Ladies and gentlemen, thank you for standing by, and welcome to the Interactive Brokers Group First Quarter Financial Results Conference Call. At this time, all participant lines are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I'd now like to hand the conference over to your speaker today, Nancy Stuebe, Director of Investor Relations. Thank you. Please go ahead, ma’am.

Good afternoon, and thank you for joining us for our first quarter 2020 earnings conference call. Once again, Thomas is on the call, but asked me to present his comments on the business. He will handle the Q&A. 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. In light of the COVID-19 pandemic, we want to emphasize that our focus is on our employees, clients and communities. Senior management at Interactive Brokers has worked together for decades, most from before the inception of the electronic broker. We were all here during the financial crisis. Many were here in 1987 as well. Our company's culture has been one of working hard independently and together to solve problems and come up with solutions, preferably automated ones. This strength of management cohesion and long-time experience enabled us to react to recent events in a coordinated way worldwide, which allowed us to move quickly to a work-from-home model. Globally, the majority of our employees are working remotely, and they have the tools needed to work effectively. Because our systems and processes are highly automated, the bulk of our employees can work from outside a physical office. Our long-time focus on automated, self-service solutions, like our IBot AI system that can answer many client questions served us well during this time. And while the market turbulence, together with the high volume of new accounts had…

Thank you, Nancy. Thanks everyone for joining the call. I hope you all are safe and healthy. First, I'll review our operating results and non-core items and my comments will follow the formality earnings release after which we will open up the call for questions. You will note that starting this quarter, we are no longer presenting separate operating business segments. After several years of winding down our market-making activity, we have reached the point where it is not contributing materially to our overall results. The streamline presentation reflects our management focus on our robust electronic brokerage business. We have also revised presentation of line items in the revenue section of our income statement, grouping the interest income and expense lines and splitting other fees and services from other income. The former contains recurring items such as market data fees and FDIC Bank Sweep Program income, while the latter contains currency impacts, U.S. treasury marks-to-market, principal trading activities and other investment gains or losses. Turning to the operating data. The operating metrics reflected record levels of trading and account openings in a high volatility environment. This was a tumultuous quarter given the impact of the coronavirus around the world. Volatility as measured by the average VIX nearly doubled to 30.7 in the current quarter up from 16.7 in the first quarter last year. In contrast to the first three months in 2019 when the VIX ranged from 15 to 20, this quarter after showing similar levels in the first two months, the index averaged 57 in March and it's floated to a high of over 82 mid-month. This dramatic increase corresponded with higher industry trading volumes and products across the board. Compared to the first quarter of 2019, our quarterly total DARTs rose 71% to a record 1.45 million. Our…

[Operator Instructions] Our first question comes from the line of Rich Repetto from Piper Sandler. Your line is now open.

Yes. Good evening, Thomas and Paul. I guess my question has to do with the press release that you put out after the close about the provisionary loss you're going to take related to the WTI contract. And I guess the question is, was this due to customers holding the positions right till close to expiration? Because I'm just wondering how they could ever fulfill like the physical delivery requirement of holding the contract.

So Rich, first of all, I would like to apologize for bringing this announcement on to everybody. So unexpectedly, this happened to us just last night. We were up most of the night trying to figure out what was going on, and we still do not have all of our facts completely in order, but I felt that we have to put out this notice. Now, as to your question, this was a cash-delivered contract, cash-settled contract. So, it was not about delivering. The cash-settled contract is priced off of the delivered contract, the CL. So this is WTI that is priced off of the CL and the CL settlement price, which is a delivered contract, determines the settlement price – sorry, CL trade price in a two-minute window of between 2:28 and 2:30 Europe Time – the volume based at average price in those two minutes on the CL contract determines the settlement price for this cash settlement contract. So most of the loss came from WTI, and some of it came from – Paul, do you remember the name of that future?

QM, which is the minimum crude oil contract.

QM, minimum crude oil contract that's trading on the CME.

Okay. So well, both the contracts are listed contracts on the CME then, is that correct?

No. The WTI is listed on ICE-Europe.

Got it. Okay.

So ICE has a European branch, and that's where it is listed.

Understood.

Part of the provision goes on that contract.

Understood. Okay. I guess the next question is, Paul, on the expected outlook on the net interest income, and I said going from $250 million, I think, you said per quarter – I thought you said per quarter to $150 million. And I guess if you could just sort of walk through sort of the sensitivities there, so we'd just better understand how you come up with that number?

