Good day, ladies and gentlemen. And welcome to the Interactive Brokers Group First 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. [Operator Instructions] As a reminder, today's program maybe recorded. I would now like to introduce your host for today's program Nancy Stuebe, Director of Investor Relations. Please go ahead.

Thank you, Operator. And welcome, everyone, to our first quarter earnings call. Our earnings were released today 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 CFO. They 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. I'd now like to turn the call over to Thomas Peterffy.

Good afternoon everyone, and thank you for joining us to review our 2017 first quarter performance. This quarter we made the difficult decision to wind down our options market making operations. Timber Hill is widely known in the industry as the pioneer of electronic trading. Starting in 1977, we built technology for market making that in subsequent years was adopted by everyone who remained in the industry as exchanges moved from open outcry to the electronic method. This technology also became the foundation for our brokerage business, giving us the technological edge and a deep knowledge of international exchanges and markets that strengthens and drives our electronic broker today. Recently, we have come to the conclusion that, in a low volatility environment that may go on indefinitely, it is difficult to earn a profit as a market maker without substantial order flow to interact with. Interestingly, that was the very same reasoning that drove us in the early 90s to expand our market making systems to providing brokerage services in the first place. At that time, we saw the large bulge bracket brokers, that are today banks, making great efforts to sell their customers on OTC derivatives at the expense of exchange traded ones. We feared that soon, we'll have no one to trade with at the exchanges and that we had to develop a source to generate our own order flow. As we began working on building this software, the idea was supplanted by what we saw as a more urgent need for a trading platform that floor traders could adopt as the exchanges started to go electronic. Providing that platform became our niche in the brokerage business. Initially we served floor traders who had to move upstairs. Later our customer base grew into the generally, financially more sophisticated…

Thank you, Thomas, and welcome everyone to the call. We have a few extra things to go over today so we’ll jump right into the summary results. We will give some additional color on the winding up of the market maker and then segment highlights before we open it up to questions. First quarter operating results reflected a solid performance in brokerage led by gains in net interest income. These were supplemented by currency translation gains but offset by a lack of trading gains in the market making segment. Operating metrics reflected a still sluggish trading environment amid historically low market volatility. As Thomas mentioned, volatility as measured by the average VIX was down 43% from the year ago quarter to 11.7 this quarter. Lower volatility gives rise to a fewer trading opportunities and in fact, our clear DART's per account were down 25%. However, on the strength of continued growth in our account base, our quarterly total DARTs were down only 12% year-over-year and up 3% sequentially. We continued to see strength this quarter in asset gathering and margin balances in brokerage, as I will describe in my comments on that segment's performance. Electronic Brokerage metrics showed robust increases in the number of customer accounts and customer equity up 18% and 38% respectively. The decline of 12% in total DARTs should be viewed in the context of the strong year ago quarter, during which the VIX averaged 20.6 and market volumes were higher. Market making contract and share volumes were down across product types and I’ll discuss the impact of winding down the market maker in my comments on that segments performance. First quarter reported net revenues declined 24% against an unusually strong quarter that benefited from high volatility last year. Pre-tax income was down 37%, for a pre-tax…

[Operator Instructions] Our first question comes from the line of Rich Repetto from Sandler O'Neill. Your question please.

Good evening, Paul. The first question I have is to Paul, and just trying to understand the increase in interest expense, looks like $35 million this quarter versus run rate of $18 to $22 per quarter last year.

Well of course, it's primarily related to the increase in benchmark rates, and we had the full effect of a 25 basis point Fed move this quarter. The thing that we focus on, obviously, is the net interest income because, given our interest tiers, and our published interest rates to our customers, we started paying more interest on credit balances as the benchmark rates increased, and that will continue. However, likewise, we earned more on the investment of those funds and charged - and earned more on funds loaned to customers who are borrowing on margin. And so I just caution you to – not take it in a vacuum; you have to actually look at both sides of the interest equation.

Okay. And one just follow-up on that, but if you look at on the interest revenues they went up $17 million quarter-to-quarter and the interest expense went up by $13 million, that what you got combined then the changes – I would expect a lot less – a lot more in interest revenue compared to the change in interest expense or am I looking at that wrong?

So are you looking at brokerage or overall?

I’m looking at overall is that okay.

You mean sequentially quarter.

Yes.

The $17 million yes, well what I can tell you is that when we publish the 10-Q we’ll have more details in the net interest margin which we will now publish quarterly, and you’ll get a little bit more color on the balances that go into each component of net interest income.

