Hi, good afternoon. Thanks, everyone, for joining. Pleased to be joined by Paul Brody, CFO at Interactive Brokers. I'd love to dive right into growth, actually. Last year, really tremendous growth at Interactive, 33% account growth, I want to say. The 30% year-over-year, 33% on client equity, actually, pardon me. So as you look ahead this year, already started, what do you see as the key drivers of account growth? And are there any particular segments or innovations, product innovations that you think could have a meaningful impact?
Sure, well, more of the same. We've been pretty successful at growing that client base on what is still a relatively low marketing and advertising spend. We've seen it pretty much across the board, particularly in the individuals' account segment, but also in I-Brokers and introducing brokers. There's a steady pipeline of those I-Brokers, and that brings us certain kinds of advantages. The I-Brokers may bring us fully disclosed accounts, which means we put all the underlying accounts on our platform and service them like we would our direct customers. But some come in as omnibus, and as a result, they're doing a lot of the upfront work, the client interface, maintaining accounts, and so forth. And we're getting all the same volume business, margin lending, etc., so we would expect more of that going forward, sure.
What is the pipeline on the introducing? How does it compare today versus where it was, say, a year or two ago?
It's a steady stream. A year ago, we talked about specific large international bank. Yeah, I remember the [audio distortion] which naturally took longer than we would have hoped, only because large international banks move a little bit more slowly than we do, but it's more a steady stream of smaller than that I-Brokers, and that's perfectly productive activity for us.
Right. Okay. Margin loan growth has been really impressive, too. January, I want to say, was like nearly 50% year-over-year. So this is sort of inherent in the question. Clearly, there's more risk appetite, so that's a reflection or an outcome of that. But is there any particular client behavior around the usage of margin that you've noticed that would suggest a focus on a particular asset class or any increase in risk-taking?
So we don't track it so much by asset class. We're happy to do margin lending with our own risk management methods. We have sophisticated risk management that is real-time, that takes into account liquidity of markets and concentration of positions and inherent volatility in the underlying positions. And yes, it is largely if the market takes a risk-on attitude, then we're the beneficiary of that. But it's also important to put it in the context that one way to look at it is our aggregate margin lending is about 11% of our customer equity, which is, from a historical perspective, actually a relatively low number. And so does that mean there's room to grow? Maybe from that measure, but most of this is coming from the market's take on risk-on versus risk-off.
Sure. When you think about that metric, because we track that, too, and we've noticed it's sort of been coming down, right? It's sort of a range. But is there any change in the customer makeup or your client base that might suggest lower levels of margin vis-à-vis the client equity?
We can't point to any. There's no straight line connection between that. Margin lending is an across-the-board activity, and there will always be some accounts in each segment that are utilizing it more and some less.
Okay. Got it. Thinking about rate sensitivity, since we're on the balance sheet, right? Are you able to increase the stability or durability of the NII in any way? Maybe some kind of a hedging strategy or adjustment in the balance sheet that you might consider?
So it's important how you look at rate sensitivity. We have a built-in spread model that says that we will pay interest to our customers on a benchmark minus something. Say in the U.S., it's Fed funds minus 50 basis points, and that's a locked-in spread. So as the benchmark goes up and down, that's a constant number, and it fluctuates. It fluctuates. It expands with expanding balances, which is exactly what we saw in the fourth quarter when rates came down. Our balances actually expanded more than that, and we were able to maintain that certain level. Where the sensitivity comes from is on what we call fully sensitive balances, small balances in accounts, first $10,000. We don't pay interest on before we start to pay a good market level of interest. And we have house capital. That's all invested at current short-term rates.
So that is, in fact, sensitive to rates going up and down. But quite frankly, the way to look at it is that we would expect our rate sensitivity to go up, and that's a good thing because it means that our customer balances are going up even more and raising the baseline from which that sensitivity comes from.
