Interactive Brokers Group, Inc. (IBKR) Earnings Call Transcript & Summary

So really pleased to introduce our next speaker, Thomas Peterffy, Founder and Chairman of Interactive Brokers. Thomas has a really storied history within the equities and brokerage business, one of the first individuals to utilize computer models in option pricing, a pioneer in automating equity options and futures market making. And his firm is a global leader amongst all the technology-driven brokers. And while he certainly has an impressive background, ultimately, when we look at the financials, it's really standout best-in-class margins, best account growth across the space and a really diverse tech stack. So Interactive has really emerged as the premier player within the brokerage space. So I couldn't be happier to have you here with us, Thomas.

Now before maybe delving into your business, you always have interesting perspective on the macro. I was hoping to get your thoughts on the interest rate backdrop, expectations around the stickiness of the higher for longer rates, and anything you'd like to share just on how that's going to impact the financial services and brokerage industry more broadly.

So I'm not saying anything new, and I tell you that interest rates go with inflation, right? And so as long as inflation stays up there, interest rates will go -- will stay up there. So I doubt that interest rates will dip below 4% because I think that inflation is driven by the 3 Ds, which is deglobalization, number one, over the past 3 or 4 decades. Due to the containerization and the Internet, the production of goods and services was reallocated over the globe to places where it's the cheapest to produce them because it is so cheap to transport them anywhere you want to use them or sell them. So as a result, cost of goods have gone down 50% to 90%. In some cases, more than 90%. Now as a result of the geographic tensions, this global -- this globalization is going to reverse now and it is in the process of reversal, and that is going to increase prices. So that's one thing that is driving inflation on the long run in my mind. Secondly, it's the 3 Ds, so deglobalization, demographics. Demographics, if you look around the map, you will see that the mean age of the population in the United States, in Europe, in China and Japan. So anywhere where we see developed economies, the mean age is 40 or higher. When you look at the rest of the globe, the mean age is 30 or lower. Sorry, I don't mean, mean. I mean median, median age. So as a result, the supply of new skilled labor, where we need it, which is in the developed countries is going to become less and less and less. And it is increasing fast, and people are growing up in the undeveloped countries. But there are not -- there is no education that -- the kind of education that we need to continue to produce what we're producing is lacking there. So for that reason, I'm saying that labor prices are going to rise in the developed countries fast. And thirdly, the deficit, right? Deficit is -- looks like it's going to be $5 trillion in the United States over the next 5 years. Now that -- the interest on that, and that's added to the current $33 trillion, right, so it will be $38 trillion. The interest on that is just going to grow higher and higher and higher. So inflation rate will increase for these 3 factors -- because of these 3 factors. You add ESG next to it on top of it, and then you see where you are, right? On the other hand, we have AI. It's a great promise, but I do not really see how that is going to help us out of here. But maybe, it will. I mean maybe, I'm wrong.

You opened up the door to that, Thomas, given your background and like deep expertise on the digital and technology side. What are your thoughts around AI broadly? And how are you maybe looking to deploy that at your own firm?

So at our own firm, we have been trying to use different versions of AI over the last -- we started about 3 years ago for customer service. Namely, we ask our customers -- when a customer calls in, we try to serve with them online, and we try to get them to type in the question, and then we give them an answer. And if they don't like the answer, they can switch to the customer service person. And that -- right now, there are about 30% of our answers are correct, which is not bad because we started at something like 2% or 3% 3 years ago. So it's getting better. And that is a demonstration that yes, we can see -- yes, we can say it's simple jobs like customer service. And so as a result, as our number of accounts are growing, we don't really have to add too many new customer service people as that AI gets better. What is more exciting about the AI, of course, is what you all do, namely trying to predict stock prices, right? And there are a number of [ con ] shops that are working on that. And what we are doing is we're trying to interface their software with our execution software, right, so that they -- because what is going to happen is that as they see the data points changing, they will very quickly will want to act on it. But of course, they are all looking at the same data points, right? So it's whoever gets there first is -- again, it's always the fastest speed that's going to win. So it is important to have this immediate ability to trade. As soon as your data changes, you want the orders to execute. So that's it.

That's great color. You talked about higher for longer being your base case. How are you managing Interactive's balance sheet for this new higher rate paradigm?

