INTERACTIVE BROKERS GROUP, INC. The following discussion should be read in conjunction with the audited consolidated financial statements and the related notes in Part II, Item 8, of this Annual Report on Form 10-K. In addition to historical information, the following discussion also contains forward-looking statements that include risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under the heading "Risk Factors" in Part I, Item 1A of this Annual Report on Form 10-K.
Business Overview
We are an automated global electronic broker and market maker (although, we have substantially exited our options market making business - see Note 2 - "Discontinued Operations and Costs Associated with Exit or Disposal Activities" to the audited consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K). We custody and service accounts for hedge and mutual funds, registered investment advisers, proprietary trading groups, introducing brokers and individual investors. We specialize in routing orders and executing and processing trades in stocks, options, futures, forex, bonds, mutual funds and ETFs on more than 135 electronic exchanges and market centers around the world. Since our inception in 1977, we have focused on developing proprietary software to automate broker-dealer functions. The proliferation of electronic exchanges over nearly the last three decades has provided us with the opportunity to integrate our software with an increasing number of exchanges and market centers into one automatically functioning, computerized platform that requires minimal human intervention. Our primary assets are our ownership of approximately 18.5% of the membership interests ofIBG LLC , the current holding company for our businesses, and our controlling interest and related contractual rights as the sole managing member ofIBG LLC . The remaining approximately 81.5% ofIBG LLC membership interests are held by Holdings, a holding company that is owned by our founder and Chairman, Mr.Thomas Peterffy and his affiliates, management and other employees ofIBG LLC , and certain other members. TheIBG LLC membership interests held by Holdings will be subject to purchase by us over time in connection with offerings by us of shares of our common stock.
Business Segments
We report our results in two operating business segments, electronic brokerage and market making (being discontinued). These segments are analyzed separately as these are the two principal business activities from which we derive our revenues and to which we allocate resources. Electronic Brokerage. As an electronic broker, we execute, clear and settle trades globally for both institutional and individual customers. Capitalizing on our proprietary technology, our systems provide our customers with the capability to monitor multiple markets around the world simultaneously and to execute trades electronically in these markets at a low cost, in multiple products and currencies from a single trading account. We offer our customers access to all classes of tradable, primarily exchange-listed products, including stocks, options, futures, forex, bonds, mutual funds and ETFs traded on more than 135 electronic exchanges and market centers in 33 countries and in 25 currencies seamlessly around the world. The emerging complexity of multiple market centers has provided us with the opportunity to build and continuously adapt our order routing software to secure excellent execution prices. Our customer base is diverse with respect to geography and segments. Currently, approximately 70% of our customers reside outside theU.S. in over 200 countries and territories, and over 50% of new customers come from outside theU.S. Approximately 65% of our customers' equity is in institutional accounts such as hedge funds, financial advisors, proprietary trading desks and introducing brokers. Specialized products and services that we have developed are successfully attracting these accounts. For example, we offer prime brokerage services, including financing and securities lending to hedge funds; our model portfolio technology and automated share allocation and rebalancing tools are particularly attractive to financial advisors; and our trading platform, global access and low pricing attract introducing brokers. Market Making. As previously announced, we transferred ourU.S. options market making operations toTwo Sigma Securities, LLC effectiveSeptember 29, 2017 and also exited the majority of our options market making activities outside theU.S. byDecember 31, 2017 . During 2019, we exited our Canadian market making operations. We intend to continue conducting certain proprietary trading activities in stocks and related instruments to facilitate our electronic brokerage customers' trading in products such as ETFs, ADRs, CFDs and other financial instruments, as well as exchange-traded market making activities in a few select markets outside of theU.S. However, we do not expect the remaining activity to be of sufficient size as to require reporting as a separate segment in the future. 33
--------------------------------------------------------------------------------
Table of Contents
Business Environment
During 2019, U.S. market volatility was generally lower than in the prior year, amid greater optimism about global economic growth and continued monetary easing by central banks. Equity market indices around the globe were predominantly up, led by theU.S. , where the S&P 500 index rose 29%.U.S. interest rates were lowered three times by theFederal Reserve in 2019, nearly reversing all the rate hikes of the prior year, while trends in benchmark rates of other currencies were mixed. Among our customer base, volatility is highly correlated with customer trading activity across product types. In 2019, lower volatility led to decreases in trading volume, notably in theU.S. , as our customers' trading activity, which is sensitive to overall market trends, showed declines. In addition, lower benchmark interest rates, which can be beneficial by reducing the rate of interest paid on customer cash, can also give us fewer opportunities to earn more net interest income on fully interest-sensitive balances. In an improving market environment, with mainly lower interest rates and rising asset values, customer account growth was robust, with total customer accounts increasing 15% from 2018 to 690 thousand. Healthy inflows from customers, combined with securities market increases that generally benefited customers' investment values, led to customer equity growth of 36% to$174.1 billion . Institutional customers, such as hedge funds, mutual funds, introducing brokers, proprietary trading groups and financial advisors, comprised approximately 50% of total accounts and approximately 65% of total customer equity at the end of 2019. We continue to attract large customers that seek our superior technology and execution capabilities, high interest rates on cash balances, and low costs, as well as our securities finance services, including margin lending and short sale support.
The following is a summary of the key profit drivers that affect our business and how they compared to 2018:
Global trading volumes. According to data received from exchanges, volumes in exchange-listed equity-based options decreased by approximately 13% in theU.S. for the year endedDecember 31, 2019 , compared to 2018. Further,U.S. volumes decreased in exchange-listed futures by 19% and in equities by 20%, due to the decline in volatility among other factors. See the "Trading Volumes and Brokerage Statistics" section below in this Item 7 for additional details regarding our trade volumes, contract and share volumes, and brokerage statistics. Volatility. Based on theChicago Board Options Exchange Volatility Index ("VIX®"), average U.S. market volatility decreased to 15.4 in 2019, down 7% from the average of 16.6 in 2018. Lower volatility tends to curtail our electronic brokerage performance because it generally corresponds to lower trading volumes. In 2019, as the VIX decreased, we saw a negative impact on customer trading activity, which decreased 6%, and our commissions revenue, which decreased 9%. Interest Rates. TheU.S. Federal Reserve conducted a series of reductions in the target federal funds rate in 2019, with rate cuts in July, September and October, while rates in other currencies were mixed. Decreases in benchmark rates can lead to lower net interest income and a narrower net interest margin. As our margin balances are tied to benchmark rates, decliningU.S. interest rates reduce the interest we receive on ourU.S. dollar customer margin balances. Falling rates also reduce the interest we earn on our segregated cash, the majority of which is invested inU.S. government securities and related instruments. Lower rates also reduce our interest expense, as we pass along the reduced interest rate to our customers. Because we pay among the highest rates in the brokerage industry on qualified customer cash balances, and charge among the lowest rates on margin borrowings, we attract customers who seek to maximize their yields and minimize their costs. We believe our low rates on margin borrowings and high yields on qualified cash balances are important factors that attract customers to our platform. While the interest we pay on customer cash balances and the interest we earn on customer margin loans is based on fixed spreads around benchmark rates, additional net interest income is earned on lower or non-interest-bearing customer balances, e.g., on securities accounts with less than$100,000 in equity, and on rising balances. Electronic brokerage net interest income grew 17%, compared to 2018. Higher net interest income was due to rising average customer credit balances, up 9% in 2019, in part due to an inflow of new accounts, along with expanded prime broker financing and strong securities lending activity. This was partly offset by average customer margin loan balances decreasing 9%, due to our customers' reduced appetite for leverage as compared to 2018. Currency fluctuations. As a global electronic broker and market maker trading on exchanges around the world in multiple currencies, we are exposed to foreign currency risk. We actively manage this exposure by keeping our net worth in proportion to a defined basket of 14 currencies we call the "GLOBAL" to diversify our risk and to align our hedging strategy with the currencies that we use in our business. Because we report our financial results inU.S. dollars, the change in the value of the GLOBAL versus theU.S. dollar affects our earnings. During 2019 the value of the GLOBAL, as measured inU.S. dollars, decreased 0.06% compared to its value as ofDecember 31, 2018 , which had a negative impact on our comprehensive earnings for 2019. A discussion of our approach for managing foreign currency exposure is contained in Part II, Item 7A of this Annual Report on Form 10-K entitled "Quantitative and Qualitative Disclosures about Market Risk." 34
--------------------------------------------------------------------------------
Table of Contents
Financial Overview