Okay, thank you. And then, Thomas, I guess on the broker, now could you talk about how you will get executions and as you observe, will there be any impact to execution quality given that your market maker, and I guess in absorbing the cost as well?

Well as we always said, the market maker has absolutely nothing to do with the broker's executions. So we never traded against our customers’ orders; customer orders are always routed to the best – potentially best venue at any moment and that will continue to be done. So if anything - some folks that have been working on routing market maker orders, where the emphasis on speed was very important, are now going to join our Brokerage Group. And so, we will get some additional out in our routing algorithms so, if anything the executions will improve as a result of closing the market marker.

Understood. And last question, Paul I thought I heard you say something about - you reduced the duration of the Treasury portfolio and just trying to understand what you meant by that?

Sure, yes I mean we never went out very far on the yield curve but in the past, we took a little more advantage of the yield curve when we felt that the environment was a bit more predictable. Going into the latter part of last year and then, through the first quarter and certainly through election season, we just felt there was more uncertainty over – the markets predictability of the future interest rate picture. And therefore we allowed some of the medium term - we never went long-term - but medium term Treasuries to expire and reinvested in shorter duration, which we have maintained for the time being. If we feel that the market’s predictions become probably more reliable, then we may go further out the yield curve again.

I may add we really think that there will be further interest rate increases and we don’t want to be “long” almost two years, so that's why we had – we let the duration come in closer.

Got it, understood. Thank you. That’s all I had, thanks.

Thank you. Our next question comes from the line of Conor Fitzgerald from Goldman Sachs. Your question, please.

Thanks for taking my questions. First one, just on the market maker, thanks for calling out the $39 million of expenses. Just wondering if we should think about any revenue coming along with that $39 million, given that I think you’re still market making in a couple of stocks?

A couple of stocks, I’m sorry I misunderstood?

Yes. Looking at your release I don’t think you fully exited the market making business 100%. I think you said you would continue to selectively make markets in a couple of products.

Not in a couple of stocks - in a couple of locations.

Okay.

Specifically in Asia, we are keeping some market making operations running.

And any sense how much revenue would be associated with that? Just trying to think about the net impact of shutting down the market maker?

Yes, I understand.

That would be very forward-looking, Thomas.

We didn’t used to give forecasts when we were fully in market making, so I think I'd like to stick to that, because it’s very hard to estimate. But we still believe that those couple of locations will generate a profit, that’s why we’re keeping them.

Okay. So not really to quantify but fair to say that $39 million is not a net number.

Right.

And then just following up on Rich’s question, a couple of questions on the net interest income. Sounds like there were a couple of moving pieces, was just hoping you could quantify a couple of them. How much was the uplift you got from the Fed hike in December? And if you could quantify how much net interest income you gave up from shortening the duration? Just trying to understand a couple of the moving pieces.

Yes, I think we’ll probably just be publishing it in the 10-Q, Conor. We had given some expectations of the 25 basis point increase – well, in the last number of quarters we’ve been putting that out. I would say we’re not out of line with what we talked about. So in other words, the fact that we are projecting that a further 25 basis point increase would, on a full year reinvestment rate basis be $49 million, that number is somewhat lower than it was in the past quarter and the quarter before because – it does – because we pay a narrow spread off the benchmark, and pay and charge to our customers a narrow spread off the benchmark, as these rates go up, it kind of becomes locked in. And our further earnings are on increases in the balances, which have been robust so that’s an offsetting factor, that as balances go up that number is going to go up on a projected basis. Otherwise, once you’re into solidly positive interest rate territory, our published tiers are locked in, and then we have a certain portion of our smaller customer balances on which we don’t pay interest, so we continue to earn more and more on those.

That’s helpful. And then just last one from me. You mentioned potentially sweeping your deposits to third-party banks starting in 3Q, and brokers who do similar programs generally earn Fed Funds or LIBOR plus a spread. Should we be expecting kind of similar economics for you, and any way you could kind of help us quantify how much of a revenue driver that could be?

Sure. So we’ve had our eye on one of these programs for quite a while, and we’ve seen generally banks’ demand for deposits ebb and flow, or flow and ebb, because somewhat after the financial crisis, the banks were scrambling for money and they all filled up and all that demand went away. It’s returning now. For whatever reason, we’re seeing more demand out of banks, and so while we don’t know exactly what we can earn on it yet until we initiate the program, it’s going to be higher than Fed Funds. And as far as the overall impact, we don’t want to estimate it just yet, but a portion of customer balances would be eligible, and then it's a question of which customers actually sign up for this program, and so only experience will tell us that, but we hope to get the program started fairly soon - over the next few months - and hopefully it gets good pick up from the customers.

