IBKR - Interactive Brokers

[ERICOPOLY]

Anyone consider the credit risk embedded on the margin loans ?  My thesis relies on continued margin debt growth but as a % of net equity capital it is already the highest amoung peers.  It posted a 34% CAGR (2011-2014) vs. peer average of 14% growth.  I believe they want to hold excess capital  to absorb ST losses on its loan book in the events of severe market turmoil similar to the Swiss surprise revaluation in January. 

 

I compared them to SCHW, AMTD, and ETFC.  As of Q2 2015, it looks like for every dollar of capital they 3.63 dollars of loans compared to 1.77 at their peers.  I understand everyone's mix is a bit different as SCHW has a banking business but in terms of margin loans it still interesting.

 

Margin Loans - % of Equity Capital

               

2012   2013   2014 Q2 2015 Schwab         140% 134% 133% 130% TD Ameritrade 195% 192% 245% 258% Etrade           118% 131% 143% 142% IBKR           205% 267% 329% 363% Average         165% 181% 212% 223%

 

Anyone worried ?

 

 

Shouldn't you be also looking at margin risk from naked options trades?  It seems incomplete to be looking just at loans.

 

Further, shouldn't you be looking at the netted risk?  I have a large margin loan with IBKR... but so what, they can't lose money on it because I've got put options that ensure my equity can't be wiped out.  So there is zero risk to IBKR from my margin loans.  They make money from my account without any risk. 

 

[benhacker]

I think this is a hard one.  From my reading of IB over the years, I would be hard pressed to find a broker with the same risk management DNA.  They have a culture built from the Timber Hill market making group over decades and you can glean / read about what kinds of markets they will and won't make in options - and I think it is telling (they disclosed a lot of this before and during the financial crisis and it was all very logical / rational, and left money on the table which is the real sign IMO that it comes from solid DNA).

 

I do think competing on price in margin loans (or options as Eric rightly notes) they will potentially attract more fraudulent customers trying to catch them in a violent move of some weird stock or underlying index.... similar to what happened in Singapore trades last year or so.

 

However, I think the following makes me comfortable (in addition to what I listed above):

1) 2008, flash crash, 2011 all sailed through just fine for the company (every time they announced losses, like LEH options, or something, it was minor and often was recouped or partly in courts).

2) Unlike other brokers, IB has a very very draconian margin "call" procedure, roughly translating to "F you if you breach your margin limits, we liquidate you immediately" (by the way, this is partly why they charge less, or a supposed reason why others charge more)

3) Mr P has like $12B+ in market value in a first loss position with us on this kind of risk, which probably sharpens the mind. :)

4) I think the difference in the above makes me far more worried about TDA's 258% ratio, than IB's 363% ratio...

 

Just my 2 cents, I think leveraged financials are challenging for questions like these... how do we "know" what risk we are taking?  In this space, I only bet with those who I think understand they should avoid black swans.  I think Mr P and team get it... but there are no guarantees.

[ABM]

Look up what IB does when customers hit margin limit and compare that to what others do...

I think that limits credit risk and that's why they can afford to have capacity to lend more...risk management.

 

 

I am more concerned with market dislocation events where liquidity disappears and you have large down gaps in value.  Liquidity is key when your a leveraged lender. 

 

 

In Q1 2015, IBKR lost $121 million on the Swiss Franc exposure related to customer margin accounts.  You can all have all the controls in the world trigger a sell order once the customer's equity is wiped out but if the liquidity in the market has disappeared you are forced to exit at the prevailing rate.  This is a direct hit to company capital to cover the loss between customer.  Loss represented ~5% of brokerage capital which was lost in a fraction of a second. 2 years prior they lost $84 million in Singapore equities related to customer margin position where the same issue occurred. 