In the fourth quarter of this year, we introduced the reporting of non-GAAP financial measures, which exclude certain items that may not be indicative of our core operating results and business outlook and may be useful in evaluating the operating performance of our business and provide a better comparison of our results in the current period to those in prior and future periods. See the "Non-GAAP Financial Measures" section below in this Item 7 for additional details. Diluted earnings per share were$2.10 for the year endedDecember 31, 2019 ("current year"), compared to diluted earnings per share of$2.28 for the year endedDecember 31, 2018 ("prior year"). Adjusted diluted earnings per share were$2.27 for the current year, compared to adjusted diluted earnings per share of$2.28 for the prior year. The calculation of diluted earnings per share is detailed in Note 4 to the audited consolidated financial statements, in Part II, Item 8 of this Annual Report on Form 10-K. Consolidated: For the current year, our net revenues were$1,937 million and income before income taxes was$1,157 million , compared to net revenues of$1,903 million and income before income taxes of$1,196 million in the prior year. Adjusted net revenues were$1,984 million and adjusted income before income taxes was$1,246 million , compared to adjusted net revenues of$1,913 million and adjusted income before income taxes of$1,206 million in the prior year. The increase in income before income taxes in the current year was mainly driven by a 17% increase in net interest income partially offset by a 9% decrease in commissions revenue and a 23% decrease in other income. Our pre-tax profit margin was 60%, compared to 63% for the prior year. Electronic Brokerage: For the current year, income before income taxes in our electronic brokerage segment increased$20 million , or 2%, compared to the prior year, driven by higher net interest income and lower execution, clearing and distribution fees, partially offset by lower commissions revenue and other income, and higher customer bad debt expense, general and administrative expenses, and employee compensation and benefits expense. Net revenues increased 4%, mainly from a 17% increase in net interest income, driven by higher average Federal Funds rates and higher average customer credit balances; partially offset by a 9% decrease in commissions, primarily driven by lower options and futures contract and stock share volumes and a 3% decrease in other income led by lower net mark-to-market gains on ourU.S. government securities portfolio and lower risk exposure fees. Pre-tax profit margin was 62% for the current year and 64% for the prior year. Customer accounts grew 15% and customer equity increased 36% from the prior year. For the current year, total DARTs for cleared and execution-only customers decreased 3% to 833 thousand, compared to 862 thousand for the prior year. As previously disclosed, over an extended period in 2018, a small number of our brokerage customers had taken relatively large positions in a security listed on a majorU.S. exchange. We extended margin loans against the security at a conservatively high collateral requirement. InDecember 2018 , within a very short timeframe, this security lost a substantial amount of its value. The customer accounts were well margined and atDecember 31, 2018 they had incurred losses but had not fallen into any deficits. During the quarter endedMarch 31, 2019 , subsequent price declines in the stock caused these accounts to fall into deficits, despite our efforts to liquidate the customers' positions. During the year endedDecember 31, 2019 , we recognized a net aggregate loss of approximately$42 million . The maximum aggregate loss, which would occur if the security's price fell to zero and none of the debts were collected, would be approximately$50 million . The ultimate effect of this incident on our results will depend upon market conditions and the outcome of our debt collection efforts.
Market Making: For the current year, income before income taxes in our market
making segment decreased
In the third quarter of 2017, we completed the transfer of ourU.S. options market making business toTwo Sigma Securities, LLC and by the end of 2017 we had exited the majority of our market making activities outside theU.S. Pursuant to the agreement withTwo Sigma Securities, LLC , we have the opportunity for future income from an earn-out agreement, based on the performance of the options market making business underTwo Sigma Securities, LLC's control. Under the agreement, we would earn a share of anyU.S. profits after variable costs and other agreed-upon costs for three years; and a separate share of any non-U.S. profits after variable costs for four years. The agreement providesTwo Sigma Securities, LLC the opportunity to enter non-U.S. parts of this business and, while it does not preclude us from participating in those markets, the earn-out would be effective only in markets where we did not compete. 35
--------------------------------------------------------------------------------
Table of Contents
Corporate: In connection with our currency diversification strategy (i.e., GLOBALs) as ofDecember 31, 2019 , approximately 30% of our equity was denominated in currencies other than theU.S. dollar. In the current year, our currency diversification strategy decreased our comprehensive earnings by$36 million (compared to a decrease of$99 million in the prior year), as theU.S. dollar value of the GLOBAL decreased by approximately 0.06%, compared to its value as ofDecember 31, 2018 . The effects of our currency diversification strategy are reported as (1) a component of other income (loss of$60 million ) in the consolidated statement of comprehensive income and (2) other comprehensive income ("OCI") (gain of$24 million ) in the consolidated statement of financial condition and the consolidated statement of comprehensive income. The full effect of the GLOBAL is captured in comprehensive income. InJune 2018 we consummated a strategic investment inUp Fintech Holding Limited ("Tiger Brokers") by purchasing preferred shares that represented a 7.4% beneficial ownership interest. OnMarch 20, 2019 , Tiger Brokers priced its initial public offering of American Depositary Shares listed on Nasdaq Global Select market and, concurrently with their initial public offering, we purchased unregistered ordinary shares in Tiger Brokers through a private placement offering which transactions resulted in a beneficial ownership interest of 7.6%. For the year endedDecember 31, 2019 we recognized a net mark-to-market gain of$9 million on this investment.
Net Revenues
Commissions
We earn commissions from our cleared customers for whom we act as an executing and clearing broker and from our non-cleared customers for whom we act as an execution-only broker. We have a commission structure that allows customers to choose between an all-inclusive fixed, or "bundled", rate and a tiered, or "unbundled", rate that offers lower commissions for high volume customers. For "unbundled" commissions, we pass through regulatory and exchange fees separately from our commissions, adding transparency to our fee structure. Commissions accounted for 36%, 41%, and 38% of our total net revenues for the years endedDecember 31, 2019 , 2018, and 2017, respectively.
Our commissions are geographically diversified. In 2019, 2018, and 2017 we generated 33%, 32%, and 32%, respectively, of commissions from operations conducted internationally.
Interest Income and Interest Expense
We earn interest on customer funds segregated in safekeeping accounts; on customer borrowings on margin, secured by marketable securities these customers hold with us; from our investments inU.S. and foreign government securities; from borrowing and lending securities; and on deposits with banks. Interest income accounted for 89%, 73%, and 53% of our total net revenues for the years endedDecember 31, 2019 , 2018, and 2017, respectively. Interest income is partially offset by interest expense. We pay interest on cash balances customers hold with us; for borrowing and lending securities; and on our borrowings. Interest expense accounted for 33%, 24%, and 13% of our total net revenues for the years endedDecember 31, 2019 , 2018, and 2017, respectively.
Net interest income accounted for approximately 56%, 49%, and 40% of our total
net revenues for the years ended
Trading Gains
Trading gains are generated in the normal course of our remaining market making business. Trading gains are, in general, proportional to the trading activity in the markets. Trading gains accounted for approximately 1%, 2%, and 2% of our total net revenues for the years endedDecember 31, 2019 , 2018, and 2017, respectively. Trading gains also include revenues from net dividends. Market making activities require us to hold an inventory of equity securities. We derive revenues in the form of dividend income from these equity securities. This dividend income is largely offset by dividend expense incurred when we make payments in lieu of dividends on short positions in securities in our portfolio. Dividend income and expense arise from holding market making positions over dates on which dividends are paid to shareholders of record. When a stock pays a dividend, its market price is generally adjusted downward to reflect the value paid to the shareholders of record, which will not be received by those who purchase the stock on or after the ex-dividend date. Hence, the apparent gains and losses due to these price changes must be taken together with the dividends paid and received, respectively, to accurately reflect the results of our market making activities. 36
--------------------------------------------------------------------------------
Table of Contents
Other Income
A primary component of other income is foreign currency gains and losses from our currency diversification strategy. A discussion of our approach to managing foreign currency exposure is contained in Part II, Item 7A of this Annual Report on Form 10-K entitled "Quantitative and Qualitative Disclosures about Market Risk." Other income also consists of mark-to-market gains and losses on ourU.S. government securities portfolio; income from market data fees, account activity fees, risk exposure fees, payments for order flow from exchange mandated programs and IBKR LiteSM liquidity providers, and other brokerage related fees; and gains and losses on financial instruments that are not held for our market making activities. Other income accounted for approximately 6%, 8%, and 20% of our total net revenues for the years endedDecember 31, 2019 , 2018, and 2017, respectively. Non-Interest Expenses
Execution, Clearing and Distribution Fees
Execution, clearing and distribution fees include the costs of executing and clearing our electronic brokerage and market making trades, as well as liquidity rebates received from various exchanges and market centers, regulatory fees and market data fees. Execution fees are paid primarily to electronic exchanges and market centers on which we trade. Clearing fees are paid to clearing houses and clearing agents. Market data fees are paid to third parties to receive streaming price quotes and related information.