That’s helpful. That’s also capital light, right, because it’s no longer - it moves onto somebody else’s balance sheet. Should we think about that having maybe a positive impact on your capital flexibility?

Well, certainly, capital light and yes, the balances do move off our balance sheet. We’re not under ratio constraints the way the banks are. Deposits aren’t a bad thing for us. In fact they provide a source of funds for us to lend money to our margin borrowing customers. Therefore, we're seeing this as sort of two parts - one is investment opportunity and the other is a value added service to the customers, who will then get FDIC coverage in addition to whatever they are currently getting with us.

Thank you for taking my questions

Thank you. Our next question comes from the line of Mac Sykes from Gabelli. Your question please.

Good afternoon, gentlemen. I wanted to know on the prime financing - just thinking about that business being ramped up, will that be additive to the 1.12% current NIM?

Well any incremental amount would be additive.

In terms of percentage NIM; I understand the revenue impact but would that be…?

So on the spread itself?

Yes.

The prime customers tend to get the best rates, so it might tend to trim the spread a little bit overall, but you know, at the opportunity to increase their revenue. We would be willing to do that at the higher levels, just like high volume customers get the best commission rates. It’s a similar impact.

And when we think about moving the $1.5 billion to support some of this prime financing, how much could that support in terms of extra balances?

Sorry, not sort of understanding the question?

The $1.5 billion of capital - how much could that support in additional interest balances? Maybe $10 billion?

We are nowhere near any capital restrictions here. We are not restrained by the available capital. The primary purpose - so we’re far away from the time when we’ll be needing all of our capital to do customer financing. So at this moment, the purpose of the capital is to continue to bolster our credibility and hopefully, at a future date, all of it will be needed.

And Thomas, could you just weigh in a little bit about the volatility we’re seeing? Absent some of the political/geopolitical aspects, is there something that's going on structurally with the markets, flow of funds, maybe participants, just customer engagement, that would sort of lead you to believe that the outlook for volatility will be lower than it has been in the past?

I don’t want to repeat myself, but on a CNBC interview, I explained what I think is going on, or what I see going on. And it is partly due to the exchanges rebating fees to traders who put in resting limit orders. So to very high volume traders, we charge $0.10 per 100, and the exchange rebates $0.23 per 100. So these traders who trade back and forth, actually get paid to trade. Because we are rebating those $0.23 per 100 back to our customers. So now couple this with the rising popularity of writing calls against a portfolio of stocks. And the fact that our margin rates are so low, so many of our customers come to us, they borrow money on margin, they go long the big stocks, and they sell calls against it, even though the VIX is low so those calls are sold at a fairly low premium. So the traders come and buy these calls, and they trade against them in the sense that they delta hedge it. So they buy the calls, they go short the stock in the proper ratio. Now as the market picks up, they become long delta. And if the market picks down, they become short delta with these positions. So every time they even out the delta, that means that they sell into rising markets and they buy into dropping markets, and so they generate a trading profit and add to this the rebate from the exchanges. So to a large extent, this low volatility is structural, because of the popularity of selling covered calls, and the rebates from the exchanges.

Thank you. And thanks Paul, for the additional comments and disclosure.

Thank you. And we do have a full queue today so we ask that you please limit yourself to one question and one follow-up. Our next question comes from the line of Doug Mewhirter from SunTrust. Your question please.

Hi good evening. Just one question, most of my number questions have been answered. So the increase in margin, that our margin loans had a very nice increase sequentially and year-over-year, do you - is that mostly due to your increase in your prime brokerage business where a lot of hedge funds or most hedge funds are levered, or is that more just more popularity on the individual investor side levering up because of market conditions, or confidence, or what have you - or is it a little bit of both?

So our margin loans increased because we are the lowest cost providers of margin loans. And first of all, it's an opportunity for more profit, but in addition we are using this really as a bait to get people to bring their accounts to us. We do not really keep track of margin loans as far as what percentage of them goes to prime brokerage customers and what percentage goes to individuals. So I really can't quite tell you the answer to that question.

Okay, thanks. That’s all my questions.

Thank you. Our next question comes from the line of Chris Harris from Wells Fargo. Your question please.

Thanks guys. I just had one question, and it relates to the commission cuts we've been seeing across the industry. It seems pretty clear that you guys don't need to respond, based on where the competitors are and where you guys are from a pricing standpoint. But if your competitors keep cutting, is there a level, do you think, where IBKR would actually need to respond, or do you think your value proposition is such - you don’t do payment for order flow, you have better execution capability and fill - that you just really wouldn’t need to address it all? Just maybe a little bit of your thoughts on that topic would be great.

