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

All right. I think we're now live. So we'll get started here. So we are delighted to have Thomas Peterffy, Founder and Chairman of Interactive Brokers. Board of Directors join us again for a fireside chat. Thomas founded Interactive Brokers 46 years ago if I had that correct.

You do.

Excellent. He's been instrumental in the creation of electronic market making and Interactive Brokers has become one of the fastest-growing broker-dealers in the market, servicing both retail and institutional clients and offering a unique tech-enabled platform. Thanks so much for joining us, Thomas.

Okay. So it's great to have you back at conference. I think a lot has changed over the past year, both in terms of the macro and frankly, your business. So maybe we could just talk about your perspective on the macro backdrop and what that means for markets and rate structures.

So I'd like to get to your point, to your question around the buzz way. If you are an investor in IBKR, you're justifiably unhappy today. When I looked at the stock at the end of November, I saw that it was exactly $2 lower than it was the year before. And that is in the face of the SMP rising by something like 18%. So what happened during the year and why did this happen? During the year, our number of accounts have risen by 22%. The customer deposits have risen by 27%. Our pretax profits went from $2 billion a year to $3.3 billion a year. So it's a rise of 65%. But the problem is that the way we achieved that was that we have taken full benefit of the rise in interest rates, while our peers have -- many of our peers have locked up their customers' money in long-term government that, which, of course, has lost a lot of its value and is there to mark to market, they would show a negative net worth, some of them. But they don't have to mark to market, so they can carry these long-term government securities on face value and borrow against them and to the extent their clients are either withdrawing money or they are moving the money into money market funds, they have to -- and they don't want to sell the long-term bonds and don't want to take the losses. So they use the face value of those bonds and borrow against them on the Fed, which is a special provision that Fed allowed for them at the time when the -- these couple of banks went bankrupt. So they don't actually have to take the loss. And even though they are showing much lower earnings. Now as the long-term rates now are going down from 5%, approaching 4%, they appear to be better off, but they don't really because they are still borrowing up 5.5% and have locked up securities still yielding less than 2%. But it looks like the future is looking [indiscernible] while ours are less so. But to -- how big a problem is this for us? 1% of lower interest rates would cost us $300 million. So if interest rates that falls into the 5% go to 4%, instead of $3.3 billion, we will only make $3 billion, other things being equal. But of course, we are expecting to go up more or less the same rate as we have been growing in the course of this year. So 22% account growth with a growth with -- growth with account deposits. And even though our commissions have not grown much because they haven't grown because '21 and '22 were very big years, mostly '21 was a very big year because of the lockup. So commissions spiked at that time. And then as they've been basically holding study, while the trading volumes have diminished drastically in overall, not ours, but overall in the industry. So how do you explain? I don't know how to explain the behavior of the stock. That's basically...

Okay. Well, let me just ask one other one...

Okay. So you're asking me high, but I see going forward as far as interest rates. I mean I don't think that I'm -- I have learned over the years to never argue with the market. If the market believes that long-term rates will be 4.16%, I don't think that it's any of my business to argue with that. But if I'm thinking about it, I see that there are several long-term trends in the economy that go for higher inflation and higher rates. And there are the deglobalization, and as you know, over the last several decades, the manufacturing of goods have been reallocated around the globe due to containerization, which reduced the shipping expenses. So they are reallocated, wherever is cheapest. And so that reduced cost of goods by very, very substantial amount by as much as 50% to 90% in many cases. We also -- so with the rise in geopolitical tensions, and transportation is going to become less certain and more expensive, insurance rates for transportation are rising every day as you see more and more international shipping vessels being attacked by various pirates and other whoever is attacking these ships, it's hard to tell. Secondly, we have the rising of -- the problem of replacing our skilled workforce. So skilled workforce is produced in the United States and Europe, mostly and to some extent in Asia. But it is all in countries whose population growth has slowed drastically even in some cases, have gone into negative. And so most of the population growth around the globe is coming from countries where skilled workforce is not produced. So as a result, skilled labor is going to cost more and more and more as we go along. Thirdly, are the deficits, again, in the same countries, especially in the United States. So these deficits are going to contribute to inflation. And therefore, it is hard for me to believe that inflation on the long run is going to substantially decrease. And add to this, the ESG spending, which is just going to be huge, right? So if you add all these 4 factors together, it's hard to see how inflation is going to subside. Even though for -- in the short term, in the next several months, it could go down, but I think that in the long run, it will come back. So there are these long-term trends that you can get away from that. And on the other side, we have the substantial increase in productivity, which we saw this morning and the productivity increase induced by AI. And that is, of course, it's very hard for me to speculate on. It could be very, very substantial, and it could be disastrous, I really don't know what's going to happen there. But so if I have to bet, I would bet on long-term interest rates, maybe 4% for now and going back to 5%, 6%, 7%, 8% as the deficit spending keeps increasing, international debts keep increasing and the refinancing of this debt is going to become more and more expensive. So that's what I see.