Employee Compensation and Benefits
Employee compensation and benefits include salaries, bonuses and other incentive compensation plans, group insurance, contributions to benefit programs and other related employee costs.
Occupancy, Depreciation and Amortization
Occupancy expenses consist primarily of rental payments on office and data center leases and related occupancy costs, such as utilities. Depreciation and amortization expenses result from the depreciation of fixed assets, such as computing and communications hardware, as well as amortization of leasehold improvements and capitalized in-house software development.
Communications
Communications expenses consist primarily of the cost of voice and data telecommunications lines supporting our business, including connectivity to exchanges and market centers around the world.
General and Administrative
General and administrative expenses consist primarily of advertising; professional services expenses, such as legal and audit work; legal and regulatory matters; and other operating expenses.
Customer Bad Debt
Customer bad debt expenses consist primarily of losses incurred by customers in excess of their assets with us, net of amounts recovered by us.
Income Tax Expense
We payU.S. federal, state and local income taxes on our taxable income, which is proportional to the percentage we own ofIBG LLC . Also, our operating subsidiaries are subject to income tax in the respective jurisdictions in which they operate. Noncontrolling Interest We are the sole managing member ofIBG LLC and, as such, operate and control all of the business and affairs ofIBG LLC and its subsidiaries and consolidateIBG LLC's financial results into our financial statements. As ofDecember 31, 2019 , we held approximately 18.5% ownership interest inIBG LLC . Holdings holds approximately 81.5% ownership interest inIBG LLC . We reflect Holdings' ownership as a noncontrolling interest in our consolidated statement of financial condition, consolidated statement of comprehensive income, consolidated statement of changes in equity and consolidated statement of cash flows. Our share ofIBG LLC's net income, excluding Holdings' noncontrolling interest, for the current year was approximately 18.4%, compared to approximately 17.8% for the prior year. ? 37
--------------------------------------------------------------------------------
Table of Contents
Certain Trends and Uncertainties
We believe that our current operations may be favorably or unfavorably impacted by the following trends that may affect our financial condition and results of operations:
•Retail participation in the equity markets has fluctuated over the past few years due to investor sentiment, market conditions and a variety of other factors. Retail transaction volumes may not be sustainable and are not predictable.
?Additional consolidation among market centers may adversely affect the value of our IB SmartRoutingSM software.
•Benchmark interest rates have fluctuated over the past years due to economic conditions. Changes in interest rates may not be predictable.
?Price competition in commissions and other fees among broker-dealers may continue to intensify.
•Scrutiny of equity and options market makers, hedge funds and soft dollar practices by regulatory and legislative authorities has increased. New legislation or modifications to existing regulations and rules could occur in the future.
•Our market making activities will continue to be impacted by the following trends until we complete its wind-down.
?The effects of market structure changes, competition (in particular, from high
frequency traders) and market conditions have, during certain periods, exerted
downward pressure on bid/offer spreads realized by market makers.
?In an effort to improve the quality of their executions as well as to increase
efficiencies, market makers have increased the level of automation within their
operations, which may allow them to compete more effectively with us.
?A driver of our market making profits is the relationship between actual and
implied volatility in the equities markets. The cost of maintaining our
conservative risk profile is based on implied volatility, while our
profitability, in part, is based on actual volatility. Hence, our profitability
is increased when actual volatility runs above implied volatility and it is
decreased when actual volatility falls below implied volatility. Implied
volatility tends to lag actual volatility.
See "Risk Factors" in Part I, Item 1A of this Annual Report on Form 10-K for a
discussion of other risks that may affect our financial condition and results of
operations.
38
--------------------------------------------------------------------------------
Table of Contents
Results of Operations
The table below presents our consolidated results of operations for the periods
indicated. The period-to-period comparisons below of financial results are not
necessarily indicative of future results.
Year-Ended December 31,
2019 2018 2017
(in millions, except share and per share amounts)
Revenues
Commissions $ 706 $ 777 $ 647
Interest income 1,726 1,392 908
Trading gains 27 39 40
Other income 121 158 332
Total revenues 2,580 2,366 1,927
Interest expense 643 463 225
Total net revenues 1,937 1,903 1,702
Non-interest expenses
Execution, clearing and distribution fees 251 269 241
Employee compensation and benefits 288 264 249
Occupancy, depreciation and amortization 60 49 47
Communications 25 25 28
General and administrative 112 96 86
Customer bad debt 44 4 2
Total non-interest expenses 780 707 653
Income before income taxes 1,157 1,196 1,049
Income tax expense 68 71 256
Net income 1,089 1,125 793
Less net income attributable to
noncontrolling interests 928 956 717
Net income available for common
stockholders $ 161 $ 169 $ 76
Earnings per share
Basic $ 2.11 $ 2.30 $ 1.09
Diluted $ 2.10 $ 2.28 $ 1.07
Weighted average common shares
outstanding
Basic 76,121,570 73,438,209 69,926,933
Diluted 76,825,863 74,266,370 70,904,921
Comprehensive income
Net income available for common
stockholders $ 161 $ 169 $ 76
Other comprehensive income
Cumulative translation adjustment, before
income taxes 4 (14) 11
Income taxes related to items of other
comprehensive income - (1) -
Other comprehensive income (loss), net of
tax 4 (13) 11
Comprehensive income available for common
stockholders $ 165 $ 156 $ 87
Comprehensive income attributable to
noncontrolling interests
Net income attributable to noncontrolling
interests $ 928 $ 956 $ 717
Other comprehensive income - cumulative
translation adjustment 20 (66) 54
Comprehensive income attributable to
noncontrolling interests $ 948 $ 890 $ 771
39
--------------------------------------------------------------------------------
Table of Contents
The table below presents our consolidated results of operations as a percent of our total net revenues for the periods indicated.
Year-Ended December 31,
2019 2018 2017
Revenues
Commissions 36% 41% 38%
Interest income 89% 73% 53%
Trading gains 1% 2% 2%
Other income 6% 8% 20%
Total revenues 133% 124% 113%
Interest expense 33% 24% 13%
Total net revenues 100% 100% 100%
Non-interest expenses
Execution, clearing and distribution fees 13% 14% 14%
Employee compensation and benefits 15% 14%
15%
Occupancy, depreciation and amortization 3% 3% 3% Communications 1% 1% 2% General and administrative 6% 5% 5% Customer bad debt 2% 0% 0% Total non-interest expenses 40% 37% 38% Income before income taxes 60% 63% 62% Income tax expense 4% 4% 15% Net Income 56% 59% 47% Less net income attributable to noncontrolling interests 48% 50%
42%
Net income available for common stockholders 8% 9%
4%
Year Ended
Net Revenues
Total net revenues, for the current year, increased$34 million , or 2%, compared to the prior year, to$1,937 million . The increase in net revenues was primarily due to higher net interest income, partially offset by lower commissions and other income. Commissions Commissions, for the current year, decreased$71 million , or 9%, compared to the prior year, to$706 million , driven by lower customer trading volumes in options, futures and stocks. Total customer options and futures contract and stock share volumes decreased 3%, 15% and 16%, respectively, compared to the prior year. The declines were in line with lower volatility and lower overall industry volumes. Total DARTs for cleared and execution-only customers, for the current year, decreased 3% to 833 thousand, compared to 862 thousand for the prior year. DARTs for cleared customers, i.e., customers for whom we execute trades, as well as, clear and carry positions, for the current year, decreased 5% to 748 thousand, compared to 791 thousand for the prior year. Average commission per commissionable order for cleared customers, for the current year, decreased 5% to$3.67 , compared to$3.87 for the prior year, reflecting smaller trade sizes across all product types.
