Good day, ladies and gentlemen, and welcome to the Interactive Brokers Group Third Quarter Financial Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Ms. Nancy Stuebe. Ms. Stuebe, you may begin.

Thank you, operator, and welcome, everyone, to our third quarter earnings call. Our earnings were released today after the market close 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'll take your questions. As a reminder, today's call may include forward-looking statements which represent the company's belief 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. Thomas?

Good afternoon, everyone, and thank you for joining us to review our 2017 third quarter performance. As usual, this quarter will mark several milestones for Interactive Brokers. First, number of accounts, customer equity, average equity per account and margin loans outstanding all hit new records. Our customer equity is now $116 billion, up 40% from a year ago. Our customer accounts are also up significantly at 457,000, up 23%. Furthermore, these metrics continue to grow at an accelerating rate. As we grow larger, more people hear about Interactive Brokers and look into what we offer. They hear that we do not sell our orders and about the quality of our executions; they see our low commission rates, our high interest payments and our best-in-class technology. After they sign on as clients, we then benefit from positive word of mouth as they use our platforms and tell their fellow investors about us. On the new product front, in August, we introduced a debit card that is linked to your account, a product we had been asked for frequently. In one single Interactive Brokers account, you can now borrow, earn, save and invest completely, managing your finances without leaving the platform. If you choose to borrow on your Interactive Brokers debit card, you borrow at our margin rates of no more than 2.66% to as low as 1.41%. As it has just been introduced, the debit program has much growing to do. Now that we have introduced the card in the United States, we will expand to Europe and Canada in the next 6 months and to Asia after that. Stay tuned for additional benefits we will offer to our cardholders in the next phases of our rollout as we work to make the IB debit card even more compelling. We also…

Thank you, Thomas. Welcome, everyone, to the call. As usual, I'll first review the summary of results, then we'll give segment highlights, and then we'll open it up to questions. . Third quarter operating results reflect a continuing strength in brokerage performance, led by growth in both commissions and net interest income. These were further supplemented by currency translation and a net reimbursement of exit costs related to the sale of our U.S.-options Market Making business to Two Sigma Securities, which closed on September 29. Without those, and other nonoperating items that I'll enumerate a little later, pretax income increased 24% over the prior year quarter. Volatility still remains at historic lows. Lower volatility generally gives rise to fewer trading opportunities. But while our cleared DARTs per account fell 6% from last year, our quarterly total DARTs were up 14% year-over-year and up 4% sequentially on the strength of continued growth in our account base. And with the growing contribution of net interest income, average net revenue per account has increased 2% over the prior year quarter. We continue to see robust growth this quarter in asset-gathering and margin balances in brokerage as I'll describe in my comments on that segment's performance. Electronic Brokerage continues to post strong increases in the number of customer accounts and customer equity, up 24% and 40% respectively. Market Making contract and share volumes were down across product types as we wound down the bulk of this activity, and I'll discuss the market maker further in my comments on that segment's performance. As reported, third quarter net revenues rose 23% despite being compared to a solid year-ago quarter with higher volatility. Reported pretax income was up 46% for a pretax margin of 63%. Excluding items such as investment in U.S. treasuries, currency translation effects and…

[Operator Instructions] Our first question comes from Conor Fitzgerald of Goldman Sachs.

First, just thanks for putting the NIM disclosure in the earnings release, it's very helpful. And then I just had 2 quick cleanup questions. Where did the recovery of the exit costs run through? And did I catch you correctly saying that x the clearing rebate, execution and clearing would have been up 23% year-over-year?

Yes, that 23% is right, and the cost recovery is recorded in other income.

Got it. And then I know it's early innings, so it's a little tough to provide details on what buying other government-backed securities could mean. But from maybe a yield uplift, could you talk about the yield you're getting on the securities you think you'll be buying and then maybe some of the margin uplift you could see from this?

We don't have many details yet, we just know that the class of securities that we're looking at, while being government-backed, tend to yield somewhat higher-than-regular treasuries. And we're developing our investment guidelines now to figure out what portion of the overall investment we would devote to that class.

