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

All right. Well, thanks, everyone, for joining. Pleased to say joined by Paul Brody, CFO and Treasurer of Interactive Brokers. Paul joined Interactive as Treasurer in 1987. I don't want to say what grade I was in at that point, but very early money on Interactive, became CFO in 2003, and retained his Treasurer responsibilities, of course. Paul, really pleased to have you here. Thanks so much for joining.

Thanks very much for having me.

All right. I'd love to start out with a broad question on strategy and macro. So appreciate that data from prior rate cutting cycles may be somewhat limited, but what's the best way to think about the -- what happens to NII in a rate cut, and how investors should think about balancing the trade-off between lower NII and the potential for higher trading activity volumes or margin borrowing?

Right. So we did talk about our interest rate sensitivity. And our policy is to provide a locked-in spread, really. We pay a benchmark less 50 basis points, say, on our credit balances and a benchmark plus 50 on margin lending. And the bulk of the client money is actually sort of locked into that spread for us. And then we have a certain portion that is what we call fully interest rate sensitive balances. And that's really where the impact from reduction in benchmark rates will come from. How do we think about it? Stands to reason that lower interest rates might spur more margin lending to the extent that it's simply reducing the cost of doing that strategy. We can't know that. We haven't actually looked at historical data to see whether there's a true correlation there.

Okay.

But -- and then as far as customer strategies, we think that more of the margin lending is probably based on the outlook on the markets than on the interest rate itself, so...

More about risk appetite than cost?

Yes, right.

Okay. But -- I mean it stands to reason lower rates would support a higher market, right? So it's logical to conclude that as long as we see that outcome, that it could lead to more margin lending. Is that fair?

Might, yes.

Okay. Great. What aspects of the Interactive growth story do you feel are underappreciated by the investor community?

So we wish that our advertising over our great interest rates would produce more customer engagement. We understand there is a certain stickiness to anytime customers move their accounts from one broker to the other, but we're still out there publishing tables and showing how much better our rates actually are. So that's a sense of frustration for us in terms of growing the customer base. We clearly have the lowest commissions around the world. Here in the U.S. where stock commissions have gone to so-called 0 rate commissions, kind of, as you all know, masks the fact that the actual cost of execution can be higher in that regard than paying out low commission and getting a better execution. That's something that's hard to transmit in advertising, so it's a concept that would get lost. And so we sort of lost the ability to advertise it that way.

Yes. I get that. As CFO, I think a lot of investors are pretty interested in your view on capital. So I would love to transition to a few questions on capital. So M&A has come up a decent amount recently in some of the earnings calls. So as CFO, how do you think about capital? And how would you describe the capital management framework and priorities?

Sure. So the first thing to understand is how much capital it actually takes to run our business. It's more than you would think, from reading our SEC filings that show what our regulatory excess capital is. That's a low requirement, therefore a large excess. It takes a lot more liquidity to run the business, especially with a growing customer base. They trade more. That requires more use of house money. And certainly, when things get very volatile, as we saw during multiple periods, the mean stock period comes to mind, the clearing houses call for multiples of the amount of margin and other mark-to-market funds that we were putting up before. And we put up those funds, and that's what large capital base is for, to actually gain business during those time periods. So not every firm was able to do that.

Okay. But even with that being said, you guys do have some excess capital, right? You've mentioned a range of $6 billion to $8 billion as a rough range. When we think about that, is that above any liquidity requirements that you all would consider? Or is that inclusive in considering any of those potential liquidity buffers?

So some of that would clearly be used for liquidity purposes, that is to say, tucked away for a rainy day. You have to have it there when everything is moving quickly in the market. Having said that, it's pretty -- it's still a pretty big buffer. And we've been happy to look at M&A opportunities over many years. We just haven't found anything that made the most sense at the right price. We've had conversations more recently, as I think Milan Galik, our CEO, has alluded to, and they didn't result in finalizing any transactions, mostly on price. But we're quite interested and we think that there are ways to expand the business other than organically, which has traditionally been our method.