So we are invested very short term, roughly about a month forward. It is also -- right now, there is a very interesting situation in the -- if you watch the long-term bond market over the last 10 days or so, you saw that long-term interest rates came down by roughly 45 basis points to 4.55% from 5%. Simultaneously, the stock market went up by about 5.5%. So what is happening is that it is institutional. I assume these are institutional accounts who are betting on lower rates. So they are buying the long-term bond futures because it's very simple to -- very liquid, very simple to buy. And it's quick to buy, and you don't immediately need a lot of money to express your view. So they are buying these futures on the hedge funds. See, the bond is trading lower than where the futures are, so they buy the bonds and sell the futures. On the other hand, when the futures are going to come due in December, what is going to happen, right? So the institutions that bought the futures will probably not want to take delivery, so they will either roll forward or just sell lot. Now if they sell lot, the futures are going to dip. So the hedge funds that are holding the cash against the futures will buy the futures and will want to sell the cash. But who is going to buy it, right? So I think that come December delivery date, the rates are going to go. And if not this time, then in the March delivery. I mean, I think if you are interested in these issues, watch interest rates around the future delivery. What was your question?

No, that's honestly -- it's about how you're managing the balance sheet. But honestly, I hadn't heard that perspective in terms of the supply that's going to hit the market and the dynamic with futures.

It's all about supply and demand in everything.

The other piece, just around client engagement. Given this macro backdrop, maybe just speak to what you're seeing in terms of trading volumes but also the utilization of margin, which ticked higher, as well as securities lending.

So margins, if the market stays where it is or goes slightly up, our margin balance will increase because margin loan balance will increase because we are the lowest provider of margin loans. We charge 0.5% to 1.5% over fed fund rates. We charge 1.5% for very small loans and 0.5% for very large loans. And for in between a month, we are in between. If ever the market goes down, then margin loans generally decrease because people liquidate or some of those who don't liquidate will liquidate them because we are -- our margin procedure is automated so that we never end up holding the bag.

And on securities lending, do you have...

Securities lending. So securities lending, it largely depends on the number of hard-to-borrow situations. The profits in securities lending are greatly dependent on that. And currently, there aren't a hell of a lot of hard-to-borrow stocks. So -- but that's a fluctuating thing, and I cannot forecast what is going to happen.

We hope for an IPO recovery. That should hopefully help. Maybe just shifting to your business specifically. You delivered consistently really best-in-class account growth. I know you've talked about 20% plus being the achievable bogey over the long term. Maybe just speak, Thomas, to the building blocks, how you get to that 20% growth sustainably.

So the account growth for the last 12 months is 22% accounts, 24% equity. The individual accounts have grown by 24% over the last 12 months. Nancy, are you here? Can you give me that, my [ feet ]?

Yes.

Individual accounts are up 24%. So 22% -- well, I don't -- I have to wait for the sheet. I'm sorry.

That's okay.

I wrote this all down on my laptop. And what happened was that instead of my Wolfe presentation, I put out my Bank of America presentation. So the answers don't match the question, so that's the problem. Okay. So individuals are growing about 24%. And drop traders, 21%; IBrokers, 18%; hedge funds, 12%; and financial advisers, 7%. However, the profitability of these segments is quite different per account because hedge funds are highest, drop traders are second, financial advisers are third, individuals are fourth, and IBrokers are the least profitable. But -- so I expect accounts growing at the same rate going forward as they have been growing in the recent past.

Well, despite not having my questions in front of you, that was my next question, so good job at least anticipating that. But maybe spending a little bit of time on the introducing broker channel. Can you maybe help frame, Thomas, the market opportunity for the broker dealers that you're targeting? And what's differentiated about your offering that's resonating with that cohort in the marketplace?

So 80% of the accounts at Interactive Brokers are not U.S.-based, so only 20% of the accounts with us are American accounts. This -- and the growth, the new accounts are outside of the U.S., even more than 80%, something like 84%. So we are basically an international broker because our accounts are coming from all over the world. And that gives us the advantage that we have very, very little competition in places where there is very little equity culture. So people who are now coming to a point where they're beginning to have enough money to invest, if they look around, the only advertisements they see for brokers is Interactive Brokers. So they open accounts with us. And that is the reason why our growth rate is faster than our peers.

Clearly, the challenges on the regulatory side, Thomas, create a lot of high barriers to entry for some of the other brokers.