Well, naturally, there's a lot of moving parts in there. So you have to make certain assumptions, some of them are relatively broad, about what rates might do or they're going to do nothing, and then of course, what balances are likely to be. And the balances are not a small part of the equation, because we've seen radical increases in cash credit balances as customers own long positions. They're happy to leave the cash with us. And then, of course, a big part of the projection has to do with the spread compression. And what I alluded to when the Fed goes below 50 basis points is that our base credit rate is Fed funds less 50 basis points, that's a very good rate versus our competitors, but of course, becomes zero when the benchmark goes below 50 basis points. So that creates the spread compression, which is also why there's this big elasticity when you see – as we talk about rates going back up, if they were to go back up, you get a lot back quickly, because for a certain portion of it, the customers side that we're paying on still doesn't go up until it passes sort of zero, right. So there are a lot of moving parts in there. We have to make certain assumptions at the moment. This is our best projection.

Got it. That's very helpful. And I guess, the last thing, Thomas, you've mentioned about this stay-at-home phenomenon, where it seems like you're benefiting from more client activity. And I guess, the question is, with all this activity, we're still not seeing any – or could you refresh us in regards to any material difference in mix of the IBKR Lite versus IBKR Pro? We're seeing people still choose IBKR Pro even in this – even with high trading volatility, and maybe it drives even more so, if they require the smart router even more so.

Right. So the more volatile the market is, the more important it is that you get the execution prices, because in a very volatile market, the execution prices can differ to the prices that you see, because it changes so up and much, much, much more. So yes, people choose IBKR Pro over the majority of them. So far, we have between 20,000 and 21,000 accounts that have chosen to convert to or open an IBKR Lite account and 760,000 I Pro. I'm sorry, these are today's numbers. So I'm sorry, I should have gotten back to the end of last quarter, yes.

No worries. That’s all I had. Thank you, Thomas and thank you, Paul.

All right.

Thank you. Our next question comes from the line of Chris Allen from Compass Point. Your line is now open.

Good evening, everyone. I was wondering if we could just dig into the net interest income outlook a little bit more. You gave us kind of the starting point to think about customer loan – margin loans for 2Q, and we can make some assumptions around that and the cash levels. How are you guys thinking about the SEC lending book? And then also, does it contemplate continued growth in your customer base from here? Obviously, we can bottom it at certain level, but then even if rates are stable, we should start to see some growth start to drive that higher. So any color on that would be helpful.

Right. But you see EBITDA growth, for the numbers, what they are today or at least what they were at the end of the quarter, the projected interest income would be even lower. But most of it is due to the fact that we get basically 15 basis points on customer cash. And that is the biggest item there, right, because we have roughly $70 billion of customer cash, of which $20 billion is lent out in margin loans and $50 billion is lent out in the short-term treasury market, and that yields only 15 basis points. So that's the culprit. As far – otherwise, the fact that the margin loans came down from close to $30 billion to $20 billion, that's another big drawback. And the third is that the short book came down from roughly around $10 billion to $7 billion or $8 billion.

Now part of that last point, if I could jump in, is that prices are down, right. But clearly, there's been some winding of the positions. But let me say what we've talked about before, which is that the securities lending business is very driven by stocks that get special for a period of time, where great interest, particularly on the short side, kicks up and they become expensive to borrow and lend. And if our customers are on the long side of that, it generates a lot of revenue. So there is, of course, a base of both the shorts and the longs, but it's very much driven by these stocks that become special for short periods of time.

Understood. And then just switching over to the provision loss, I appreciate the color there. Obviously, there's a lot of chatter just around what's going on in oil ETFs. Are you seeing any other dislocations in markets like there? Any thoughts on the market structure in these products in terms of things that we have to worry about moving forward from a credit loss perspective?

Well, hopefully, not on our end, but I think there are other people out there with various problems having to do with exchange-traded notes and funds that are holding oil futures. And as I said on the TV interview, there are folks – we have 15% of the open interest. So there is 85% out there in somebody – some other folks. And so that’s a proportion of loss to the percentages. And there is also a big winner out there, at least one or many, who was holding the opposite side.

Understood. I'll get back to you. Thank you.

Thank you. Our next question comes from the line of Will Nance from Goldman Sachs. Your line is now open.

Hi, good afternoon. Thomas, I was wondering if you can provide some more clarity around the regulatory matters mentioned in the press release. And if you could provide some more clarity around the findings around the BSA/AML practices, maybe if you have some sort of idea around what the shortcomings identified were and what it will take to remedy them? And then, I guess, either Thomas – go ahead.