Preferred method, right? Right. One of the things that we -- I hear sometimes as an analyst is some concerns around concentrated ownership. So is it on the table to consider using some of that excess capital to buy back a block of Thomas' stake? I know he's express frustration with the valuation at times, but the market has helped him out, no doubt, a little bit here recently.

Yes. So we understand we have a 25% float or so, and we'd love that to be bigger. The buyback would not be a mechanism to achieve that. It wouldn't be a buyback. It would be the company buying Thomas' shares somehow. But rather, he has expressed an interest in, at the right valuation, selling out small amounts at a time into the market, which he has done in years past. He has his own targets for what he thinks that valuation is, which I'm not privy to. But that would really be -- the way to increase the float is to sell more shares into the public, and that would certainly be his long-term plan.

Right. Okay. All right. So you made reference to M&A. Certainly, that's been topical. Understanding that you might be limited in what you can say, can you talk about what type of targets you might be considering on the M&A side? And what metrics or what type of an acquisition you might be interested in?

Yes. So several different kinds might be interesting. Over time, we've been shown e-brokers that might not be especially interesting to us because maybe they have software that's not as good as ours and maybe we're going to get those accounts anyway. We have pretty good account acquisition experience doing it all on our own. And maybe if they had good software, it might be more valuable to somebody else than us, like a private equity firm or somebody who actually doesn't have that to begin with. But there might be certainly firms in parts of the financial services world or in geographies that we haven't penetrated as much as we would like to. Marketing and advertising locally is absolutely a local endeavor. You have to have cultural feet on the ground to really penetrate the minds of potential customers. And so we do that well in some places and we do not as well in others. And if we found a firm that did it really well in some large potential markets, that might be a good fit. There are probably also firms that have good systems for analytics that -- we've developed a lot of things on our own, but not to say that we wouldn't find somebody that might enhance the offering that we have.

Okay. I know this is -- there are some questions that you know are going to be tricky to answer, so -- but any sense of timing around any potential deal? And when we think about structure, we talked about 25% before. Could using equity be another means to get around some of that smaller float and introduce some more shares?

Well, so if we're going to -- cash is more likely, because we have a lot of excess and it would satisfy a lot of investors, probably, to utilize it that way. And then, of course, you have to think that your equity is overvalued in some way in order to really want to use it for M&A, and we certainly don't feel that way.

Clear. Clear. Okay. And you didn't touch my timing, which is, I don't doubt, intentional.

If you had asked me 5 years ago, it would have been the same answer. We're happy to look, and couldn't possibly comment on timing.

Totally fair. So you all have a really remarkable pretax margin profitability, and it's been preserved remarkably well over time. If we end up seeing rate cuts manifest, and that would present a headwind, of course, in the near term at least, would you consider reducing spending in order to defend that margin? Or similarly, you flagged an expected expense growth. It's high single digit, 8% to 9%, slower though than recent history. So what's driving that slowdown in the expense growth?

So firstly, starting off at a 70-or-so percent margin is a pretty good place to be at. And even before the rate started to come up, it was 60%, let's say, and that's also a pretty good place it'd be at. So I wouldn't say that it drives much of our mentality around this. I think -- sorry, prompt me on your question again?

Well, one is if we get rate cuts, would you calibrate the expense growth? If we just not break it into the healthy part, so we'll start with that one first.

We were hiring quite aggressively for several years. We've built up a lot of capacity in compliance as well as software and compliance. We built up much more capacity in client services and in software development, which is really what drives our business. We've simply chosen not to be as aggressive in the past. I wouldn't say it's going to level out. I'd say that our growth in that -- in staffing has continued, but at a much slower pace. And quite frankly, our other expenses are such a small portion of our net revenues that we spend a certain amount on technology, certain amount on communications and so forth. Those aren't really up for grabs. So we think we're in a pretty good place in terms of looking ahead at the growth of our employee compensation and benefits.

Got it. And so has the slower pace of hiring really been what has allowed the expense growth to slow down here? In your outlook, you guys are looking for 8% to 9%, which is a little slower pace.

Yes, I think -- when I think about that, probably, mainly. Yes.