Okay. That's very clear. Maybe we can just turn to your strategy, investment priorities. Maybe where do you see the best opportunities to invest today? And then I know this is really difficult because your TAM is sort of every financial asset out there. And I know you've talked about that, but how do you think about your market share today and you can take that in any direction you'd like. And then what are your aspirations for what that market share could look like 3 to 5 years from now?

So our market share is negligible. It's almost nothing, right? We have 2.5 million customers, theoretically, we could have 100 million or 200 million or 300 million. So it's really -- it's less than 1%. And this is true in all the segments we are in with the potential exemption of proprietary traders. So proprietary traders tend to come to us because they like our executions and they like our technology and they like our prime services, and they do not have the customers that hedge funds would also like to come to us, but their customers want them to go to the large primes. So proprietary traders don't have that pressure. So with proprietary traders, I do not know, but I think that our market share is very substantial, especially in the United States and probably in Europe. It's unknown how many they are, so we cannot tell what our market share is. Now as far as individuals, I mean, our market share is -- our accounts are growing kind of rapidly around 25% a year, and that's been basically the same over many, many years, and it's probably going on forward, going to be similar. So eventually, on the long run, we will get there. What is important for us is the recognition worldwide that free market economy is the way to go. And in many countries, that is not really accepted or understood or well known. So it is our job to teach people about the free market economy and how public -- how corporations would naturally evolve in a free market economy where there is free competition, and then you take the invention of so-called publicly owned corporations, which is -- I mean, it's originally European, but lately an American idea. But -- so to spread that idea in the countries where it is not a popular and well-accepted way of growing the economy. So it is our job to teach the public about that and to develop the educational aspect of our platform, and we are going to spend a lot of money on that in the years to come, and we expect that people who learn about the economy and investing on our platform will become our customers. What our market share will be? I don't even know what the size of the market will be. So I have no idea.

Fair enough. Maybe if we could just turn to introducing brokers, and I understand why you don't want to give as much detail on those given the delays you've had so far this year with adding those 2 new IBrokers. But maybe you could just take a step back and talk about what the longer-term opportunity is in your mind for IBrokers based on the lessons you've learned this year and how the opportunity set has perhaps changed.

So we -- I've been talking for a long time about 2 large potential introducing brokers coming on to a platform. The smaller of the 2 has done so and the large one has not yet and it turns out that there are more less centrally governed institution than we thought they were. So it's basically -- they are [indiscernible] that are basically under one umbrella, and they have a lot of individual authority as to whether they want to put their customers onto our platform or not. The central governance would like them to do so, but they don't necessarily have to go along. So it's the -- all the legal agreements have finally been ironed out, but I really cannot tell at what rate they will proceed and put their clients on our platform. But we do have a large number of other institutions because basically, other than Pershing, we are -- other than Pershing, which is Bank of New York and Saxo, which is a small Danish bank relative to Pershing is very small, relative to us it's very small. We basically have no competition around the world as far as marketing our platform to other financial institutions to use for their individual customers. So that's what introducing brokers are. And there are -- the opportunity is huge because there are many, many banks around the world who do not have the technology, and it wouldn't be -- it would not be conceivable for them to develop this technology. And all the people around the world want to trade in the United States. So basically, we have developed -- as you know, we have the platform, but we also have developed the AML and all the local regulatory requirements that we have to comply with in many, many countries. And so they are able to bring the customers onto our platform. And there are literally hundreds of these kinds of institutions. So it's going to be a long process that is happening and it's happening hopefully at the increasing rate.