Got it. And then just wanted to revisit how to think about kind of expenses on the go-forward. I think you still got something like $9 million of expenses coming out of the market maker, just backing into it, you talked about $10 million sticking around. So is [ 1 50-ish ] a decent way to think about the expense base going forward?

So you mean the quarterly? Sorry? A quarterly total expense base?

Yes.

It will be, on a run rate basis, probably a little bit higher than that because when I describe that 50% of our expected annual, that's a run rate basis. In other words, at the end of the quarter, we had transferred enough personnel resources, such that on a go-forward basis, we have now captured about 50% of that $40 million. But the results for the quarter, the third quarter, it was not an entire quarter's worth of that expense, right? So it will be a little higher than your estimate, but not much.

Got it. And I guess the other thing to keep in mind is execution and clearing should pick back up without the rebate.

In other words, it will return to its normal rate. Yes, that's correct.

And our next question comes from Rich Repetto of Sandler O'Neill.

So I guess the first, you confused me a little bit. You said you had half the run rate in, but, okay, what portion of, I guess, isn't -- of that half isn't in? Could you sort of give us a little estimate of that?

Think of it this way. We estimated the run rate of $40 million a year to be absorbed into our brokerage business, so call that $10 million a quarter. Out of that $10 million, we absorbed, because we had just started the process, about $2 million in the second quarter and about $3.5 million in the third quarter. But I want -- in order to clarify it from your point of view, we are expecting an additional $10 million a quarter once we're at full run rate. We're just not there yet.

Okay. Because like you said 2 -- about $2 million in the second quarter, $3 million in the third. So that would imply you got $5 million out -- or $20 million, but you really didn't realize that in the third quarter, I guess, is what you were saying, only a portion of the $3 million. Is that fair to say?

The $3.5 million was the actual number absorbed in the third quarter. Had we moved all resources over to brokerage that we expect to, that number would have been $10 million for the third quarter. But we're in the process of migrating resources and so they haven't been fully absorbed, the $3.5 million instead of the eventual $10 million.

Okay. I guess the next question is when would you expect to move the capital from the market maker to the broker? You sort of left that a little bit open.

Right. So we're looking at all of the optimal ways to redeploy that capital. It will be opportunistic. Whether we move between legal entities or set up financing arrangements, has not been finally determined yet, and there might be a mix of those things. But the capital, as it frees up, will become available whether or not it moves across legal entities. And ultimately, we'll cease to report segments and it will all be in one company's report.

Okay. Okay. And then lastly, for Thomas, a little bit about the sort of the options, the retail options business. Can you give us an update on Scottrade because the deal closed and I'm not sure how aggressively they're trying to move or bring clients back? But could you give us an update on that? And then also, the payment for order flow. What I understand -- you didn't -- you don't pay -- there is no payment for order flow, but there is some passed-on exchange -- there's still some rebates there. Could you explain that one, just remind us of why that is?

Okay. So as you know, exchanges pay for limit orders, right? And so some of those limit -- some of those payments we share with our customers, and I think we share all of it with our customers. So that's what -- that's where it comes from, it's not a lot of money. So in other words, it's exchange payment for order flow. Now on the Scottrade question, we haven't really -- I think what I heard is that they want to get the accounts back by the end of the first quarter of 2018, but I wouldn't swear to it, but that's what I remember. And obviously, these are their accounts and they can pull it back whenever they like. And if the customers don't want to go, they don't want to go. We will not interfere with this situation in any way. So it's between Scottrade and their customers -- I mean, sorry, Ameritrade and the Scottrade customers, right.

Right. Okay. And that's helpful. In other words, you've not seen any movement here yet?

No. So far, we haven't seen any, no. And again, it's not lots of accounts. It's somewhere around 2,000 accounts, I think.

And -- but it would be their more active option customers, I would assume?

No, I'll tell you frankly, I haven't looked up this currently. I don't know how active they are. They certainly are not as active as original Interactive Brokers customers.

And our next question comes from Mac Sykes of Gabelli.

With respect to the market maker divestiture, how much impact has that had on recent client acquisition?