Yes. Got it. Okay. So when we think about NII, right, so the securities lending market has recently been a little more muted, with the revenue in that business roughly half of the 2021 levels. What do you think is causing this? Is it a function of maybe less M&A announcements, so less merger arb, a softer IPO calendar. Have you seen any? And then are there any signs of it picking up?

Yes. The securities lending markets are very opportunity-driven. So what we see is by offering really excellent services like locates for short stock opportunities and good rates on various things. We have a fully paid securities lending program where we share the revenue with the customers. That builds the base over time great. But really, the opportunities come and go. Hot stocks, where everybody piles in and then the shorts pile in, and then we're actually matching. Customers are borrowing a margin stock, and then we're lending at the customers who are going short, and that's a great situation for us. So really, those revenues are down because we haven't seen a whole lot of action there in the last year. But to the extent that it might return and these stocks become hard-to-borrow stocks, which is the industry term for stocks that you have to pay a lot to go short, that would return. We're well positioned for it. We've built a lot of software and systems to be able to recognize the rates in the market and recognize and capitalize on the opportunities.

Have you seen any leading indicators in that picking back up or not yet?

Not really.

Not really.

You see little green shoots here and there. But anybody could look at the market and see where the really, really hot stocks are. I can tell you that NVIDIA, being an extremely hot stock, has not produced. There aren't a lot of shorts out there for obvious reasons. If that turns, I mean it's also an extremely liquid stock. So that tends to drive stock loan rates to flat instead of something interesting. But it's so widely held, if something -- I mentioned it because it's a hot stock, but it's not a stock that drives securities lending revenue.

Right. Yes. Yes, for sure. So I appreciate that you guys gave the NII sensitivity on the last earnings call, right? $75 million, I believe, is the reduction in NII for each global rate cut. That assumes balances as of year-end, right? So is there a way to calibrate that number for different levels of balance sheet growth?

That's hard to do. So our fully sensitive interest rate balances have been fairly stable even as the business has grown. One would think over time, yes, they'll grow, but it's very much a function of how much customers are invested in the market as opposed to leaving their balances on the side. This only affects the balances on the side, so when customers pile their cash into the markets, this number doesn't change or it might even go down. It hasn't gone down, but it's been fairly stable. So it's a little hard to model. Yes.

Got it. Okay. And is there -- is it likely -- if we end up seeing rate cuts -- it sounds like no, but is there -- likely to see some growth in cash balances that would offset -- given what we talked about before rates go down, markets go up, it actually might seem even the opposite. People might be likely to put more cash to work.

Very much market-driven, again. Less rate-driven, more market-driven. What we do see is when customers are out of the market, thereby raising their cash balances, they're happy to leave them with us because we have large net worth, we're solid, we're stable, and we have better interest rates than others. And so we don't see those proceeds from the sales leaving us. They stay there.

Got it. And then when we think about margin balances as a similar sort of question, it's sort of interesting, we've seen margin balance growth despite the fact that the rates are higher, right? So the idea here is it's just a risk appetite function, really, more so than any kind of rate sensitivity. So is there -- is it too -- so therefore, if we think about rate cuts, right, it's going to be more about the market reaction to that driving any change in margin balances. Is that a fair conclusion? And you could think that if we see rate cuts, yes, you're going to have NII decline. But as long as it supports equity market growth, you could see them offset with margin balances?

Could be. But again, the margin borrowing on the part of the investors is very much market outlook-driven, for obvious reasons. But that's really what drives it. All we can do is offer the best rates we can possibly offer, in the hopes that when they do turn their thinking to grow their margin lending, they'll do it with us.

Okay. Got it. So let me talk about the asset base a little bit. So you all have been very short in the duration on the asset side, which has allowed you to reprice quicker during this past hiking cycle. But if we -- what would you want to see as far as maybe the yield curve or whatever in order to maybe take a little bit more duration? And how should we think about other environments where you might have seen a greater duration? And how would that be calibrated?