All I can say about that is that we have been on this topic working on this topic for about at least two years. And as you can imagine, the part of the press release was very carefully drafted. And given the thing is still not has not closed, but it's likely to be closed within probably certainly by the next quarterly meeting, you just have to wait. I mean, I'm sorry, but those are telling you to be very, very careful in whatever you say about open cases.

Sure. And maybe leaving aside and I totally understand that there's probably you're probably limited on what you can say. Maybe leaving the fine aspect aside, can you talk about what you're thinking about with the third-party consultants and what the kind of scope or what that might entail from a cost perspective going forward would be?

Well, we have been working with these consultants for at least a year, I'm sure. And so there will be the same consultants, and we're working with them very well. And I assume that the cost will be going forward will be similar to what they have been in the past. So I don't think there is any surprises coming from there.

Got it. That makes sense. And then maybe switching gears over to expenses. I guess, one, just a little housekeeping item. The given the strong volumes, I would have thought execution and clearing might have been a little bit higher. Was there anything to call out that drove that to be a little bit lower than expected this quarter? And then separately, more bigger picture, given the decline in net interest income that you expect, given the rate environment, are there any levers to pull on the cost side that might offset some of this and maybe help you retain some of your kind of best-in-class margins?

So well, as far as the second question goes, we have always been, throughout our history, been focusing on growth. And well, sometimes revenues are low, sometimes they are high. We do not look at that. When we deal with expenses, we always spend as much money as we productively can to grow the business. That's always been our focus, and we have never looked at expenses. Now, of course, you hopefully – so I don't remember the first question, but I remember that the answer is that trades were generally smaller in this quarter. Oh, you asked how the trading – the expenses on the trader were not higher. It's because trades are generally lower in size than previous quarter, even though as you see the volume was much, much, much greater. You can just extrapolate by volume because you have to include the size of the trade. And if you look at the monthly releases, you can see that, right.

Right. So if I look at more on shares traded and...

Right.

Got it. Okay. And then if I could squeeze one more, a quick one in just for Paul. If I think some people are probably a bit surprised by the magnitude of the decline in net interest margin. I think everyone understood that lower rates pressure the spread, but the absolute size is probably a little bit larger. Is it a fair statement to say that a big driver of that is just the decline in margins? And could you maybe talk about how sensitive that $150 million run rate could be if we see kind of a rebound in margin balances over the next several quarters?

So if I may I'm the fellow who is responsible for investing the customer cash. And the fact is that we do not do anything sensitive. We are investing in short-term treasuries. So we fluctuate with the short-term treasury rates. And as you know, when treasury rates go above 0.5%, that extra, we return to our customers. So we're only sensitive here where the interest rate is between 0% and 0.5%. Once we're above 0.5%, we return that excess to the customers, at least to those whose accounts are larger than $100,000, which I think is over – only $10 million of our customer funds are in accounts that are less than $100,000. As far as the margin balances, as I said before, they have gone down from $30 billion to $20 billion. And obviously, we do not want to increase the margin rates because we hope to work that up back up to $30 billion, $40 billion, $50 billion. So we're never trying to maximize income for the next several quarters. We are always trying to maximize income for the years to come.

Got it. Appreciate you taking the questions.

Thank you. Our next question comes from the line of Kyle Voigt from KBW. Your line is now open.

Hi, good evening. Sorry to belabor the point on NII, but I just want to ask a couple of more questions. One, you just mentioned you're responsible for investing that client cash. I remember that back in 2016, I think over 90% of the securities portfolio at that time was invested in U.S. government securities, and repo is really a small part of what you're doing. Now it's kind of inverted, mostly just overnight, repo. Could you take any more duration risk go out two-year, three-year, four-year or two or five-year on the treasury curve? And then the second part of that question is, you were looking previously at potentially expanding the securities that you will be comfortable investing in for that securities portfolio, I think some other agency securities? Is that on the table as well to maybe pick up some additional yield in that book?

So I think it's basically the same question, whether we do agencies or longer-term treasuries. My answer is that especially on these rates, I mean, it's hard to imagine that they can go any further down. As a matter of fact, the federal government pushing all this money out and more and more and more and more, I think eventually, the inflation will enter the picture and the fact you have to do something to counteract that. So I would not, at this time – certainly, at this time, would not go further out on the yield curve.

Got it. And then maybe just a follow-up for Paul. I know you mentioned that $150 million run rate. Is that a run rate as of today? Because you also mentioned that you still had securities had some duration to them, those treasury securities, but maybe a year or over duration in that portion of the book that I assume would provide you kind of a more of a gradual landing point to maybe get to $150 million a couple of quarters or a few quarters out. But it sounded like that's really the run rate today. Just maybe if you could clarify that.