Interest Income and Interest Expense
Net interest income (interest income less interest expense), for the current
year, increased
Net interest income on customer balances, for the current year, increased$87 million , compared to the prior year, driven by a$4.4 billion increase in average customer credit balances, a portion of which were invested in interest-bearingU.S. government securities and a 0.33% increase in the average Federal Funds effective rate to 2.16%, compared to the prior year. We earn income on securities loaned and borrowed to support customer long and short stock holdings in margin accounts. In addition, our Stock Yield Enhancement Program provides an opportunity for customers with fully-paid stock to allow us to lend it out. We pay customers a rebate on the cash collateral generally equal to 50% of the income we earn from lending the shares. We place cash collateral securing the loans in the customer's account. 40
--------------------------------------------------------------------------------
Table of Contents
In the current year, average securities borrowed increased 19%, to$3.9 billion and average securities loaned increased 3%, to$4.1 billion , compared to the prior year. Securities borrowed and loaned balances were both impacted by increased activity in the electronic brokerage segment. Net interest earned from securities lending is also affected by the level of demand for securities positions held by our customers. During the current year, net interest earned from securities lending transactions increased$41 million , or 19%, compared to the prior year. It should be noted that securities lending transactions entered into to support customer activity may produce interest income (expense) that is offset by interest expense (income) related to customer balances. The Company measures return on interest-earning assets using net interest margin ("NIM"). NIM is computed by dividing the annualized net interest income by the average interest-earning assets for the period. Interest-earning assets consist of cash and securities segregated for regulatory purposes (includingU.S. government securities and securities purchased under agreements to resell), customer margin loans, securities borrowed, other interest-earning assets (solely firm assets) and customer cash balances swept intoFDIC -insured banks as part of our Insured Bank Deposit Sweep Program. Interest-bearing liabilities consist of customer credit balances, securities loaned, and other interest-bearing liabilities. Yields are generally a reflection of benchmark interest rates in each currency in which the Company and its customers hold cash balances. Because a substantial portion of customer cash and margin loans are denominated in currencies other than theU.S. dollar, changes inU.S. benchmark interest rates do not impact the total amount of segregated cash and securities, customer margin loans and customer credit balances. Furthermore, because interest is paid only on eligible cash credit balances (i.e., balances over$10 thousand or equivalent, in securities accounts with over$100 thousand in equity, and in smaller accounts at reduced rates), changes in benchmark interest rates are not passed through to the total amount of customer credit balances. Finally, the Company's policies with respect to currencies with negative interest rates impact the yields on segregated cash and customer credit balances as effective interest rates in those currencies fluctuate. Generally, as benchmark interest rates rise a larger portion of the interest earned on securities lending transactions is reported as net interest income on "Segregated cash and securities, net" instead of "Securities borrowed and loaned, net" because interest earned on cash collateral held in specially designated bank accounts for the benefit of customers, in accordance with theU.S. customer protection rules, increases. ? 41
--------------------------------------------------------------------------------
Table of Contents
The table below presents net interest income information corresponding to
interest-earning assets and interest-bearing liabilities for the periods
indicated.
Year-Ended December 31,
2019 2018 2017
(in millions)
Average interest-earning assets
Segregated cash and securities
26,483 29,253 23,289
Securities borrowed 3,930 3,310 3,964
Other interest-earning assets 5,407 4,362 2,930
FDIC sweeps 1 2,046 1,259 124
$ 65,678 $ 59,095 $ 54,131
Average interest-bearing liabilities
Customer credit balances $ 52,625 $ 48,179 $ 45,515
Securities loaned 4,088 3,982 3,917
Other interest-bearing liabilities 196 241 101
$ 56,909 $ 52,402 $ 49,533
Net Interest income
Segregated cash and securities, net
694 677 392
Securities borrowed and loaned, net 257 216 192 Customer credit balances, net 2
(515) (362) (137)
Other net interest income 1/3 121 90 40
Net interest income 3 $ 1,117 $ 958 $ 688
Net interest margin ("NIM") 1.70% 1.62% 1.27%
Annualized Yields
Segregated cash and securities 2.01% 1.61% 0.84%
Customer margin loans 2.62% 2.31% 1.68%
Customer credit balances 0.98% 0.75% 0.30%
___________________________
(1)Represents the average amount of customer cash swept into FDIC -insured banks
as part of our Insured Bank Deposit Sweep Program. This item is not recorded in
the Company's consolidated statements of financial condition. Income
derived from program deposits is reported in other net interest income in the
table above.
?
(2)Interest income and interest expense on customer margin loans and customer
credit balances, respectively, are calculated on daily cash balances within each
customer's account on a net basis, which may result in an offset of balances
across multiple account segments (e.g., between securities and commodities
segments).
?
(3)Includes income from financial instruments which has the same characteristics
as interest, but is reported in other income in the Company's consolidated
statements of comprehensive income, of $34 million , $29 million and $5 million
for the years ended December 31, 2019 , 2018 and 2017, respectively.
Trading Gains
Trading gains, for the current year, decreased$12 million , or 31%, compared to the prior year, to$27 million , on the remaining market making operations. Our market making operations executed 17.1 million trades compared to 18.7 million trades executed in the prior year, reflecting the continuing wind-down of our market making activities. In addition, market making options and futures contract and stock share volumes decreased 16%, 27% and 21%, respectively. Included in trading gains are net dividends. Dividend income and expense arise from holding market making positions over dates on which dividends are paid to shareholders of record. When a stock pays a dividend, its market price is generally adjusted downward to reflect the value paid, which will not be received by those who purchase stock on or after the ex-dividend date. Hence, the apparent gains and losses due to these price changes, reflecting the value of dividends paid to shareholders, must be taken together with the dividends paid and received, respectively, to accurately reflect the results of our market making activities. ? 42
--------------------------------------------------------------------------------
Table of Contents
Other Income
Other income, for the current year, decreased$37 million , or 23%, compared to the prior year, to$121 million . Other income from core items decreased$5 million , or 4%, compared to the prior year, to$136 million , mainly driven by a$10 million decrease in risk exposure fee income, partially offset by a$5 million increase inFDIC sweep fee income. Other income from non-core items decreased$32 million , to a$15 million loss, mainly driven by a$41 million decrease due to our currency diversification strategy, partially offset by net mark-to-market gains of$16 million on our investments, including$9 million on Tiger Brokers. A discussion of our approach to managing foreign currency exposure is contained in Part II, Item 7A of this Annual Report on Form 10-K entitled "Quantitative and Qualitative Disclosures about Market Risk."
Non-Interest Expenses
Non-interest expenses, for the current year, increased$73 million , or 10%, compared to the prior year, to$780 million , mainly due to a$40 million increase in customer bad debt expense, as described above in the Financial Overview section; a$24 million increase in employee compensation and benefits expenses; a$16 million increase in general and administrative expenses; and an$11 million increase in occupancy, depreciation and amortization; partially offset by an$18 million decrease in execution, clearing and distribution fees, compared to the prior year. As a percentage of total net revenues, non-interest expenses were 40% for the current year and 37% for the prior year.
Execution, Clearing and Distribution Fees
Execution, clearing and distribution fees, for the current year, decreased$18 million , or 7%, compared to the prior year, to$251 million , driven by lower trade volumes as customer options and futures contract and stock share volumes decreased 3%, 15% and 16%, respectively, compared to the prior year.
Employee Compensation and Benefits
Employee compensation and benefits expenses, for the current year, increased$24 million , or 9%, compared to the prior year, to$288 million , associated with a 16% increase in the average number of employees to 1,523, for the current year, compared to 1,317 for the prior year. Within the operating business segments, we continued to add staff in customer service, legal and compliance, and software development to support electronic brokerage and to reduce staff in market making. As we continue to grow, our focus on automation has allowed us to maintain a relatively small staff. As a percentage of total net revenues, employee compensation and benefits expenses were 15% for the current year and 14% for the prior year.
Occupancy, Depreciation and Amortization
Occupancy, depreciation and amortization expenses, for the current year, increased$11 million , or 22%, compared to the prior year, to$60 million , mainly due to higher office rent and related expenses as we expand our physical space for both offices and data centers. As a percentage of total net revenues, occupancy, depreciation and amortization expenses were 3% for both the current year and the prior year. Communications
Communications expenses, for the current year, were unchanged, compared to the prior year.
General and Administrative
General and administrative expenses, for the current year, increased
Customer Bad Debt
Customer bad debt expense, for the current year, increased
?