All right. I want to turn to the trading trends you're seeing. I think a lot has changed, frankly, over the past year. You've seen the continued proliferation of 0DTE options, and I think you've benefited from that. I'd be just interested as you look at the business, perhaps if you could just differentiate between the trading trends you're seeing for your retail customers versus the institutional ones and sort of what the outlook is for trading generally.

So these zero day options appear to be a controversial thing. But the fact is that we had done for 50 years. We -- although 50 years ago, we only had 4 zero day expiration options a year. And then we went to 12, when options were listed for every month. And then when options were listed for every week, we went to 52 zero day options. And then the finally when they were listed for every day, now we have 250 of them. I don't think -- I mean it's -- they are substantially cheaper, especially if you're looking at certain corporate actions that are like earnings or they come out at a specific date, so why would you have to buy a 1 month's long option if you want to speculate on what the specific earnings would be. I think you wait for the day before and you buy it at that time. So you pay a lot less. And so -- also, markets are relatively illiquid for moving large portfolios, whether you want to buy them or sell them. So it makes sense to, during the day instead of buying or selling the portfolio to buy or sell the zero day call or put depending upon whether you want to buy your portfolio or sell it and then just do the trade on the close. And then you don't care what price you pay when you do the trade because the same price is going to be reflected in the option when it expires. So you will get paid whatever you lose in the execution. So I think it has zero day options, had a very good economic justification for existing. Now you're asking me what -- what we think...

Yes, absolutely, just trading trends and differences that you're seeing between the retail and the institutional clients.

Well, I'm very confused about what is a retail client, what is an institutional client. So the way we separate them is that if you are an account holder in an individual name, then you are an individual client and you call that retail, even though it could be a person like me who has a very, very large account or -- so corporate names are institutional for us and individual names are retail. I do not -- we do not really look at the differences in the trading. So I tell you, frankly, I don't know what the difference is in the trends.

Okay. That's fair enough. Well, maybe we could just unpack a little bit more on the account growth. You reiterated just a few minutes ago the sort of 20% to 25% account growth. Maybe you could just unpack a little bit of the difference that what's driving that account growth and maybe split by the various customer segments and maybe even geography as well.

So the highest current growth rate is on the individual customer side. But again, I say that it doesn't mean retail. Many of them are retail. And so if I characterize retail, I'd say somebody who has less than $100,000. And so say, accounts under $100,000 are retail, accounts over 100,000, maybe professional. Most of our accounts -- so our average account starts at something like $30,000 to $40,000. 6 months later, they tend to double and a year later, they tend to double from that. So they start at $30,000 to $40,000 and up to $150,000, $160,000 an account. That is, of course, an average. And as you know, no account is an average account. So many of them are under and many of them -- and some of them are much, much larger accounts. The growth rate, as I said, is the largest in individual accounts than come proprietary trading groups, hedge funds introducing brokers and lastly, financial advisers. That's basically the rate. Financial advisers are growing the slowest. And that's, to some extent our fault because we haven't placed as much emphasis on financial advisers as other types of accounts, especially proprietary trading groups because the best parts of our platform is basically executing trades, borrowing money at a lower rate, getting a higher rate on your cash, seeing if you want to short which financial advisers practically never do, you see our short inventory. We display our rates, our rate where we're willing to borrow any security and the rate at which we're willing to lend it. So -- and these rates are usually substantially better than what is offered to prime broker, other prime brokers, where we basically don't know until you call and you start to negotiate with them. With us, there is no negotiation. What you see is what you get. And it's usually more favorable than your prime broker has to offer you. So larger hedge funds, many of them are having second, third or fourth prime broker, and that is us. And that is often because of the short-term capability on our platform.