So our customer, both credit and margin lending rates are based on a spread off of benchmarks. These are overnight benchmarks, and so they literally change almost every day. I think we would have to see a turnaround and a positive yield curve that we would have to be convinced was going to have some stability to it to go further out in our investment of those client funds because we're still paying them on an overnight basis. So if we think back to pre, pre, back when we had that condition, we never went far out, but we went out to maybe an average duration of 9 months. And there's a bit more risk in that, but we would probably push out. We're never talking about 7 to 10 years. We're not ever taking that approach. And we think that matching maturities is a safer way to go. But if there were a little yield curve extra in it, we would take a little bit of yield curve extra.

Okay. All right. But this is something that will be measured in months, basically, and that's rather...

Yes, which is currently measured in days, right, because the yield curve just doesn't allow for it.

Sure. As far as thinking about the brokerage business, so really impressive growth amongst hedge fund cohort in recent years. Can you describe the typical hedge fund that utilizes Interactive in terms of maybe size and geography? And do you ever find that the platform appeals to smaller hedge funds, and then some hedge funds end up outgrowing the platform?

So our sweet spot is still the small hedge funds, some of which got actually thrown out by their funds maybe, but -- at some point or another, but we can provide them with a suite of services that they like. We would like to attract more in the $50 million to $100 million range and then certainly beyond that. That's tough. It's -- hedge funds are very sticky in how many primes they use. And once they've got more than 2, it's nearly impossible to add another. And there are services that we're really good at. Our securities lending is great, as I was just talking about, and our rates are good and so forth. But we don't do capital introductions, and we don't do the same things with -- we don't do investment banking, so we're not on the IPOs and we'll offer them on the day that they come out, but it's a whole different thing. We're putting new efforts into figuring out how to improve our sort of white glove service, which is a suite of some of the prime services that are offered out there, improving on what we have and improving on where we think our competitive advantage already is, what we're really good at: trade execution, keeping the cost down, good interest rates, financing.

Got it. The institutional push, hedge funds and proprietary traders, it's a small portion of the client equity, about 3% of accounts, but nearly 1/4 of commissions. Appreciate that they're more likely to use higher fee services, probably, but have you looked over past business cycles and seen whether or not they've shown resilient -- any greater resilience to market conditions or whatnot as far as like engagement?

So those institutional customers -- it's interesting. The proprietary traders and the hedge funds, their market engagement tends to be -- obviously, they're much more active than other customer segments. It depends a bit on are those strategy-based or are they trading-based as to whether their volume will come and go with market conditions and so forth. So we have a spectrum of those. I don't think that we can pigeonhole them into just one kind or another.

Yes, because it's just a spectrum. It depends on the strategy.

Yes.

Yes. Okay. Fair enough. Broader adoption of options has definitely been robust, and volume at Interactive, up 12% in 2023. Which client segments have contributed the most of the growth in the options activity? Or has it been more broad-based?

Well, to the extent that -- so options are clearly being used more broadly, generally speaking, as people become more educated in what their value is and what -- how they can be used to position yourself and the hedge and so forth. And then, of course, there's this -- the latest topic of interest is a zero-day options trading, which is pretty extraordinary. These are one-day bets that basically pay the same commission as a 3-month bet. So that's obviously good for us. And I have not seen a breakdown across customer segments. I would imagine it's pretty broad-based, and to the extent that there might be institutional customers looking to trade against retail flow, if you will, they're probably coming in to meet the other orders that are zero-day option orders. So there's quite a lot of volume there. I think even in the statistics that the CBOE puts out on the S&P volume show that a pretty good portion of it is happening now in the zero-day options.

Zero-day, yes. That's what's driving the volume, is the 0DTE?

Not solely, but it certainly has contributed.

A substantial majority.

Yes.

Yes. Got it. Is there any way to think about what -- whether or not certain cohorts are more prone to the 0DTE versus other parts of the customer base, or not really?

I don't really have an insight into this. Yes.

Okay. Fair enough. I can take some questions from the audience here in a minute, if anyone has any, and you can use the polling automated system, too, if you'd like. But before we do that, last year was a busy year for Interactive as far as product launches, including dashboard of securities lending for institutional clients. So what's been the feedback on a lot of these rollouts last year? And could you give us a sense of which product areas you might be focused on for innovation here in the near term?