And for us too because I tell you, the AML thing, of course, is extremely complex with accounts from all over the world because a U.S. applicant is very quick to AML online, right? But with foreigners, the online AML is much more difficult, and we have to use people to follow up on these account applicants. And so we have some 400 people now doing nothing but AML.

We've had one interesting development is -- I know it's a very different demographic cohort but Robinhood, who serves a very different clientele, is launching in the U.K. They have other ambitions to expand that more broadly internationally. Maybe speak to the competitive landscape and whether you perceive folks like Robinhood or others, that are trying to make a similar push, as meaningful threats in that regard.

I was asked this question on CNBC 2 nights ago. And I answered saying that I do not understand Robinhood's business model because they have 5x as many accounts as we have and they repeatedly are reporting losses. And we have $3 billion of profit a year roughly. So I do not understand. First, they wanted to grow themselves to profitability hoping that if they have more accounts, their cost will not increase at the same rate. But that didn't happen, so now they are trying to shrink themselves to profitability and trying to get rid of the least profitable accounts. But that doesn't give them profits either. So how will they ever get to profitability is a very interesting question. And I tell you, I'm not going to do them -- do their homework.

Fair enough. Well, we have them presenting later today. So...

Really? Ask them that. And I am very much interested in what he's going to say.

And maybe just spending some time on the prime brokerage side. You noted that the hedge fund segment is the most profitable or at least has the highest profitability profile, I should say. What about the offering of Interactive that's really resonating with some of the hedge funds? And are there any capabilities you're adding to maybe attract larger funds onto the platform?

So we are very lucky with the hedge funds because what happens is that the large primes will not take hedge funds under $100 million. Or you have to back them and if you have a related fund that's over $100 million, then they'll take you. Otherwise, they won't. So if you -- and most of the funds we get are under $100 million. And so if you are in the under $100 million category, you have to go to a mini prime. And mini primes are -- they don't clear or custody themselves, so they go between the big primes and the hedge funds. And that, of course, adds to the cost, and small funds are very sensitive to cost. Large funds are much less sensitive, and that is our problem because basically, what we have to offer is better executions, more streamlined work and less expense. So we basically believe that we add 1% to the performance of a hedge fund. And large funds don't care much about 1%. They care more about hedge fund handholding and all the white glove stuff that they get from the major primes. So second, what do we do about it, right? So one of the things -- so we are trying to go after the large prime brokers for part of their business, which is that they can keep their custody wherever at Morgan Stanley or Goldman Sachs. But if they give some of their execution business and maybe a little bit of their custody to us, that's great. And then they get access to our short availability, where we are the only prime broker who display all of our short inventory and the rate at which you can borrow it. Now many of the funds look at that and then instead of really doing the business with us, they go back to Goldman and Morgan Stanley and beat them up saying, look, interactive Brokers lends me this stock at 2%. Why do you want 4%, right? And then they usually get what they say. But lately, I have heard that some hedge funds say, Interactive Brokers gives me a 2%. Why don't you match them? And the fact is that we had that stock at 3%, right? And the primes are picking up on the hedge funds lying to them, and they no longer match. So I don't know what will happen. But anyway, we just came out -- we are just coming out with a -- next week, we are coming out with a way to -- from your iPhone, you can enter the stock symbol and see the rate at which we are able to lend you the stock and the range which we pay on the short proceeds and not only in U.S. dollars but also Hong Kong dollars or euros. So depending upon what -- where you are and what currency your account is based in because, as I say, this is basically a global world, and America is only part of these service accounts.

Well, I know you've been climbing up the prime brokerage ranks. And now that the banks have to grapple with some tougher regulatory and capital burdens, I imagine there'll be a growing TAM, at least at your side.

Thank you very much.

Shifting to the product side, Thomas. You've been an advocate for options trading for decades. The...

I've been right.

You have been right. And certainly, the adoption statistics support that. I mean is your expectation that the options utilization continues to grow as a percentage of trading on your platform and maybe even across the broader industry?