That did not have any impact on client acquisition. I don't see why you would connect the 2 things. Oh, you mean because we can freely say that we don't have this conflict anymore, that's what you're referring to. Well, it's very hard to say. And besides, it's only started. It's only been the last 2 weeks, right? So we don't know of anyone who specifically came and said, now that you no longer have a conflict, we will transfer our account to you, but I would think that, that does happen in people's minds, especially in hedge funds.

Understood. And when I think of IBG, I think of technology innovation, a broad suite of global debt vehicles and as you mentioned, sophisticated traders. And love it or hate it at this point, Bitcoin's market cap is now about 1/3 of JPMorgan's. So 2 questions on this. Have you considered accessing this marketplace? And number two, have you heard client feedback asking for this kind of access?

The answer is yes to both, and the result is that we're not going to do it.

Got it. What would make you just change your mind?

If the United States of America said, you know, besides dollars, we also have Bitcoins, and you can pay your taxes in Bitcoins, we would be the first one to go and do it.

And our next question comes from Chris Harris of Wells Fargo.

Can you help us understand how the bank sweep program is going to work conceptually, and then I'm just also wanting to know what the economics behind that program might be?

Sure. So basically, it's structured to help clients with -- larger clients with funds that exceed the SIPC insurance limit, with -- which is $250,000 in cash per brokerage account. We're offering it up to $2.5 million in additional coverage on top of that, that would be FDIC coverage because their funds would be swept to FDIC-covered banks, not unlike other brokers who offer the program, but the primary difference is that we are offering our same high interest rates on that product. What you see the other brokers offer are fairly dismal rates on FDIC sweeps. So they're gaining FDIC insurance but they're not sacrificing anything in rate by signing up for our program. And then the rate that we will receive will be higher than our average investment rates, so we will simply benefit by a larger spread. It's too early on to -- I mean, we've done some modeling, but it's too early on to know how big the program will be in its entirety, and it will certainly grow over time. And -- but it's literally just rolled out, so we don't have any hard data yet.

Okay. Understood. And with respect to your yield on, say, cash, nice increase. I guess some of that should be -- not a surprise, clearly. But as we think about the setup going forward, I mean, excluding the initiatives you guys are working on, is there any reason to believe that, that yield will continue to rise absent what the Fed may do?

You mean the yield that we receive will rise absent what the Fed will do? Yes, but -- and inside of this program you mean? Yes, we still have a little bit of treasuries we bought some time ago. So as that gets reinvested, yes, that will rise, but not by a substantial amount. It's single basis points, single-digit basis...

Okay. Great. Then really quick, last question. On the account growth, obviously, the introducing brokerage just continues to do well there. When you guys kind of market the company and you think about how big the backlog could be there, I guess, I'm trying to size up how large that opportunity can really be for Interactive. I mean, it's just tough for us to size it. I was just wondering if you had any thoughts...

500 million accounts. It'd be 500 million accounts.

And how do you get that number?

There are 7.3 billion people. How many brokerage accounts are there in the world? And there are more and then they are growing very rapidly because in many developing countries, there are barely any so far, but they are coming very rapidly. Now, of course, we still have competitors, who will try, who will do their best to not let us have them all.

And our next question comes from Kyle Voigt of KBW.

I just had a few follow-ups. Just one more question on the expense front. So the $87 million of fixed expenses in the e-broker, Paul, I know you said $3.5 million of the run rate from the market maker's already come over, so that implies there's another $6.5 million left to be migrated into the e-broker. But then the expenses in the market maker, that just goes away. So the $19 million, you're only going to see $6.5 million come over, and then it's going to be -- the rest of that will be eliminated. Is that the right way to think about it?

Yes, the $19 million also includes variable. And this quarter was $6 million of execution and clearing. So if you -- the fixed portion of that, I'd say $13 million. And yes, that will go away.

That's really helpful. And then just one follow-up on the FDIC program. Just wondering, I know -- and it's a stretch, but maybe I just thought I'd try. But the eligible credit balances now that you have for the program, I know there are specific requirements that you post on the website. So I know you said you did some internal modeling. I'm not sure what percentage of your credit balances you think might be even eligible, not necessarily those that you think are going to come over, but those would be eligible.