43
--------------------------------------------------------------------------------
Table of Contents
Income Tax Expense
Income tax expense, for the current year, decreased$3 million , or 4%, to$68 million , compared to the prior year due to lower income taxes at some of our foreign subsidiaries. In 2017, the Tax Act significantly revisedU.S. corporate income tax law by, among other things, reducing the corporate income tax rate from 35% to 21% and implementing a modified territorial tax system that includes a one-time transition tax on deemed repatriated earnings of foreign subsidiaries. As a result of the Tax Act, the prior year results include a net reduction of approximately$84 million related to the following: (1) the one-time transition tax on deemed repatriation of earnings on some of our foreign subsidiaries resulted in an additional income tax expense of$62 million , to be paid over an eight-year period, (2) the remeasurement of deferred tax assets and liabilities at the reduced corporate income tax rate of 21% resulted in additional income tax expense of$115 million , and (3) in connection with the remeasurement of our deferred tax asset arising from the acquisition of interests inIBG LLC , we also remeasured the related Tax Receivable Agreement liability, payable to Holdings, resulting in the recognition of a$93 million gain, which is reported in other income in the consolidated statements of comprehensive income. See Note 9 - "Other Income" and Note 11 - "Income Taxes" to the audited consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K. ? 44
--------------------------------------------------------------------------------
Table of Contents
The table below presents information about our income tax expense for the
periods indicated.
Year-Ended December 31,
2019 2018 2017
(in millions, except %)
Consolidated
Consolidated income before income taxes $ 1,157 $ 1,196 $ 1,049
IBG, Inc. stand-alone income before income taxes (1) 2 92 (1)
Operating subsidiaries income before income
taxes $ 1,158 $ 1,194 Operating subsidiaries Income before income taxes$ 1,158 $ 1,194 $ 957 Income tax expense 23 32
31
Income tax expense - effect of the Tax Act - -
62
Net income available to members$ 1,135 $ 1,162
IBG, Inc. Average ownership percentage in IBG LLC 18.4% 17.8%
17.0%
Net income available toIBG, Inc. from operating subsidiaries$ 207 $ 206 $ 147 IBG, Inc. stand-alone income before income taxes (1) 2 92 (1) Income before income taxes 206 208
239
Income tax expense 45 39
48
Income tax expense - effect of the Tax Act - -
115
Net income available to common stockholders
Consolidated income tax expense Income tax expense attributable to operating subsidiaries$ 23 $ 32 $ 93 Income tax expense attributable IBG, Inc. 45 39
163
Consolidated income tax expense$ 68 $ 71
Consolidated effects of the Tax Act One-time repatriation tax expense $ - $ -$ 62 Remeasurement of U.S. deferred tax assets - -
115
Remeasurement of liability under the Tax Receivable Agreement - -
(93)
Total decrease in earnings resulting from the Tax Act $ - $ -$ 84 ___________________________
(1)Includes a
Operating Results
Income before income taxes, for the current year, decreased$39 million , or 3%, to$1,157 million , compared to the prior year. Pretax profit margin was 60% for the current year and 63% for the prior year. Comparing our operating results for the current year to the prior year, excluding the effects of our currency diversification strategy, our net mark-to-market on investments and unusual bad debt expense: adjusted net revenues were$1,984 million , up 4%; adjusted income before income taxes was$1,246 million , up 3%; and adjusted pre-tax profit margin was 63% for both the current year and the prior year. See the "Non-GAAP Financial Measures" section below in this Item 7 for additional details.
Year Ended
For a discussion of changes for the year endedDecember 31, 2018 compared to the Year EndedDecember 31, 2017 refer to the Annual Report on Form 10-K filed with theSEC onFebruary 28, 2019 . ? 45
--------------------------------------------------------------------------------
Table of Contents
Trading Volumes and Brokerage Statistics
The tables below present historical trading volumes and brokerage statistics for our business. However, volumes are not the only drivers in our business.
TRADE VOLUMES:
(in 000's, except %)
Brokerage
Brokerage Non Market Avg. Trades
Cleared % Cleared % Making % Total % per U.S.
Period Trades Change Trades Change Trades Change Trades Change Trading Day
2015 242,846 18,769 65,937 327,553 1,305
2016 259,932 7% 16,515 (12%) 64,038 (3%) 340,485 4% 1,354
2017 265,501 2% 14,835 (10%) 31,282 (51%) 311,618 (8%) 1,246
2018 328,099 24% 21,880 47% 18,663 (40%) 368,642 18% 1,478
2019 302,289 (8%) 26,346 20% 17,136 (8%) 345,771 (6%) 1,380
CONTRACT AND SHARE VOLUMES:
(in 000's, except %)
TOTAL
Options % Futures (1) % Stocks %
Period (contracts) Change (contracts) Change (shares) Change
2015 634,388 140,668 172,742,520
2016 572,834 (10%) 143,287 2% 155,439,227 (10%)
2017 395,885 (31%) 124,123 (13%) 220,247,921 42%
2018 408,406 3% 151,762 22% 210,257,186 (5%)
2019 390,739 (4%) 128,770 (15%) 176,752,967 (16%)
BROKERAGE TOTAL
Options % Futures (1) % Stocks %
Period (contracts) Change (contracts) Change (shares) Change
2015 298,982 125,693 157,366,444
2016 265,457 (11%) 129,082 3% 142,356,340 (10%)
2017 293,860 11% 118,427 (8%) 213,108,299 50%
2018 358,852 22% 148,485 25% 198,909,375 (7%)
2019 349,287 (3%) 126,363 (15%) 167,826,490 (16%)
BROKERAGE CLEARED
Options % Futures (1) % Stocks %
Period (contracts) Change (contracts) Change (shares) Change
2015 244,356 124,206 153,443,988
2016 227,413 (7%) 128,021 3% 138,523,932 (10%)
2017 253,304 11% 116,858 (9%) 209,435,662 51%
2018 313,795 24% 146,806 26% 194,012,882 (7%)
2019 302,068 (4%) 125,225 (15%) 163,030,500 (16%)
___________________________
(1)Futures contract volume includes options on futures.
?
46
--------------------------------------------------------------------------------
Table of Contents
MARKET MAKING
Options % Futures (1) % Stocks %
Period (contracts) Change (contracts) Change (shares) Change
2015 335,406 14,975 15,376,076
2016 307,377 (8%) 14,205 (5%) 13,082,887 (15%)
2017 102,025 (67%) 5,696 (60%) 7,139,622 (45%)
2018 49,554 (51%) 3,277 (42%) 11,347,811 59%
2019 41,452 (16%) 2,407 (27%) 8,926,477 (21%)
___________________________
(1)Futures contract volume includes options on futures.
BROKERAGE STATISTICS:
(in 000's, except % and where noted)
Year over Year 4Q2019 4Q2018 % Change Total Accounts 690 598
15%
Customer Equity (in billions) (1)$ 174.1 $ 128.4 36% Cleared DARTs 719 856 (16%) Total Customer DARTs 797 951 (16%)
Cleared Customers (in $'s, except DART per account) Commission per Cleared Commissionable Order (2)
$ 3.63 $ 3.79
(4%)
Cleared Avg. DART per Account (Annualized) 266 364
(27%)
Net Revenue per Avg. Account (Annualized)$ 2,801 $ 3,225 (13%) ___________________________ (1)Excludes non-customers.
(2)Commissionable order - a customer order that generates commissions
Business Segments
The following sections discuss the results of our operations by business
segment, excluding a discussion of corporate segment income and expense. In the
following tables, revenues and expenses directly associated with each business
segment are included in determining income before income taxes. Due to the
integrated nature of the business segments, estimates and judgments have been
made in allocating certain revenue and expense items. Transactions between
business segments generally result from one subsidiary facilitating the business
of another subsidiary through the use of its existing trading memberships and
clearing arrangements. In such cases, certain revenue and expense items are
eliminated to accurately reflect the external business conducted in each
business segment. Rates on transactions between business segments are designed
to approximate full costs. In addition to execution, clearing and distribution
fees, each business segment's operating expenses include: (i) employee
compensation and benefits expenses that are incurred directly in support of each
business segment, (ii) general and administrative expenses, which include
directly incurred expenses for property leases, professional fees, travel and
entertainment, communications and information services, equipment, and
(iii) indirect support costs (including compensation and other related operating
expenses) for administrative services provided by corporate segment
subsidiaries. Such administrative services include, but are not limited to,
computer software development and support, accounting, tax, legal and facilities
management.
?
47
--------------------------------------------------------------------------------
Table of Contents
Electronic Brokerage
The table below presents the results of our electronic brokerage operations for
the periods indicated.