 

 

Disclosure from the company 10-Q

"As of June 30, 2015, we had $19.0 billion in margin credit extended to our customers. The amount of risk to which we are exposed from the margin credit we extend to our customers and from short sale transactions by our customers is unlimited and not quantifiable as the risk is dependent upon analysis of a potential significant and undeterminable rise or fall in stock prices."

 

 

Since the margin book is blackbox, how concerned should we be about IBKR's ability to cover losses on margin loans in rare market events ?  The CEO himself has implied this is why the company hold's such a large amount of excess capital. 

 

I am long the stock and subscribe to the low cost producer in consolidating industry with years of growth in front of it theme but I am just making sure I understand/fully appreciate the risks. 

 

Shouldn't you be also looking at margin risk from naked options trades?  It seems incomplete to be looking just at loans.

 

Further, shouldn't you be looking at the netted risk?  I have a large margin loan with IBKR... but so what, they can't lose money on it because I've got put options that ensure my equity can't be wiped out.  So there is zero risk to IBKR from my margin loans.  They make money from my account without any risk.

 

Cannot do anything you say based on disclosures...

 

 

[scorpioncapital]

IB is in the business of promoting trading to customers. I get tons of Communiques and training emails. Why? Because they know that if people trade once for $1 and sell a stock in 5 years again for $1, IB has made a net total of $2 from that customer +/- margin loans and use of their cash if any. As long as people trade, for the right or wrong reasons, they will make money. It is my express goal to give them as little money as possible, sadly I never am able to minimize this but I'm trying and dream of the day when I will give them something like $10 per year while using their low cost loans. I yearn to kill their profits :)

 

 

 

 

 

[60North Investments]

Anyone have an idea what's up with the insider sales? Since August there's been a lot of them, all the way from Galik to other directors etc.

 

https://www.insidertracking.com/company?ticker=IBKR

[benhacker]

I think the stock is statistically quite pricy.... Seems like a decent time to sell if you are overweight. I think probably as simple as that. I have had a large stake for a long time and have reduced this year a bit.

[frommi]

When you factor in untapped pricing power the stock is still pretty cheap. They could easily double prices and still be the cheapest broker. Of course they then wouldn't take market share at the same speed, but earnings would triple overnight.

[Homestead31]

Anyone have an idea what's up with the insider sales? Since August there's been a lot of them, all the way from Galik to other directors etc.

 

https://www.insidertracking.com/company?ticker=IBKR

 

there is some talk about this on the VIC thread... the short version is that for tax reasons insiders can't hold more than X% of the company, so if their % ownership goes up due to share grants (or float shrink) they are incentivized to sell for tax reasons, not fundamental reasons.

[KCLarkin]

I think the stock is statistically quite pricy.... Seems like a decent time to sell if you are overweight. I think probably as simple as that. I have had a large stake for a long time and have reduced this year a bit.

 

How are you valuing this?

 

Here is my fuzzy math. In a bull market, a rapidly growing, capital light business should sell for 10 to 20x pre-tax income. Let's say 15x. Petterfy thinks the brokerage business will be on a $1B run rate by the end of 2016. So brokerage alone should be worth at least $15B in 2016. So 13.5B present value. So worst case, it is 20% overvalued?

 

I added today.

[benhacker]

How are you valuing this?

 

I think a (high) multiple to per-tax (brokerage) is a decent way to approach.  I think the growth assumptions, as well as how you treat MM capital (excess / cash like or not) changes the assumptions but probably easy to handle on an individual basis.

 

Generally, I tend to let these kinds of businesses run (insider owner, unrespected franchise, long term consolidation / growth potential, history of good capital allocation...), but I am also very mindful of:

 

1) Most great businesses in the past you could acquire at "statistically" (used loosely, TTM earnings, FCF, etc) average prices during their run (sometimes frequently), even if those prices turned out to be super cheap in hindsight... very few businesses have carried monster valuations from day one (MSFT, SBUX, maybe HD are exceptions I think).