Right. Okay. Revenue from securities lending has been sort of in focus. You guys, I guess, put a new graphic in your investor presentation that helps with this, but I think it might be helpful to walk through for the audience and folks listening to the webcast, so number one, there's a slide to point to, which I thought was really instructive, and then could you maybe talk about what's going on there and why the securities lending revenue, when you consider it in total, is actually way more stable than it looks on the reported basis?
Sure, and thanks very much for pointing to that presentation and that chart. The thanks go to Nancy Stuebe, our Director of Investor Relations, who came up with that because you all have been asking so many questions to gain an understanding of it, which we can appreciate. The basic way to look at it is this: so our securities lending revenue all in has been actually quite stable at between $150 and $200 million a quarter. You have to put the components together, and only one component for accounting purposes is reported as coming from securities lending. The basic transaction is that we lend out customer shares and take in cash collateral. Take the cash collateral and put it, you invest it or deposit it in banks somewhere, and it earns, let's just say, the benchmark rate.
When rates are low, the revenue from that transaction comes out in the securities lending side because you're earning very little on the other side. When rates are higher, as they have been, 4%-5%, you take the cash collateral, put it at an interest-bearing instrument, and now more of the revenue generated by that transaction is coming out on that side. All in, they add up to a fairly stable balance overall of revenue generated by that activity.
Right. When you consider all the different component parts.
Yeah. So we're happy with securities lending revenue that grows as our customer base grows. And also, of course, we do the best to take advantage of stocks that become hot, short stocks with high lending rates. We lend out customer stocks, and it generates revenue for us.
Right. And the hard-to-borrows or specials, as they're called, have been pretty low. How much of that do you think—and that's not just an Interactive thing, that's an industry-wide—because we've heard a lot of companies that are involved in that business. How much do you think it's because we've had such a quiet banking? There's very little M&A, so there's not a lot of merger arb. The IPOs are limited. A lot of that can lead to more hard-to-borrow, right? Have you looked at how much you think maybe the slower banking is holding you back?
Those are contributing factors, to be sure. If you can tell me what's going to happen in that environment with IPOs and mergers and acquisitions and so forth, I can tell you that at least there will be more opportunities because we will see more hard-to-borrow stocks come and go. They do have an impact. They are short-term impact, but very high-rate stocks, so they definitely generate revenue.
Right. Well, from my perspective, either the M&A revenue is going to grow about 20% this year or some of these investment banks are way overvalued, so we'll see. Operating margins were a pretty impressive 73%. Commentary on the call, though, suggested that that was as much as we should expect from a margin expansion perspective. Maybe could you add some color on why that would be the case and what factors could drive a little more operating leverage?
Sure. I always consider this question, not just what have you done for me lately, but what are you going to do for me in the next quarter? Yes, they're quite high because our entire business model is to automate as much of the process as possible of trading and brokerage. We've been quite successful at that in creating technology and automation for that. What could drive it higher? Hard to say. Thomas has said there's not that much space between 75% and 100%. One way to look at it is to the portion of our revenue that's generated by commissions. We talk about something we call gross transactional profit, which is the commission revenue less the strictly variable cost of executing and clearing trades, and that's contained in our reported line item called execution, clearing, and distribution.
But what we do is we take out the distribution fees that are like market data fees and distill it down to when you execute a trade, there's a commission component and there's a cost component. And what that shows us is that the margin on that activity is about 79%. So that's flowing to the bottom line. So to the extent that our commission revenue is one-third or more of our total, any expansion of that would drop to the bottom line. Any pullback in that would have similar downward effects.
So that's the volume-driven incremental margin, and then I would assume that NII is probably a bit higher margin. Is that fair, or is it similar?
It drops down with essentially no cost. We don't add people or expenses, really, just because we're lending more money.
Right. Yeah. Okay. So you guys have had a lot of traction with the hedge fund business as you have continued to tweak your approach, your come-to-market approach. How have your high-touch Prime Brokerage services been received? I mean, it certainly seems like it's going well, but is this offering the key to driving a lot of that traction? And how is it working from a retention perspective too?