Year-Ended December 31,
2019 2018 2017
(in millions)
Revenues
Commissions $ 706 $ 777 $ 648
Interest income 1,738 1,386 829
Other income 164 169 108
Total revenues 2,608 2,332 1,585
Interest expense 687 490 180
Total net revenues 1,921 1,842 1,405
Non-interest expenses
Execution, clearing and distribution fees 238 254 210
Employee compensation and benefits 142 131
122
Occupancy, depreciation and amortization 21 17 18 Communications 16 16 15 General and administrative 263 243 178 Customer bad debt 44 4 2 Total non-interest expenses 724 665 545 Income before income taxes$ 1,197 $ 1,177 $ 860
Year Ended
Electronic brokerage total net revenues, for the current year, increased$79 million , or 4%, compared to the prior year, to$1,921 million , due to higher net interest income, partially offset by lower commissions and other income. Commissions, for the current year, decreased$71 million , or 9%, compared to the prior year, to$706 million , driven by lower customer trading volumes in options, futures and stocks. Total customer options and futures contract and stock share volumes decreased 3%, 15% and 16%, respectively, compared to the prior year. The decline was in line with lower volatility and lower industry trade volumes. Total DARTs for cleared and execution-only customers, for the current year, decreased 3% to 833 thousand, compared to 862 thousand for the prior year. DARTs for cleared customers, i.e., customers for whom we execute trades, as well as, clear and carry positions, for the current year, decreased 5% to 748 thousand, compared to 791 thousand for the prior year. Average commission per commissionable order for cleared customers, for the current year, decreased 5% to$3.67 , compared to$3.87 for the prior year, reflecting smaller trade sizes across all product types Net interest income, for the current year, increased$155 million , or 17%, compared to the prior year, to$1,051 million driven by a$4.4 billion increase in average customer credit balances, a portion of which were invested in interest-bearingU.S. government securities and an 0.33% increase in the average Federal Funds effective rate to 2.16%, partially offset by a$2.8 billion decrease in average customer margin loans. As a result of the increase in the average Federal Funds effective rate, interest expense on customer credit balances denominated inU.S. dollars increased from the prior year, in part, as we passed along more interest to our customers. Increased customer activity impacted securities borrowed and loaned balances. During the current year, net interest earned from securities lending transactions increased$33 million , or 16%, compared to the prior year. Note that securities lending transactions that support customer activity may produce interest income (expense) that is offset by interest expense (income) related to customer balances. Other income, for the current year, decreased$5 million , or 3%, compared to the prior year, to$164 million , mainly driven by a$10 million decrease in risk exposure fees, and a$7 million net mark-to-market gain on ourU.S. government securities portfolio in the current year compared to a$9 million net mark-to-market gain in the prior year, partially offset by a$5 million increase inFDIC sweep fee income and a$4 million increase in account activity fee income, compared to the prior year. Non-interest expenses, for the current year, increased$59 million , or 9%, compared to the prior year, to$724 million . The increase is driven by a$40 million increase in customer bad debt expense, as described in the Financial Overview section above; a$20 million increase in general and administrative expenses, mainly due to higher expenses related to legal and regulatory matters; and an$11 million increase in employee compensation and benefits expenses driven by a 13% increase in the average number of employees providing services to the electronic brokerage segment. Within non-interest expenses, execution, clearing and distribution fees 48
--------------------------------------------------------------------------------
Table of Contents
decreased$16 million , reflecting the decline in trade volumes in the current year. As a percentage of total net revenues, non-interest expenses were 38% for the current year and 36% for the prior year.
Operating Results
Income before income taxes, for the current year, increased$20 million , or 2%, compared to the prior year, to$1,197 million . As a percentage of total net revenues for the electronic brokerage segment, income before income taxes was 62% for the current year and 64% for the prior year. Comparing electronic brokerage operating results for the current year to the prior year: excluding the net mark-to-market gains and losses from ourU.S. government securities portfolio, and the unusual bad debt expense described in the Financial Overview above, adjusted net revenues were$1,914 million , up 4%; adjusted income before income taxes was$1,232 million , up 5%; and adjusted pre-tax profit margin was 64% for both the current year and the prior year. See the "Non-GAAP Financial Measures" section below in this Item 7 for additional details.
Year Ended
For a discussion of changes for the year endedDecember 31, 2018 compared to the Year EndedDecember 31, 2017 refer to the Annual Report on Form 10-K filed with theSEC onFebruary 28, 2019 . ? 49
--------------------------------------------------------------------------------
Table of Contents
Market Making
The table below presents the results of our market making operations for the
periods indicated.
Year-Ended December 31,
2019 2018 2017
(in millions)
Revenues
Trading gains $ 27 $ 39 $ 40
Interest income 48 49 89
Other income 7 9 16
Total revenues 82 97 145
Interest expense 15 21 59
Total net revenues 67 76 86
Non-interest expenses
Execution, clearing and distribution fees 14 16 32
Employee compensation and benefits 11 10
25
Occupancy, depreciation and amortization - - 3 Communications 1 1 7 General and administrative 11 15 46 Total non-interest expenses 37 42 113 Income (loss) before income taxes$ 30 $ 34 $
(27)
Year Ended
As previously described, since 2017 we have been winding down our options market making operations and the market making results described below reflect this pull back. Market making total net revenues, for the current year, decreased$9 million , or 12%, compared to the prior year, to$67 million , due to lower trading gains and other income, partially offset by higher net interest income. Trading gains, for the current year, decreased$12 million , or 31%, compared to the prior year, to$27 million , on the remaining market making operations. Our market making operations executed 17.1 million trades compared to 18.7 million trades executed in the prior year, reflecting the continuing wind-down of our market making activities. In addition, market making options and futures contract and stock share volumes decreased 16%, 27% and 21%, respectively.
Net interest income, for the current year, increased
Other income, for the current year, decreased$2 million , or 22%, compared to the prior year, to$7 million , mainly due to a decrease in consulting fee income and the non-recurrence of an$2 million recovery of costs related to the sale of ourU.S. options market making operations toTwo Sigma Securities, LLC in the prior year, partially offset by an increase in dividend income from investments. Non-interest expenses, for the current year, decreased$5 million , or 12%, compared to the prior year, to$37 million . Within non-interest expenses, execution, clearing and distribution fees decreased$2 million , or 13%, on lower trading volumes in options, futures and stocks, and general and administrative expenses decreased$4 million , or 27%, compared to the prior year. As a percentage of total net revenues, non-interest expenses were 55% for both the current year and for the prior year. Income before income taxes, for the current year, decreased$4 million , compared to the prior year, to$30 million . ? 50
--------------------------------------------------------------------------------
Table of Contents
Year Ended
For a discussion of changes for the year endedDecember 31, 2018 compared to the Year EndedDecember 31, 2017 refer to our Annual Report on form 10-K filed with theSEC onFebruary 28, 2019 . Non-GAAP Financial Measures We use certain non-GAAP financial measures as additional measures to enhance the understanding of our financial results. These non-GAAP financial measures include adjusted net revenues, adjusted income before income taxes, adjusted net income available for common stockholders and adjusted diluted earnings per share ("EPS"). We believe that these non-GAAP financial measures are important measures of our financial performance because they exclude certain items that may not be indicative of our core operating results and business outlook and may be useful to investors and analysts in evaluating the operating performance of the business and facilitating a meaningful comparison of our results in the current period to those in prior and future periods.
Adjusted net revenues, adjusted income before income taxes, adjusted net income available for common stockholders and adjusted EPS are non-GAAP financial measures as defined by SEC Regulation G.
•We define adjusted net revenues as net revenues adjusted to remove the effect of our currency diversification strategy and net mark-to-market on investments.
•We define adjusted income before income taxes as income before income taxes adjusted to remove the effect of our currency diversification strategy, net mark-to-market on investments and unusual bad debt expense.
•We define adjusted net income available to common stockholders as net income available for common stockholders adjusted to remove the after-tax effects of our currency diversification strategy, net mark-to-market on investments, and unusual bad debt expense attributable toIBG, Inc. Mark-to-market on investments represents the net mark-to-market gains (losses) on ourU.S. government securities portfolio, which are typically held to maturity, investments in equity securities that do not qualify for equity method accounting which are measured at fair value, and equity securities taken over by the Company from customers related to losses on margin loans described below. Unusual bad debt expense includes material losses on margin loans resulting from unusual events that occur in the marketplace. For the twelve months endingDecember 31, 2019 , unusual bad debt expense reflects losses recognized on margin lending to a small number of our brokerage customers that had taken relatively large positions in a security listed on a majorU.S. exchange, which lost a substantial amount of its value in a very short timeframe. (See Note 14 - "Commitments, Contingencies and Guarantees" to the audited consolidated financial statements in Part II, Item 8 of this Annual report on Form10-K.)