Definitely. I mean that's what we've been seeing. I started in the option business 47 years ago, and options have been around for 50 years. The CBOE started in '73. And throughout those 50 years, you see almost straight-line growth with a little bit of a curve upward in the last year or so, last 2 years. And so the fact is that, as I say, where we are, where most of our new accounts come from, is outside of the United States where options utilization is much, much lower. And there is -- so we are in a very good position to market options. As a matter of fact, we do a lot of joint marketing with the CBOE and the CME at different places around the world. And so we have a very good situation as to where we are marketing. And I expect that this is going to continue to yield good new options accounts.

And maybe on 0 DTE options specifically, that there's been a significant tailwind to option volumes on your platform and even broadly across the industry. Can you help investors -- help us, at least, to understand why sort of have [ dated ] options have become so popular? And what's the runway for growth in your mind for that particular product?

So the reason is very simple. Short-rated options are so popular because the shorter the option is, the cheaper it is. So people like to put up $100 and see whether they are right or wrong by the end of the day with the 0-day option, and they don't have to worry about managing the position overnight because it's a cash option and it expires at the end of the day. So it's a very, very simple proposition to buy or sell an option. Now most of our customers are trading vertical spreads. Namely, you buy an SPY, you buy Standard & Poor's options, right? You buy a $3,200, sell a $3,300 option. So your cost is reduced by the -- if the market is around $32 something, your cost is much less. And so you are risking basically $100 or something like that. And at the end of the day, you either have a profit or a loss and it's a lot of fun. Also, if you want to trade your way into a portfolio during the day, the market is kind of illiquid. So what people often do is if you want to accumulate a portfolio, you buy an in-the-money there [ all-day ] call option, which is very liquid. And at the end of the day, you put in the portfolio order to buy on the close because you know that the option expires at the close, right? So when you buy on the close, you get the price that you paid for the option, basically. So that's -- and the same way, liquidating a portfolio, you buy a put option.

Thomas, I think one of the biggest differentiators in terms of your performance relative to the peer group is certainly your margins, which I think last year, when you were here, you said you don't know if there's room for expansion. They have since expanded. They're now in the low to mid-70s type of zone.

73%, to be exact.

Okay. That's what. I appreciate the precision, 73%. How should we think about that margin trajectory in a higher-for-longer backdrop, confidence around the sustainability of that?

Well, we'd like to be able to sustain it over the low 60%. I think it will be 60% to 75% for the next 3, 4 years, and then it's going to go as inflation is going to rise. As I said, it's going to -- I don't think we can go much higher than 75% because the profit margin for the average U.S. corporation, what is it, maybe 10%, right? So it's impossible to imagine that we could go much beyond 75%, right?

I would have said that last year too that you wouldn't gone much beyond the mid-60s, yes. But the expense growth has actually been a big driver of that positive surprise. Even as the account growth has been trending in line with your targets, the -- that 15% growth in fixed expenses, you tended to deliver better than that. Why is the 15% the right benchmark? And can you sustain that even with the inflationary outlook that you just outlined?

Well, it no longer is because I think that our expense growth is going to be more like 8% to 9% because the expenses grew very fast because we had to put in broker -- new broker subsidiaries in various countries, which we continue to do, but at a slower rate now. And second, I mentioned before that we had to very, very substantially boost compliance. The compliance department is becoming almost the most expensive department of the firm. And so now that it's all [ fat ] and we have put in a lot of compliance software, we can ease up on that expense a little bit, so our expense growth will come down to the 8% to 9%.

That's great. Well, I know, Thomas, we only have one more minute here. I did want to ask you around M&A. You did note on the 3Q earnings call that you were looking at 2 potential M&A targets. I wanted to just better understand your M&A philosophy. What are the types of companies you're interested in acquiring? Are they smaller broker dealers that you could fold into your current business? Or is it more of a product capability add that you're looking for from an M&A standpoint?

So as you hear in the news, we haven't done very well on that because there is no news. So we haven't done any M&A., and the problem is that we don't want to get into the Robinhood situation where we have millions of accounts and not make any money, right? So we don't want to buy any of these small brokers. And the large brokers are more relationship driven, and we are not good at that either. We are good at building technology. So we're kind of stuck here. We would like -- the money we have keeps accumulating. We are now at $13.6 billion of equity, and we are making about -- after tax, about $2.4 billion a year. And it just keeps accumulating on the bottom line. We have to spend it somehow or give it back as dividends. But we'll see.

Great way to close. Thomas, thank you so much for being here again. Really appreciate it. And next up, we will have the heads of Pershing. So thank you again.