Yeah. So we're really pleased with how it's gone so far. It's in its infancy. We onboarded 30-something hedge fund accounts that had already been on our platform that we can now offer this much more inclusive service that really combines at least three different teams on our side between securities lending, sorry, securities finance in general, client services, and we have a block trading desk. And so we give a higher level of service. It's gone well. Has that led to retention? We've been retaining these kinds of clients anyway, so we're just giving them a higher level of service. And then looking forward, the idea would be to develop that more into attracting new hedge fund clients who know that they can get this level of service, whereas before the rest of what we offer is sometimes not enough for them.
Have you noticed any shift in your client demographics as far as the size of hedge fund that you've been attracting or servicing?
Not in particular. I would say we're happy with our hedge fund client acquisition. We would love to push it more. They are opportunistic in terms of things like corporate actions and positioning themselves and giving us opportunities for more securities financing, sometimes over a short period of time in hedged transactions. All of that makes us happy because we're good at providing that, and so to your earlier point, if there's more action in that marketplace, M&A style, that might bring back some more of those opportunities, and hedge funds will come to us for that kind of financing.
Okay. Got it. You touched on the introducing broker before and a little on the pipeline and the fact that it seemed like generally towards maybe smaller introducing broker clients. But when we think about, you have a few different ways that those clients can connect. When you think about the, is there a difference in profitability or how Interactive engages or monetizes those clients depending on how they connect, whether it's omnibus or thousands of accounts?
So we don't treat them differently, but the components fit together differently, right? So as I mentioned before, if they bring a fully disclosed account, that's just like bringing direct accounts onto our system. We know what to do there. If they come in as an omnibus broker because they want to retain the direct relationship with their own clients, that's fine with us because they're absorbing some of the costs and the efforts that it takes to interface with those clients and maybe do handholding and any other services that they want to provide on their end. And as a result, it costs us less to support those kinds of accounts. And in return, the introducing broker will bring us high volume and get the benefit of our best-tiered pricing because they're coming in like one client.
And so it's very much a mutually beneficial relationship because they're getting very good rates and they're taking over some of the work.
Right. Okay. You guys more recently, in recent years, have built up some decent momentum with RIAs. Do you have visibility into the platforms that those advisors are joining from? And given that it's sort of more of an asset-heavier rather than revenue-heavier mix for you all, can you maybe walk through how you view this opportunity and the level of resources that you're dedicating to it?
So we have some visibility. In the U.S., there's a nice account transfer system that's automated, ACAT, that we can actually see where the accounts are coming from, like direct accounts as well. And suffice to say, we get the largest number of accounts from the largest brokers, so it's fairly obvious. And in terms of the service that we're offering, we've built out an awful lot for the RIAs to do flexible reporting and various things that they need. And we've seen some flow from other U.S. brokers, and when you get them outside the U.S., it's a little harder to track them, and it's a little less automated to take them on board. But they're quite happy once they get going. You might ask another question.
Yeah, well, I was also actually going to ask a follow-up, but sort of the resources that are required in order to service, but specifically, we saw in the past year or two, there was a merger of a big provider for that market. Did you see maybe an increase in the amount of activity and the movement that happened on the back of that? It got a lot of attention in investor circles.
Sure did. We didn't see as much activity as we had hoped for. I can't attribute it to any one factor. One thing we can say is that we market the fact that we don't have any in-house advisors. It's not part of our model. We put a lot of efforts into supporting independent advisors. There's no built-in conflict of interest between those two sets of advisors maybe competing with each other. We'll continue with that because we think it's an important aspect of advisors migrating to us.
Yeah. Yeah. We hear that from some other folks who compete in that space, that it matters. We'd love to—I have a few on capital. Always something to discuss with you all. So you've got a pretty substantial equity base, about $17 billion. To say it exceeds your required capital, to put it lightly. How are you thinking about capital allocation today?
