Business Breakdowns
· Zack Fuss
[00:00:00] S0: I think one of the things that's interesting is if you look at the headcount of IBKR relative its peers, it obviously speaks to their interest in making sure that everything is tech-enabled. I will say amongst some investors who use the platform, they do complain about the lack of customer service at times, but it's what allows them to offer such incredible low-cost execution. And then the other aspects of it being really your ability to use leverage at a very low cost of capital. Can we just talk about how they use their balance sheet in a way that provides such a structural cost advantage relative to their peer set?
· Jacopo Di Nardo
[00:00:00] S2: Fundamentally, there's a couple of points here to be made. The first one is a bit like Jamie Dimon at JP Morgan talks about, having a fortress balance sheet in financials is of paramount importance to succeed over time. It allows to obviously survive crises if they happen. Interactive has a similar approach. If you look at the balance sheet today, at the end of 2025, it's probably going to be about $18 billion of excess capital, which is about 95% of the total capital they have. That allows them obviously to grow the business in a fairly serene way without necessarily participating in the ups and downs of the market. And the second point being when offering low-cost margin loans, it stems partly from that and partly from again going back to the automation point. The big risk when offering margin loans is that eventually those accounts will need to be basically closed because with a market drawdown, the fall in value is superior to that of a margin loan. And there's plenty of examples around, the latest one actually coming from Archegos, where even at investment banks, which one would think are fairly well invested in technology, still require quite a lot of human involvement and personal calls in order to make that decisions. That never happens at Interactive because everything is automated and the account, if it doesn't post the required collateral within a very short period of time, is automatically liquidated and eliminated. And if you think about that dynamic, that is exactly what allows Interactive two things. One is to underprice competition in terms of cost. For the margin loan, it's about half the cost of Fidelity or Schwab or whoever else competes in the US. And it also allows them to offer slightly more leverage than competition without really affecting the total risk. If you're able to cancel that account or to close down that account fairly quickly, and you're also able to mitigate the risk of loss from that account in a better way than competitors, that allows again to foster that competitive advantage coming from lower cost and obviously higher automation.
· Zack Fuss
[00:00:00] S0: And so I think it would be helpful to illustrate how this manifests by demonstrating what an account looks like and how a customer uses the business. For example, let's say you have someone that's a professional trader that has a million dollar account and maybe is running at 2 or 3 million dollars of gross long and short. They're obviously borrowing and lending securities. What does it look like? And then how does that translate into the different revenue line items? So the commission revenue, the net interest income, the fees and services that they provide, just to really drive home how people interact with this business and its ability to be differentiated on every service that it provides to its key customers.
· Freddie Lait
[00:00:00] S1: The difficulty here is that one does need to disaggregate a little bit. We've been discussing this as an online broker, which makes it feel very much like it's aimed entirely at individuals logging onto a website or an app. The truth is more than 50% of the business and a large portion of the growth in the business, although individuals are still growing very nicely, is the other three main cohorts which are white labeling the platform and service for RIAs advisors around the world, prop traders and hedge funds. They're now the fifth largest prime broker in the world. So they're larger than many of the big banks you could name from a standing start about 10 years ago. They're growing far faster than the market for prime because they are seen as more attractive to the hedge fund groups in general. And then the final one which is just worth touching on is what they call introducing brokers. And you can think about this as another bank or another brokerage business who is outsourcing and canceling their own internal technology investments. As an example, they just brought on HSBC globally and then they're going to plug in the underlying trading capability of Interactives. And I would think about this in the same way that a lot of people have become comfortable with outsourcing admin or custody to JP Morgan or these large custody banks like Northern Trust. A large number of these huge global institutions, as opposed to investing in the technology, are renting it implicitly from Interactive. And that is where a lot of the growth's coming from. So what we see at an account level is slightly averages of those things. We can make some assumptions about where the margin skews towards the hedge funds and the prop traders and obviously away from a lot of the RIA business. But what you see is an average account balance that even when it was individual-led was much higher than most other firms and very normal, typical to have 100, 150, $200,000 as the average account balance. Against that there are two other interesting assets which are the margin loans which we've discussed, which used to be far higher actually and have come down as a percentage of equity over the last 10 years, but are ticking up again at the moment in the short term at about 10 to 12% of assets.
· Freddie Lait
So if you've got a $200,000 account, you might have $20,000 of margin loans against some securities in there on leverage. What's also been very popular with all of the brokerage platforms, including Interactive, has been securities lending. And again, as we've probably become boring saying this is fully automated so you can sign in if you want to. Your securities, your stocks can be lent out to people who wish to borrow them and to short them. They're still fully tradable, they're fully collateralized from our perspective as shareholders, by cash. And the client earns most of that lending fee. And again there's a small but very honest spread which is all transparent. So they have a similar amount of securities lending about that sort of, for a $200,000 account, about $20,000 of lending. So 10% of the base. So that's the kind of average. But we do believe it skews a lot. A lot of the introducing business and a lot of the RIAs we think are probably using less, probably trading less as well under that sort of 200 trades per year. And then really the majority of this stock lending margin loan, and even the turnover, the number of trades or darts as they call them, daily average revenue trades. If anyone's reading the annual report after this, that skews towards the hedge fund business. So it's a variety of different clients, all benefiting from the same low-cost platform, but they're using it in different ways.
· Zack Fuss
[00:00:00] S0: When you look at this business's P&L and I'm looking at 2024 as a reference, you have about $1.7 billion in commissions which results in around $2 billion of non-interest related income. And then the rest $3 billion. Is that net interest income that NIM resulting in about $5 billion of revenue? How do you think about how that should evolve over time? The mix in quality as it relates to the evolution of their customer base, which you just mentioned? And then a second question related to that: When you see a business that's as significant an earner on net interest margin, you beg the question as it relates to interest rates and how they impact the business and what would happen in an environment where rates were going down versus going up. Just curious on those two items, really. Revenue mix and NIM. As the business evolves over time.