 

2) I am biased to overvalue the business because I have made so much money here, and my thesis has largely played out as planned... I kind of force myself to sell a little in these cases to avoid biasing my brain.

 

I have a nearly 10% position in this for my accounts, but I was 15% recently (I sold a large ~20% chunk of my holdings above $44)... Long term I probably should have done nothing... but this stock could easily drop 30% without a ton of folks stepping up to the plate.  At <$30, I'd probably take it back up to 12-15% all else equal.  As they say, lots of reasons people sell (both me and IBKR insiders)... but only one reason to buy more. ;-)

 

Especially in times like these (long in the tooth, stupid bull markets, my opinion of course), I am mindful of short term drawdowns preventing me from being more aggressive when the time comes.

 

I think IBKR will prove to be underpriced as of today based on prospective returns... *but* when we start justifying business valuations based on 20+x forward pre-tax multiples, we should probably all take a deep breath and go to the beach for a while (no offense as I agree with your methodology generally, just a sign of where we are in the cycle).

 

My < 2 cents.

[KCLarkin]

I don't disagree with your logic. I am just curious how you are valuing it.

 

I am just using pretax as a quick rule of thumb. It is no bargain here, but when you compare to something like priceline it seems very reasonable.

 

I have a more complex model where it only looks 10% above 2010 and 2011 levels.

[benhacker]

Yeah, understand KC.  I have some beliefs about what premium to tangible book the franchise is likely, and could be worth.  I also have some rough thinking about global online brokerage profits, and what % IB can get in 5 or 10 years.  I also have some general guidelines about what Mr. P has done in terms of compounding since inception, and how that may be moderated due to his size, and also how it may increase given the business he is now in.

 

All together, think just about probabilities (rough numbers, don't have my notes in front of me):

 

1) Chance of a ~$10B premium to book being a bargain for Mr. P and the franchise in place (probably pretty good, but seems steep).

 

2) Chance that given the competitive dynamics at work and global brokerage structure IB will be able to grow to 10x their level of current profits? (probably good, maybe takes 15 years?  Could be earlier)

 

3) Downside if things don't work out well (maybe 50% down from here based on tangible equity value + modest premium)

 

4) Chance that it really goes sideways (close to zero in my mind).

 

Kind of just heuristics.

 

#2 is is what keeps me in the name (the potential to a $2, 3, 4B global brokerage powerhouse with economies of scale and low incremental capital for generating returns)... #1 and #3 are why I am not too scared to wait / hold.

 

I don't generally do explicit valuations (I look more in terms of expected returns from a long term hold which of course is essentially a transfer function of sorts of the same idea).  Not trying to hide a magic formula from you.... :)

 

 

[KCLarkin]

That's useful, thanks.

[kab60]

I think this sounds pretty good - I still haven't finished my account, but this might help people like me who wants 1 foot hurdles or atleast some extra bait. From CC:

 

"Just this past week, we came out with our latest periodic communique that summarizes the many improvements we have made to our systems during the past several months. The most significant one of these is the way we deal with applications for new accounts that we expect will increase our number of account openings. Until now, only about 35% of new account applicants actually completed their applications and funded their accounts.

 

With this new system, as soon as the applicant enters their username, password, and email address, we immediately send to them our trading platform with 15 minute delayed prices. They can populate the screens and set up optional fields the way they would want to use the actual account."

[KCLarkin]

i don't think the simulator will help conversions. I have an 8% position in this stock. Yet, I have started applications twice to open an account. i have never converted. The onboarding process is just too complicated.

 

The good news is they are growing 18% per year despite the 35% conversion.

 

[Liberty]

i don't think the simulator will help conversions. I have an 8% position in this stock. Yet, I have started applications twice to open an account. i have never converted. The onboarding process is just too complicated.

 

The good news is they are growing 18% per year despite the 35% conversion.