Yes. So because the duration is fairly short, the roll-off happens basically in if you were to project out four quarters, it all happens in the first quarter, and then your reinvestments happen at whatever you assume the reinvestment rate is. So depending on the scenario, say, up 25 basis points, you start to pick that up a little bit of a lag, which is why when I projected $79 million for the first four quarters, but about $94 million full-year run rate, that's exactly why, because it assumes that full investment. Similarly on the downside, we don't have too far to go down. But you have that greater impact – as we said before, you have that greater impact, because essentially, you're not paying anything to customers on their credit balances at the moment. Therefore, any pickup in the rates go straight to the bottom line, if you will, until you get to that 50 basis points, and then as Thomas said, it becomes a spread.

No, I get that. I guess, I'm just saying that on the securities book yield, I thought there were some of the securities book that was invested in treasuries that may have had a duration of a year or over that portion of the book that would have repriced over a year instead of repriced immediately. But I guess you're saying everything is essentially repriced already?

Well, you're right. Some of it is treasuries-owned, that's primarily for the commodities business to meet regulatory requirements. It's a much smaller piece of the total, and some of those do mature a bit further out. But we take all that into account when we talk about that overall duration.

Okay. Got it. And then just the last one from me is just a follow-up on the losses related to WTI. Just wondering if you could just let us know what if those losses were from hedge fund clients or retail clients or just kind of give us an idea of the client segment?

There were many clients, so we don't have hedge fund clients or our retail clients. We have institutional clients and individual clients. And my understanding is that most of these are from individuals. But as you know, I mean, these individual clients tend to be all traders and people that usually know what they are doing.

Thank you. Thanks, Thomas.

All right.

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

I'm sorry if I missed it, but can you elaborate a little bit on why do you think account growth picked up so materially in the quarter?

Stay-at-home company. So I think there are many people who have for years been telling themselves that one of these days, I'm going to open a brokerage account, and I'm going to begin to manage my finances myself. And they just never get around to it. And so finally, they have the time and they have the motivation. So they are doing it. It's an educated guess on my part. That's what I think.

Okay. And we've been talking a lot about net interest and the impact on your business. One thing I was thinking about is one of the value propositions of IBKR is the favorable rate you pay the customers on deposits. But now that everybody is...

Yes. Unfortunately, that has gone away. I think has gone away.

Yes, right, exactly. So do you think that's going to have much of an impact on the outlook in terms of growth? Or are people still going to be attracted to the other parts of your business, whether it be the smart routing order capability or whether it's the lower rate on margin and so on?

It remains. It remains. Well, as interest rates were coming down, it became less and less relevant already in the quarters preceding this. But of course, I mean, it is zero, and we will not be able to give them anything until Fed goes over 0.5%. But to tell you frankly, I do not think that – I do not hear that that is as important as the margin rate is. But I really don't know. I mean, it's a different type of person who – it's probably a less vocal person who is worried about receiving interest on the cash and the person who is trying to get achieve margin loan.

Okay. Thank you.

Thank you. [Operator Instructions] Our next question comes from the line of Mac Sykes from Gabelli. Your line is now open.

Good afternoon, Thomas. Can you just talk a little bit about the level of volatility, the trade-off between what's good for commission revenue, but still okay for sustaining your customer base?

Well, that's hard to – it's a very difficult path, right. Because the higher the volatility, the more trades we do and the customers tend to do less well. And I don't think it's that much due to the volatility, as the volatility tends to be higher and the market goes down basically. So that's why customers tend to do less well. And so up until the market turned around in the last two or three days, things were looking pretty good. Of course, it's a different story again. I really can't tell you where the balance is, what is the ideal ratio of volatility and trades.

Okay. And then on margin lending, I know you have the card facility. Have you noticed in the last month, any kind of additional margin loan that would be suggestive of stress versus kind of increase in allocation to the market?

No. So our margin loans have come down drastically and they maybe picked up just a tiny bit in the last two or three weeks, but not much. So no, we haven't seen any of that, no.

Thank you.

Thank you. At this time, I am showing no further questions. I would like to turn the call back over to Nancy Stuebe for closing remarks.

Thank you, everyone for participating today. 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 our site tomorrow. Thank you, again, and we will talk to you next quarter-end.

Ladies and gentlemen, this concludes today's conference call. Thanks for participating. You may now disconnect.