Well, on the one hand you are right, we don’t think that they will ever compete with us as far as total execution cost is concerned. But as far as advertising these goals, if they really were to cut the commissions to zero, as Schwab for example could easily do, I think we would have to go out and explain in advertisements more thoroughly as to what is going on here behind the scenes. Because interestingly enough, they advertise that their commissions now are $4.65 a trade, but we see that their commissions are more like $8 or $9 a trade. So - how do you figure out what’s happening?

Got you. Thank you.

Thank you. Our next question comes from the line of Rob Koehn from Ivy Lane Capital. Your question please.

Thanks. So in the first quarter, there was a pretty big step up in new accounts and assets and I wanted to ask if there were geographies or customer segments that you could point to that drove that step up in the quarter?

Yes. Of course as far as new accounts, Asia grew faster and even Europe grew faster than Americas, and that was also the case at least for Asia as far as client equity is concerned. So yes, Asia is the shining star here.

Asia okay. And what are you seeing in terms of the average size of new accounts, compared with what you’ve seen historically. I mean it just looks like, looking at the numbers, that maybe the new accounts are bigger but maybe that moves around.

It does move around, and the difficulty in tracking that is that, generally, an account that opens with X dollars tends to have nearly 2X dollars in a year and a half after the account opening.

So because, somebody puts in a small amount, then they add to it?

That’s right.

Okay. And anything you can call out in the prime brokerage business in terms of growth, and maybe impact in Europe, with some of the European banks?

Interestingly enough, prime brokerage accounts grew second fastest, prime broker accounts having grown the fastest. So, hedge funds are the second fastest growing segment.

Okay. Good, thank you.

Thank you. Our next question comes from the line of Kyle Voigt from KBW. Your question please.

Hi, just had two questions. One was really just around kind of the customer segments where you’re growing faster. I think you mentioned some of them have smaller accounts sizes, some of the segments specifically. And just thinking about those accounts that would have potentially less than $100,000 in assets that they need to hit to get paid on their cash balances. I am just wondering if you could just give some more details around the percentage of those $43.8 billion of credit balances, credit balances that you’re not paying interest on, I guess, what percentage of those balances are held in accounts with less than $100,000 in client equity or if its cash balance is under $10,000?

No, the bulk of it is smaller accounts.

Okay. And I guess just a follow-up I guess on the brokerage expenses. I see non-interest expenses were up 15%. I know you’ve made a lot of investments on the customer service area and a few other areas. Can you just help us think about the investment areas, going forward over the next 12 to 18 months, and whether you still expect kind of strong expense growth through the next year?

We are certainly going to continue to build up our development team and our customer service team. So we get a big shot in the arm from transferring all these folks from the market making area to these areas. But in addition to that, we are also going to continue to add to our strengths there.

Okay, thanks.

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

Good evening guys. This question is probably more for Thomas, and it’s part question, part suggestion. Speaking to the development of developing a platform, kind of a marketplace ecosystem more than just a brokerage, have you guys considered extending Wall Street research capabilities to clients? Meaning, personally, we have an account of Bloomberg, and we can access Wall Street research through the Bloomberg platform. Are you guys considering or would you consider enabling that sort of functionality?

Sure we would, but we have a lot of research on our platform currently. Now it may not be the type of research you are looking for, but we certainly - we have the soft dollar methodology, but it's very rarely used for reasons I don’t really understand. So I assume that if you, for example, wanted to buy Wall Street research with soft dollars and you were on our platform, then you would use it, right?

Not to opine on the relative value of the research - I was actually on the portal today and yes, like you said, the research available through the portal may not be appropriate for hedge funds such as ours; maybe it’s for other clients of yours. But we, as other institutional investors, definitely want access to Wall Street research, and typically, I know a bunch of my contemporaries that they traditionally access it through systems like Bloomberg. And I'm just thinking, that to develop the ecosystem marketplace, the platform, that you suggested you'd like to build out for Interactive Brokers, I just thought it would be an additional mechanism to build out the platform, allowing clients to access research through that.

No, I would appreciate if I could call you about that, to understand then in detail what you're talking about, and figure out how we could do that.

Thank you. And this does conclude the question-and-answer session of today's program. I’d like to hand the program back to Nancy Stuebe for any further remarks.

Thank you everyone for participating today. As a reminder, this call will be available for replay on our website and we 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.

Thank you ladies and gentlemen for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.