The effect of our currency diversification strategy, net mark-to-market on investments and unusual bad debt expense are excluded because management does not believe they are indicative of our underlying core business performance.
These non-GAAP measures should be considered in addition to, rather than as a substitute for, measures of financial performance prepared in accordance with GAAP2. ___________________________
2 Refers to generally accepted accounting principles in
?
51
--------------------------------------------------------------------------------
Table of Contents
The table below presents a reconciliation of consolidated GAAP to non-GAAP financial measures for the periods indicated.
Year-Ended December 31,
2019 2018
(in millions, except share and per share
amounts)
Adjusted net revenues
Net revenues - GAAP $ 1,937 $ 1,903
Non-GAAP adjustments
Currency diversification strategy, net 60 19
Mark-to-market on investments (13) (9) Total non-GAAP adjustments 47 10 Adjusted net revenues $ 1,984 $ 1,913
Adjusted income before income taxes
Income before income taxes - GAAP $ 1,157 $
1,196
Non-GAAP adjustments Currency diversification strategy, net 60
19
Mark-to-market on investments (13) (9) Unusual bad debt expense 42 - Total non-GAAP adjustments 89 10 Adjusted income before income taxes $ 1,246 $
1,206
Adjusted pre-tax profit margin 63%
63%
Adjusted net income available for common stockholders Net income available for common stockholders - GAAP $ 161 $
169
Non-GAAP adjustments Currency diversification strategy, net 11 3 Mark-to-market on investments (2) (2) Unusual bad debt expense 8 - Income tax effect of above adjustments1 (3)
(1)
Total non-GAAP adjustments 13
1
Adjusted net income available for common stockholders $ 174 $ 170 Adjusted diluted EPS Diluted EPS - GAAP $ 2.10 $ 2.28 Non-GAAP adjustments Currency diversification strategy, net 0.14 0.05 Mark-to-market on investments (0.03) (0.02) Unusual bad debt expense 0.10 0.00 Income tax effect of above adjustments1 (0.04) (0.02) Total non-GAAP adjustments 0.17 0.01 Adjusted diluted EPS $ 2.27 $ 2.28 Diluted weighted average common shares outstanding 76,825,863 74,266,370 ___________________________
1 The income tax effect is estimated using the corporate income tax rates applicable to the Company.
52--------------------------------------------------------------------------------
Table of Contents
The table below presents a reconciliation of GAAP to non-GAAP financial measures for the electronic brokerage segment for the periods indicated.
Year-Ended December 31,
2019 2018
(in millions)
Adjusted net revenues
Net revenues - GAAP $ 1,921 $ 1,842
Non-GAAP adjustments
Mark-to-market on U.S. government
securities portfolio (7) (9)
Total non-GAAP adjustments (7) (9)
Adjusted net revenues $ 1,914 $ 1,833
Adjusted income before income taxes
Income before income taxes - GAAP $ 1,197 $
1,177
Non-GAAP adjustments Mark-to-market onU.S. government securities portfolio (7) (9) Unusual bad debt expense 42 - Total non-GAAP adjustments 35 (9) Adjusted income before income taxes $ 1,232 $
1,168
Adjusted pre-tax profit margin 64% 64%
Liquidity and Capital Resources
We maintain a highly liquid balance sheet. The majority of our assets consist of investments of customer funds, collateralized receivables arising from customer-related and proprietary securities transactions, and exchange-listed marketable securities, which are marked-to-market daily. Collateralized receivables consist primarily of customer margin loans, securities borrowed, and securities purchased under agreements to resell. As ofDecember 31, 2019 , total assets were$71.7 billion of which approximately$71.1 billion , or 99.2%, were considered liquid. Daily monitoring of liquidity needs and available collateral levels is undertaken to help ensure that an appropriate liquidity cushion, in the form of unpledged collateral, is maintained at all times. We actively manage our excess liquidity and we maintain significant borrowing facilities through the securities lending markets and with banks. As a general practice, we maintain sufficient levels of cash on hand to provide us with a buffer should we need immediately available funds for any reason. Based on our current level of operations, we believe our cash flows from operations, available cash and available borrowings will be adequate to meet our future liquidity needs for more than the next twelve months.
Liability balances, as of
Cash and cash equivalents held by our non-U.S. operating subsidiaries as ofDecember 31, 2019 were$1,121 million ($769 million as ofDecember 31, 2018 ). These funds are primarily intended to finance each individual operating subsidiary's local operations, and thus would not be available to fundU.S. domestic operations unless repatriated through payment of dividends toIBG LLC . In 2018 a dividend of$54 million was paid toIBG LLC from one of our non-U.S. subsidiaries. As ofDecember 31, 2019 , we had no intention to repatriate further amounts from non-U.S. operating subsidiaries, except forTimber Hill Canada Company , which discontinued its market making activities inCanada this year. With the enactment of the Tax Act, we recognized a$62 million liability for the one-time transition tax on deemed repatriation of earnings of some of our foreign subsidiaries for the year endedDecember 31, 2017 . As a result, in the event dividends were to be paid to the Company in the future by a non-U.S. operating subsidiaries, the Company would not be required to accrue and pay income taxes on such dividends, except for foreign taxes in the form of dividend withholding tax, if any, imposed on the recipient of the distribution or dividend distribution tax imposed on the payor of the distribution. Historically, our consolidated equity has consisted primarily of accumulated retained earnings, which to date have been sufficient to fund our operations and growth. Our consolidated equity increased 11% to$7.9 billion as ofDecember 31, 2019 from$7.2 billion as ofDecember 31, 2018 . This increase is attributable to total comprehensive income, partially offset by distributions and dividends paid during 2019. 53
--------------------------------------------------------------------------------
Table of Contents
Cash Flows
The table below presents our cash flows from operating activities, investing activities and financing activities for the periods indicated.
Year-Ended December 31,
2019 2018 2017
(in millions)
Net cash provided by operating activities
(89) (57) (26)
Net cash used in financing activities (419) (399) (374)
Effect of exchange rate changes on cash, cash
equivalents, and restricted cash 24 (79) 65
Increase in cash, cash equivalents, and
restricted cash $ 2,182 $
1,821
Our cash flows from operating activities are largely a reflection of the changes in customer credit and margin loan balances in our electronic brokerage business. Our cash flows from investing activities are primarily related to other investments, capitalized internal software development, purchases and sales of memberships at exchanges where we trade, and strategic investments where such investments may enable us to offer better execution alternatives to our current and prospective customers, allow us to influence exchanges to provide competing products at better prices using sophisticated technology, or enable us to acquire either technology or customers faster than we could develop them on our own. Our cash flows from financing activities are comprised of short-term borrowings, capital transactions and payments made to Holdings under the Tax Receivable Agreement. Short-term borrowings from banks are part of our daily cash management in support of operating activities. Capital transactions consist primarily of quarterly dividends paid to common stockholders and related distributions paid to Holdings. Year EndedDecember 31, 2019 : Our cash, cash equivalents, and restricted cash (i.e., cash and cash equivalents that are subject to withdrawal or usage restrictions) increased by$2,182 million to$12.3 billion for the year endedDecember 31, 2019 . We raised$2,666 million in net cash from operating activities. We used net cash of$508 million in our investing and financing activities, primarily for distributions to noncontrolling interests, dividends paid to our common stockholders and payments made under the Tax Receivable Agreement. Investing activities mainly consisted of purchases of other investments and property, equipment and intangible assets.
Year Ended
For a discussion of changes in cash flows for the year ended
Year Ended
For a discussion of changes in cash flows for the year ended
Regulatory Capital Requirements
Our principal operating subsidiaries are subject to separate regulation and capital requirements in theU.S. and other jurisdictions.IB LLC ,TH LLC andIB Corp are subject to the Uniform Net Capital Rule (Rule 15c3-1) under the Exchange Act,IB LLC is also subject to the CFTC's minimum financial requirements (Regulation 1.17). IBC is subject to theInvestment Industry Regulatory Organization of Canada risk adjusted capital requirement, IBUK is subject to the United Kingdom Financial Conduct Authority Capital Requirements Directive, IBEU is subject to theLuxembourg Commission de Surveillance du Secteur Financier financial resources requirement, IBKRFS is subject to theSwiss Financial Market Supervisory Authority eligible equity requirement, IBI is subject to theNational Stock Exchange of India net capital requirements, IBHK is subject to theHong Kong Securities Futures Commission liquid capital requirement, IBSJ is subject to theJapanese Financial Supervisory Agency capital requirements and IBA is subject to theAustralian Securities Exchange liquid capital requirement.