Sure. Well, we want to continue to support a robust balance sheet. There's no question that high-level clients and institutions and hedge funds want to be able to tell their clients they're with Interactive Brokers without their clients saying so. And so it has a real impact. With regard to excess, it's not as much as you think. It takes an awful lot of capital, of your own capital, to support the breadth of business we do around the world, the number of markets, the number of separate affiliates that we maintain in different regulatory jurisdictions, all of which have to maintain their own independent capital. They have to meet stress tests. And the more customer lending we do, that's as well a use of capital.
And then on top of that, you must maintain buffers in this business to be there when the activity hits and the market's in turmoil. It always requires an injection of house money into things like the clearinghouses are calling for margin or settlement money or what have you. We've seen this happen multiple times in the past. And so you really must maintain that. So that excess is certainly only a fraction of our, say, $16.5 billion equity. It's probably more like a third of that.
It's more like what?
It's more like a third. It's probably more like six billion plus that we maintain for buffers after we look at everything devoted directly into the business.
Okay. So the buffers that you think are appropriate just in case we see spikes in activity or whatever?
Sure. Yeah. I mean, that number is somewhat in excess of the buffers.
In excess of. Okay.
But it's nowhere near the entire capital. Our capital is well deployed to actually supporting the client activity.
Yep. And one of the uses of capital you guys have spoken to recently has been M&A, but it's been challenging to find something that makes sense. So are you still actively looking? And what kind of deals would you be interested in beyond the obvious?
Yeah. It's a complex question. We've been talking about it for some time. We're not out in the marketplace actively hunting down targets, but rather ideas are brought to us all the time. We take those up. We evaluate. We spend our time on what might make sense. We haven't been able to get to a positive conclusion on these yet. And what might make sense? That's also a complex question, right? The typical online broker that might have created its own software and system for interface with its customers and otherwise will probably be of less value to us because we have a better system for doing that ourselves than it would be to another kind of investor like private equity or so forth, where they're actually buying something of value that they don't have.
So then it comes down to, well, does it make sense if we're just acquiring customers at that cost? Probably not because our customer acquisition rate is so high and our costs of doing that are low. We have low advertising, marketing expenditure. We get a tremendous amount of our client growth through word of mouth, about 40%. So what does that leave? Well, there can be firms that are either in the business where they maybe are specializing in a product set or a region or a country where we feel that we could do better and maybe at the right cost. It might make sense to take something like that over. It could be in other areas that we're not yet as proficient or expert as we would like to be. We've been experimenting with AI.
There's a lot of firms out there who have smart people who are offering things at varying levels. What we've done so far has really to do with things like answering client inquiries. We have some software that is now developing responses that human beings look at before they actually get back to the client, but results are there are positive, but would an outside expert firm jump-start that? Maybe. It has to be interesting to us and at the right cost, and that's a tough combination.
Right. Yeah. Nice. Okay. The dividend. So the payout, there's at least one now. For a while, there was none. But the payout ratio, when you look at it as a percentage of earnings, is low. It's teens, 13%. Are there any other priorities, maybe like reinvestment or buybacks to consider with the excess that you have?
We have no plans right now. Certainly, buyback would not necessarily be in our interest because our float being now 25%. We started years ago at 10% on our IPO. It's now gone up to 25%. Most investors would love to see it higher. So the buyback is working against that principle. And as far as the dividend is concerned, we have no immediate plans to increase that. Yes, the yield has diminished as the price has gone up, but that's a good problem to have.
For sure.
And so that's where we stand right now. And as I just got done explaining our uses of capital, we wouldn't have much reason to do a special dividend or anything that would simply reduce the capital level because we like where it is now.
Okay. Can take a moment and see if there's any questions in the audience. Haven't been having a high batting average on the audience questions today.
No participation?
Yeah. They'd rather leave it to me. I wanted back.
Thank you, so you were talking about your hedge fund business. We were trying to attract clients, new clients. The biggest challenge is basically access to long-term capital, especially for new managers. Is that something that you've thought about? I mean, you have, as you mentioned, quite a bit of capital. Sprinkling some of that capital will go a long way to helping sort of what is kind of a nascent sort of market since you've bifurcated into gigantic hedge funds, and a lot of the small hedge fund managers have kind of had a hard time sort of getting access to capital.