Great. So I just want to turn to some of the dynamics around your margin profile, which has certainly always been impressive and actually has continued to improve over the past few years. Do you think that the sustainable low 60s percent margin guidance is achievable in a lower NII growth environment like what you talked about at the beginning of this chat. And then just how should we think about the growth trajectory of some of the major expense categories?

Well, our -- I think that in this last quarter, our pretax profit margin was 75%. And that, of course, is, I mean, unparalleled not only in the industry but probably very few publicly owned companies have that kind of profit margin. So I don't expect that number to go higher. And as we talked about reduction in rates. It's probably going to go lower. I don't expect it to ever go below 60. And it hasn't been below 60, I think, in years. So I think our profit margin is going to be between 60% and 75%. I hope it's going to be much closer to 70% than 60%. Now our expenses, well, our largest expense is compensation. We do pay our -- many of our employees, our technology workers. And we are very particular about getting the best one. So we pay them more than what is usual in the financial industry, and that is going to continue that way. So I expect that our compensation is going to continue to grow -- compensation expense is going to continue to grow around 8% to 9%. And the rest of our expenses -- fixed expenses are depending upon execution costs that is not really up to us. That's just the pass-through from the exchanges and trading venues. And then we have hardware expenses and we just buy the hardware we have to buy at the cost that we're being charged. It's not -- we don't have much room for negotiation there.

Yes, that makes sense. Maybe just one other one on this side of the P&L, which is just thinking about hiring for next year. How are you thinking about recruiting generally across technology, sales, just sort of the opportunity set and what you're thinking for next year?

We expect it to go about at around high single, low double-digit rates, so around 10% or so.

Okay. That's easy enough. So I think another one that has been, in my mind, very interesting was what's going on with you're looking for a bank charter in Europe. So maybe you could just update us on how you're thinking about the opportunity for a bank charter in Europe. You obviously didn't go ahead with the Hungarian one. And then I think it would just be really interesting if you could dig in on just exactly what sort of opportunity that creates in terms of freeing up capital on the margin loan side?

So in the U.S., we can lend our customers' cash to other customers. In Europe that is not allowed. So only a bank can do that. And that is what prompted us to try to get a bank. We started out doing that in Hungary, it didn't work out because Hungary being a small nation, comes out with rules every night, unexpected rules that we simply can't cope with it because we are not -- we are an internal -- we serve all the countries inside Europe. And so you can't -- it puts you at a competitive disadvantage. Now this is not an area where we are that is extremely urgent. But in the back of our minds, we are constantly looking for opportunities, and there are plenty of opportunities, but we are not really pursuing them with a very high vigor.

Okay. Just one last one here, which is around inorganic growth. You have alluded to the potential for acquisitions, I think, a few times in recent months. Maybe you could just speak to what you're seeing in the market and whether there are any potential targets on the table today?

There are always potential targets, and they always look very good because we have technology that we believe is much, much superior to anybody else has. So the idea is that why don't we can buy a firm and we put it on our platform and the cost will be drastically reduced? But once we approach an actual target and we look at their business, it seems that -- many of these businesses are not like us at all because we are very automated and we're very inexpensive, but we give you the rate that we published. And that's what it is, and there is not much negotiation. At other firms, it turns out that everybody has a different deal. And that is very difficult, very difficult to automate. So we basically look at the firm and we say, well, how much more profitable they could be if they were with us, but the fact is that the profits come from all kinds of different little charges and it's not -- they all appear to be free, but then they charge for this and charge for that. And that's where the profits come from, we wouldn't know how to replicate it. So, so far, we have looked at a number of them and nothing really seems to work out. So we just have to rely on our own growth.

Pretty darn good growth. So with that, thank you so much, Thomas. This is fantastic.

Thank you very much.