As of
?
54
--------------------------------------------------------------------------------
Table of Contents
The table below summarizes the capital, capital requirements and excess
regulatory capital as of
Net Capital/
Eligible Equity Requirement Excess
(in millions)
IB LLC $ 5,381 $ 549 $ 4,832
IBKRFS 584 91 493
IBHK 360 145 215
Other regulated operating subsidiaries 867 44 823
$ 7,192 $ 829 $ 6,363
Capital Expenditures
Our capital expenditures are comprised of compensation costs of our software
engineering staff for development of software for internal use and expenditures
for computer, networking and communications hardware, and leasehold
improvements. These expenditure items are reported as property, equipment, and
intangible assets. Capital expenditures for property, equipment, and intangible
assets were approximately $74 million , $36 million , and $28 million for the
three years ended December 31, 2019 , 2018, and 2017, respectively. The increase
during 2019 is mainly driven by the renovation of our U.S. headquarters and the
relocation of our primary data center. In the future, we plan to meet capital
expenditure needs with cash from operations and cash on hand, as we continue our
focus on technology infrastructure initiatives to further enhance our
competitive position. In response to changing economic conditions, we believe we
have the flexibility to modify our capital expenditures by adjusting them
(either upward or downward) to match our actual performance. If we pursue any
additional strategic acquisitions, we may incur additional capital expenditures.
Contractual Obligations Summary
Our contractual obligations principally include obligations associated with our
outstanding indebtedness and interest payments as of
Payments Due by Year
Total 2020-2021 2022-2023 Thereafter
(in millions)
Payable to Holdings under Tax
Receivable Agreement (1) $ 139 $ 33 $ 39 $ 67
Operating leases 150 36 32 82
Transition Tax liability (2) 56 10 10 36
Total contractual cash obligations
81 $ 185
___________________________
(1)As of December 31, 2019 , contractual amounts owed under the Tax Receivable
Agreement of $139 million have been recorded in payable to affiliate in the
consolidated financial statements representing management's best estimate of the
amounts currently expected to be owed under the Tax Receivable Agreement.
Through December 31, 2019 , approximately $188 million of cumulative cash
payments have been made.
(2)The Tax Act implemented a modified territorial tax system that includes a
one-time transition tax on deemed repatriated earnings of foreign subsidiaries
to be paid over an eight-year period starting in 2018. We believe this tax will
not have a material impact on our liquidity.
Seasonality
Our businesses are subject to seasonal fluctuations, reflecting varying numbers of market participants at times during the year, varying numbers of trading days from quarter-to-quarter, and declines in trading activity due to holidays. Typical seasonal trends may be superseded by market or world events, which can have a significant impact on prices and trading volume.
Inflation
Although we cannot accurately anticipate the effects of inflation on our
operations, we believe that, for the three most recent years, inflation has not
had a material impact on our results of operations and will not likely have a
material impact in the foreseeable future.
55--------------------------------------------------------------------------------
Table of Contents
Investments in
We invest inU.S. government securities for the purpose of satisfyingU.S. regulatory requirements. As a broker-dealer, unlike banks, we are required to mark these investments to market even though we intend to hold them to maturity. Sudden increases (decreases) in interest rates will cause mark-to-market losses (gains) on these securities, which are recovered (eliminated) if we hold them to maturity, as currently intended. The impact of changes in interest rates is further described in Part II, Item 7A of this Annual Report on Form 10-K entitled "Quantitative and Qualitative Disclosures about Market Risk."
Strategic Investments and Acquisitions
We regularly evaluate potential strategic investments and acquisitions. We hold strategic investments in electronic trading exchanges includingBOX Options Exchange, LLC andOneChicago LLC . In addition, inJune 2018 , we consummated a strategic investment in Tiger Brokers, an online stock brokerage established for Chinese retail and institutional customers. OnMarch 20, 2019 , Tiger Brokers priced its initial public offering ("IPO") of American Depositary Shares listed on Nasdaq Global Select market and, concurrently with the IPO, we purchased unregistered ordinary shares in Tiger Brokers through a private placement offering which transactions resulted in a beneficial ownership interest of 7.6%. We intend to continue making acquisitions on an opportunistic basis, generally only when the acquisition candidate will, in our opinion, enable us to offer better execution alternatives to our current and prospective customers, allow us to influence exchanges to provide competing products at better prices using sophisticated technology, or enable us to acquire either technology or customers faster than we could develop them on our own. As ofDecember 31, 2019 , there were no other definitive agreements with respect to any material acquisition.
Certain Information Concerning Off-Balance-Sheet Arrangements
We may be exposed to a risk of loss not reflected in our consolidated financial statements for futures products, which represent our obligations to settle at contracted prices, and which may require us to repurchase or sell in the market at prevailing prices. Accordingly, these transactions result in off-balance sheet risk, as our cost to liquidate such futures contracts may exceed the amounts reported in our consolidated statements of financial condition.
Critical Accounting Policies and Estimates
Our consolidated financial statements have been prepared in accordance withU.S. GAAP, which requires management to make estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements and accompanying notes. These estimates and assumptions are based on judgment and the best available information at the time. Therefore, actual results could differ materially from those estimates. We believe that the critical policies listed below represent the most significant estimates used in the preparation of our consolidated financial statements. See Note 2 - "Significant Accounting Policies" to the audited consolidated financial statements for a summary of our significant accounting policies in Part II, Item 8 of this Annual Report on Form 10-K.
Contingencies
Our policy is to estimate and accrue for potential losses that may arise out of litigation and regulatory proceedings, to the extent that such losses are probable and can be estimated. Significant judgment is required in making these estimates and our final liabilities may ultimately be materially different. Our total liability accrued with respect to litigation and regulatory proceedings is determined on a case-by-case basis and represents an estimate of probable losses based on, among other factors, the progress of each case, our experience with and industry experience with similar cases and the opinions and views of internal and external legal counsel. Given the inherent difficulty of predicting the outcome of our litigation and regulatory matters, particularly in cases or proceedings in which substantial or indeterminate damages or fines are sought, or where cases or proceedings are in the early stages, we cannot estimate losses or ranges of losses for cases or proceedings where there is only a reasonable possibility that a loss may be incurred.
Income Taxes
Our income tax expense, deferred tax assets and liabilities, and reserves for unrecognized tax benefits are based on enacted tax laws and reflect management's best assessment of estimated future taxes to be paid. We are subject to income taxes in both theU.S. and numerous foreign jurisdictions. Determining income tax expense requires significant judgment and estimates. Deferred income tax assets and liabilities arise from temporary differences between the tax and financial statement recognition of the underlying assets and liabilities. In evaluating our ability to recover our deferred tax assets within the jurisdictions from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies, and results of recent operations. In projecting future taxable income, historical results 56
--------------------------------------------------------------------------------
Table of Contents
are adjusted for changes in accounting policies and incorporate assumptions including the amount of future state, federal and foreign pre-tax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax-planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses. In evaluating the objective evidence that historical results provide, three years of cumulative operating income (loss) are considered. Deferred income taxes have not been provided forU.S. tax liabilities or for additional foreign taxes on the unremitted earnings of foreign subsidiaries that have been indefinitely reinvested. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations. Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities in the future. The enactment of the Tax Act onDecember 22, 2017 significantly revised theU.S corporate income tax law by, among other things, reducing the corporate income tax rate from 35% to 21% and implementing a modified territorial tax system that includes a one-time transition tax on deemed repatriated earnings of foreign subsidiaries. See Note 11 - "Income Taxes" to the audited consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K. We record tax liabilities in accordance withFinancial Accounting Standards Board ("FASB") ASC Topic 740 and adjust these liabilities when management's judgment changes as a result of the evaluation of new information not previously available. Because of the complexity of some of these uncertainties, the ultimate resolution may result in payments that are different from the current estimates of these tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which new information becomes available. We recognize that a tax benefit from an uncertain tax position may be recognized only when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, on the basis of the technical merits. A tax position that meets this standard is measured at the largest amount of benefit that will more likely than not be realized on settlement.
Accounting Pronouncements Issued But Not Yet Adopted
For additional information regarding FASB Accounting Standards Updates ("ASU"s)
that have been issued but not yet adopted and that may impact the Company, refer
to Note 2 - "Significant Accounting Policies" to the audited consolidated
financial statements in Part II, Item 8 of this annual Report on form 10-K.
© Edgar Online, source