Yeah. Good question. We have something we call a Hedge Fund Marketplace where we do make capital introductions in a semi-automated fashion, which, of course, is more along the lines of the way we operate. And smaller hedge funds can get on there. They must be sort of vetted and certified, and then they can show themselves. And so there's some of that activity. This is not a major activity for us. We would like to continue to expand on that. So we're going to put some efforts in there. We are not an investment bank, so we're not going to get to the level of all that that entails by any means. But we understand that there's a segment of the market that could do well if we could offer that in addition to everything else that we offer. So we're going to put more work in there.
Maybe just a follow-on. In another sort of business, have you considered having your own asset management arm?
No. We spend all of our time, and we have our hands very full with expanding our brokerage offering. And so while bigger deviations into new business lines are not rejected out of hand, they're simply not at the top of our priority list right now.
Any more? I suppose I should quit while I'm ahead since that's already, I'm above my average here. Last year, you had spoken a little bit about some new capabilities that you were excited about rolling out. Without asking to tip your hand competitively, but is there anything that you're able to speak to that you guys are working on? You guys are regularly rolling out new tools, new capabilities, new functionality. What's on the docket here for 2025?
Yeah. You're right. We don't really talk about what we're working on right now for lots of reasons, competitive reasons among them. Happy to mention a few things that we have rolled out in the past 6, 12 months: a new IBKR Desktop, which is a new way for the clients to interface in a more intuitive way. That seems to be getting pretty good reception. We have regionally put our feet on the ground in Dubai. We often open up a small office primarily for sales. As well, in the region, we opened up trading at the Saudi Exchange and [SA]. That's definitely an area of expansion for us. I would expect some of that to continue. It's never easy getting started, but once you're started, you can launch more easily into other products and other services like that.
So suffice to say that we will continue to work on all of these types of things, and we expect good things this year.
Yeah. One of the things that we hear regularly in dialogue with investors is how engaged the most retail investors are right now. When you look at your book of business and the folks that would represent individuals, where is the activity level today versus historical reference? Are we already past meme level, or where is it?
Yeah. Interesting question. We don't actually track activity by, I mean, yes, we look at commissions. We look at equity held in each segment. The individuals are outpacing the other groups. It's our biggest group, obviously, by far to begin with. And as well, they're outpacing in most of those categories. Professionals tend to be a little more heavy on margin lending. Introducing Brokers are some mix of how they're managing their clients' funds. Some are small introducing brokers with five clients, and some might have a thousand. And of course, introducing brokers, I'm sorry, financial advisors, I meant.
Yeah.
Introducing brokers also come in small and large sizes. So, yeah, I mean, the individuals have certainly been riding the wave of more interest in the markets, more optimism about the stock market. Just look at the prices. That just translates into more activity for us. Very good thing.
Yep. Without a doubt. So last one from me, and I feel like I did it last year. I got asked about it again. Thomas went on record in the last earnings call about the fact that he's not interested in selling. But previously, he had noted that he disliked the price. He was not happy with it. The stock was a beast in the past year. It's been an outstanding stock. Do you have any idea about what his temperature is or thoughts around whittling down his stake at a reasonable pace or at least making progress?
I don't. But I'll freely admit, it's not a topic of conversation I have with him. I think that one important thing to investors is to understand that there's not a risk of the overhang. He's not ever looking at dump shares on the market. He has talked in the past about selling plans that actually, if they were to meet certain price targets and conditions, they would sort of dribble out small amounts of stock into the market. And other than that, no particular insights. But he has talked about, we think that we're chasing the target a little bit because the better off we do from a financial performance standpoint, the more he founded this company, he built this company, he believes so solidly in it, and clearly most of his net worth is in it, that he feels aligned with investors.
He has in mind probably a high price target. The better off we do, the higher that target probably gets.
Sure. Right. That's fair. And two, why not finish on that high price target, right? Thanks a lot for your time, Paul.
Real pleasure, Brendan.
Thanks very much.