpful. Thanks. That's all my questions.

Thank you. And our next question comes from the line of Rob Koehn from Ivy Lane Capital.

Hey, thanks for taking my question. So first, to follow up on Conor's question on a future Fed funds hike, so with the next Fed funds hike, Paul, of 25 bps, you cited $41 million. So, given that interest income is generated three or four different ways, say there was a second hike. Is that maybe a different way of asking the question? How much net interest income increment would we expect from a second hike of 25 bps? Would it be $35 million? Would it be…?

So, we actually looked at those two scenarios to come up with the $41 million. If they were two sequential 25 basis point increases – in other words, two sequential and then stay flat for the rest of the year, the number would be about $47 million.

Okay, okay.

And that takes into account the component. In other words, our tiered schedule of paying interest and charging interest and the maturity schedule on our investments and so forth.

Okay, okay. And then on the Electronic Brokerage for Q4, to make sure I have my numbers right, the reported net revenue of $294 million, if you exclude the $11 million of Treasury mark-to-market hit, that becomes $305 million net revenue?

Yeah, that’s right.

And therefore, that would flow – all of that would flow down to brokerage pretax. So, or $168 million would become $179 million?

Yes.

And so, the margin would be 59% instead of the 57% that's listed?

The margin would be 59%, right.

Okay. Great. And I understand that there – the auditors probably don't make it easy for you to put out a pro forma table, and I know somebody's asked this before. But I do think that one of the biggest challenges here is the fact that these are extremely confusing quarterly reports between the GLOBAL marks and the Treasury marks, being a brokerage instead of being a bank. And there's not much you can do about that. But if there's any way to make this more clear, I think that would be helpful to everybody involved.

What we’ll do is, we just decided that – at each month end, along with our brokerage metrics, we will publish the change in the GLOBAL for the month and the quarter-to-date and year-to-date, so we’ll always know what the number is. If you like, along with that, we could also publish the Treasury marks. Everybody should understand that the reason why we have these marks is that we are not – we must mark them to market, but at the end it all becomes just part of the interest income.

Thank you. And our next question comes from the line of Sean Brown from Teton Capital.

Hi, guys. I have just one quick question around the individual account business vertical. And it's around IRAs, in particular. I see that, I guess, two weeks ago, you've insourced the IRA custodian business. I think that was outsourced before and customers had to kind of pay an extra fee, and now it's going away. Is this a big market space for the long term or…?

I don’t know what you just said. What did you just say? Two weeks ago, what happened?

On January 1 – I think, yeah, Interactive Brokers insourced the IRA, individual retirement account custody.

Insourced?

Yes. That’s right.

It’s primarily a fiduciary and reporting function that we did take in-house. It's not something that we would expect to turn into a business line to do for others. We plan to do it. Our plan right now is we’re doing our own IRA custodian and reporting function for our own customers. I think that's what you're asking about.

Right, right. And it seemed that as you've presumably built out internal capabilities for that and some automation in the systems around that, maybe that is a business line that could be poised for growth, just on an organic basis. Would that be correct? Or is this just not a big enough market to grow for the long term?

Well, I think, if anything, we might look at it along the lines of when we build automation for compliance services, in general, we think that that attracts certain types of customers. It makes them sticky customers because we can perform those compliance activities for them and they might be brokers. And I suppose this could turn into one of those. But we’ve got to get it right on our own first, and this is our first leg in.

Got it. So, for now, I should think of it as more of a cross-sale to our existing individual customer base; and then later on, it could be an attractive capability to the potential Introducing Broker customers?

I wouldn’t call it a cross-sell because it’s a transparent function to the customer. The customer just wants his custodian function and his reporting done on an annual basis. In the background, it’s now being done in-house at IB.

Right, right. But due to the $30 per year fee that was passed on to the customer previously, I'm guessing there were a lot of Interactive Brokers customers who had just created their IRA at Vanguard or ETRADE or Fidelity, somewhere that didn't have a fee previously, even if they had an individual broker account or margin account at IB.

I’m not sure what other brokers charge in terms of administration fees for IRAs. However, small IRAs are not of great interest to us. They don’t tend to trade a lot. They’re retirement accounts. They often are threshold accounts, so that it allows introducing brokers or financial advisors to bring on a whole group of accounts over to us if we can support the IRA portion of those accounts. We have been doing that for a number of years and now we’ve improved on the process.

Got it. Got it. Thank you.

Thank you. And we have time for one more question. Our final question for today is a follow-up from the line of Rich Repetto from Sandler O’Neill.

My question has been asked and answered. Thank you.

Thank you. And we would now like to take a question from the line of Rob Koehn from Ivy Lane Capital.

Thank you. Just one follow-up. So, on Introducing Brokers, can you – Paul, can you quantify a contribution margin? Since you're not providing customer service to these introducing broker customers, even though they're generally at a lower commission rate because they're on the grid. Is that still like a nearly a 90% or 95% contribution margin type of business then?

Thomas, do you want to respond?

It’s very hard to tell. So, our customer service is still being used by the introducing broker himself up until his people are well trained. And that takes quite a long time. And then our expenses as far as customer service, it’s not a major part of our – it’s not the majority of our expenses. So, to the extent the – at a later stage in the life of an account, that expense is no longer imputable - it’s very hard to guess.

Right. It's a theoretical question. Okay. But, presumably, you've done the math and you're comfortable that it's still a very profitable business at any rate.

Sure. It’s a profitable business, yes.

Okay. And then – well, I'll just leave it at that. Maybe to follow-up on the one other comment the other gentleman made, maybe it would be a good idea to have like a hedge fund day at IB headquarters to allow people to come see the facility and learn more about the company.

Thank you for the suggestion.

Okay, thank you.

Thank you. And that concludes our question-and-answer session for today. I’d like to turn the conference back over to Nancy Stuebe for any closing comments.

Thank you, everyone, for participating today. And as a reminder, this call will be available for replay on our website. We will also be posting a clean version of our transcript on our site tomorrow. Thank you, again. And we will talk to you next quarter end.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone, have a great evening.