We prefer not to give any specific numbers now primarily because it's so early on and we have to see what the uptake is. We'd be probably happy to talk about it as the number's actually material, and we'll be -- we'll be reporting as part of our net interest income.

And this is going to be a program that your clients need to elect into, correct? So it's not going to be like an automatic selection for someone that opens an account over a certain size.

Yes, they do need to elect in. Right, I mean, from our point of view, while we don't know the takeup rate, there's no reason not to elect in, because we're paying the same good interest rate and they're getting additional coverage. So we would expect the uptake to be pretty good.

And the rates you're getting on the bank sweep program right now, it's just, I'm assuming, it's a bit above Fed funds, so you're at -- your, say, cash, I guess, is earning 109 bps, so it would be above that. Is that the right way to think about it?

It's above that, yes. They're pegged to Fed funds plus.

Okay. And then, sorry, one more -- I guess on the IB debit card feature that rolled out in the quarter, I guess is the strategy here really just to try to grow your share of wallet from existing customers, so potentially having them migrate more of their savings or investment-type cash into IB accounts? And then just wondering if you could kind of give any indication onto the early response you've seen from the client base?

Absolutely. So we hope that existing accounts will do more and more of the banking with us since we pay a higher yield on cash than the banks do. If -- unless they want to invest their money for some term, they are better off having the money with us. Obviously, it's also very convenient to not have to worry about overdrawing your account when they use our card for purchases when they basically run out of cash. The uptake so far has been favorable, but we're very early into the process. And we do hope that eventually, not only our customers will use the card but also the card itself, the availability of the card, will bring us additional customers. So people who have margin accounts at other brokers will be more likely to consider us. Our salespeople have come back from time to time saying that certain investment advisers will come to us if we allowed them to have a payment feature on the account.

And our next question comes from Doug Mewhirter of SunTrust.

Most of my questions have been answered. I just wanted to go back to the Market Making operation. It sounds like you've essentially closed the deal with Two Sigma. And would you be putting that -- those revenues into discontinued operations in the fourth quarter? Or do they run off -- or I'm just trying to know how it's going to be structured. I heard that you are no longer going to report segments, but I was just wondering how the -- you're going to account for the operations that you've sold to Two Sigma.

So the most likely thing to happen is that since we are continuing some of the smaller non-U.S. operations, it will be continued to be reported as a segment until those actually wind down, which will probably occur next year at some point. So expect the continued segment reporting. At some point, when the GAAP and SEC reporting guidelines take over, and I think that happens when it's fully shut down, then there's some reporting as discontinued operations, yes. That's a relatively technical matter.

Okay. And just going back to the debit card, one technical question. To the extent that they can -- they can use it to sort of borrow against their account, which I'm assuming that, that is one of the key functionality points, what -- are you -- do you charge them whatever margin interest rate is? Or is it margin plus something?

No, it's the margin interest rate. So that is why we can say that the highest you ever pay is 2.66% and the lowest is 1.41% because those are our margin rates up until the Fed raises, are within these 2 numbers. So that's why the card is so incredibly attractive to people who spend more than the cash they had.

And our next question comes from Chris Allen of Rosenblatt.

I just wanted to circle back real quick on execution and clearing. The 23% year-over-year increase applies $76 million execution and clearing fees. There was a [ $50 million ] rebate, is that what you're saying? And does that rebate occur every year? It sounds like it does. I just wanted to clarify that going forward.

So I'm not exactly sure what numbers you're quoting. Execution and clearing was $61 million for the quarter, and that had several million of rebate and it was not a great big number.

Got it. Okay. I was curious about the 23% increase you talked about. Was that -- so all it did was take 23% over the $62 million from last year?

So in my remarks, I was referring to the brokerage side. And the portion of execution was $55 million, and that was up 20% and that would have been up 23% if we had not booked a rebate. I just want to be clear on -- because we know that there's a focus on run rate, and therefore we wanted to disclose that.

And I am not showing any further questions at this time. I would now like to turn the call back over to Nancy Stuebe for any closing remarks.

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

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a wonderful day.