So securities lending is near and dear to my heart. I have a group myself that runs that part of the business. We listened to a lot of feedback from higher-level customers that we work with in securities finance in building out that dashboard and those functions, and we get a lot of positive feedback on it. These are basically functions that allow -- really give the customers who are interested some insight into what's going on in the securities lending market, which probably feeds some of their view on what's going on in the traded market as well. So we're quite pleased about that. And with regard to our -- the latest things we're working on, we don't really talk about products that we haven't rolled out yet, for some obvious reasons there. We have lots of competitors, and they probably want to know what we're working on as well.

Sure. Sure. But it's safe to say we can count on continued innovation from Interactive.

Well, it's been our entire history. And I've been with the company for 37 years, and so there hasn't been a moment we weren't innovating something.

Right. Fair enough. We've seen really, really strong individual investor growth. When we look at the account growth in 2023, it seems like that momentum continued into January. Any trade-off between signing up or marketing to individual investors versus going after some of the lumpier channel wins like IB?

So we're quite pleased with the growth in the individual customer segment, and it happens organically. A lot of it is word of mouth. Obviously, we do some advertising and so forth. But it doesn't -- other than efforts and money we devote to advertising and other kinds of marketing, we're not -- there's no expenditure associated with those accounts. We're willing to put out efforts. Institutional sales team, more -- much more onboarding involved with bringing on IBrokers, which in 1 lump can deliver 5,000 or 10,000 customer accounts underlying that. And even though some of those customer accounts might be smaller than our average target, that's fine with us because those brokers are doing some upfront work that we don't have to do or wouldn't be prepared to do. They're doing some handholding. They might have wealth management areas that they're also managing. They have -- this is their own customer base. So we're more than happy to do what we're best at. We do their execution and clearing. We lend them money. We often -- most often get these accounts on what's called a fully disclosed basis, which means we put each underlying account on our books as if they were individual accounts. So for statistics, we keep them in the introducing broker segment but they show up in our account numbers, and we're more than happy to do the upfront work that it takes to get those accounts.

Got it. I'll now open it up to the audience. Anybody has any questions, you can raise your hand. We can run mics or you can submit a question. I see we've got one on the platform here. Can you please explain the rationale for acquiring less efficient brokers and what you're looking to gain from M&A?

Yes. Well, we can't find a more efficient broker. The rationale. If we can find a way to bring aboard more customer accounts at a lower cost than it would -- it runs us to get them organically, that would make sense. Those can come from less efficient brokers where we could add value with our level of automation and systems and all of that. So there might be something in there, out there that made sense that would -- the combination of those things might make sense. Could we rationalize a lot of costs if we did that? Absolutely, right? We -- look at our cost base. Automation is everything we do. And it's often very -- a small portion of what other brokers do. So there could be quite a bit of synergy there if we found the right one.

Got it. Got it. Anybody? Questions? One I'm kind of curious about. AI has been a big technology topic past year. And certainly, Interactive has a rich history of being technologically innovative. How are you thinking about how AI fits in at Interactive? And what can you share that you all are working on, on the AI front?

So we've been experimenting with AI for some time. We have, in fact -- we don't have it in production, but rather we have some earlier versions of things that are like AI that we have rolled out on our own. For example, if you query something on our website, you will get an answer from something called IBot, which gives it kind of a plain English answer. Now are we looking to improve that kind of thing with AI? Probably. That would make sense. Are there more meaningful things in the future that might go towards analytics that we provide to customers or maybe order execution? I hadn't heard that discussed, but these are the kinds of things that AI is such a broad area that it could bring a lot of benefits. And so we continue to research and experiment. We absolutely have people working in that area, and maybe it will produce some of the kinds of things that the rest of the world thinks it will produce.

End of that. All right, last call in the room for any questions. Okay. Well, with that, Paul, let me say thanks a lot for your time. Really appreciate it.

Thank you for having me. Pleasure.