 

What is it that you found complicated? I don't remember it being harder than opening an account at TD Waterhouse or RBC Direct Investing (the other two that I've tried). I wonder if there's a difference between the process in Canada and the US... I'd guess it would be fairly similar, but maybe not.

[kab60]

I don't think it will make a big difference by itself but at least they recognized there might be some low hanging fruit. I'm still surprised they haven't called me to ask why I got stuck but they probably checked my AUM and number of trades. :)

[KCLarkin]

I am in Canada. I have opened up numerous (maybe two dozen) accounts with BMO investorline, BMO Nesbitt Burns, TD, and etrade (now scotia). In their defense, my wife had hassles with BMO. Otherwise, I don't recall any issues with the others.

 

My current stumbling block: I need to prove my identity by having a notary or similar attest to my identity. Not a big deal, but automatically gets sent to the back of my long to do list.

 

The other concerns:

- selecting your real-time quote packages is crazy complicated. i don't know why they don't offer some basic package free based on your assets.

- other brokers reimburse transfer fees, I don't think IBKR does. On a per account basis, this isn't much but if you have multiple accounts, this is a real switching cost.

 

[Liberty]

Weird, I never had to prove my identity using a notary. Probably just did fairly standard stuff, but I can't remember exactly what it was. Are you an edge case on that front (non-citizen or something like that)?

[KCLarkin]

Weird, I never had to prove my identity using a notary. Probably just did fairly standard stuff, but I can't remember exactly what it was. Are you an edge case on that front (non-citizen or something like that)?

 

All financial institutions need proof of identity. IBKR attempts to use some automated 3rd party service to verify identification (probably credit bureau). I failed, for whatever reason.

[rmitz]

- selecting your real-time quote packages is crazy complicated. i don't know why they don't offer some basic package free based on your assets.

 

Simple; I don’t use one. Free delayed data.

[writser]

As far as I know they have a basic package; the US value bundle. It's free when you reach $30 commission / month otherwise it's $10. Real time quotes for a lot of US stocks. For all other stocks: if you don't have real-time pricing you can right click the ticker, select 'buy market data subscription' and you go to a page where you can see on which exchange the stock is traded, what package you need and how much it costs. Alternatively you can use the 'market data assistant' which you can find in account management. This is all explained in their online documentation.

 

Granted, you have to spend some time to figure it out but I wouldn't call it crazy complicated. I do agree that opening a new account is tedious (they pretty much acknowledged this in the latest conference call) but if you have a >80 IQ and a spare evening you should be able to figure things out.

 

Some things are difficult at first but if you take the time to learn to understand their platform it is much more powerful (and cheaper) than their competitors. If you want a broker where you can open an account in 5 minutes and buy & hold Berkshire through an easy-to-use web interface you should not be interested in IB and IB is not interested in you. Retail is not their target audience.

[sternalot]

I do agree that opening a new account is tedious (they pretty much acknowledged this in the latest conference call) but if you have a >80 IQ and a spare evening you should be able to figure things out.

 

This assumption is scary, and let me use a great man to help illustrate my concern with this seemingly indefinite growth that people assume for IBKR:

 

"Think of how stupid the average person is, and realize that half of them are stupider than that." - George Carlin

 

The IBKR platform is INCREDIBLY intimidating, and people really aren't that intelligent. As an investment professional, it took me at least two weeks to figure it all out and get set up. Maybe I'm a moron, but I'm not sure there are many outside the finance world that I would recommend IBKR to.

 

With that said, I believe there is most certainly a cap on market share for this business (as long as its platform remains as it is), and I'm guessing my estimate would be lower than most. So what do people expect the terminal market share to be?

 

[sleepydragon]

I used to have an account there.

Keep in mind the complicated stuffs is intentional. They want customers who are day traders, not someone who buy and hold. that's why their interface is complicated, with automated margin control and even order APIs.

[Liberty]

Second level thinking would imply that their complex sign up process and intimidating platform are opportunities. If these things were already perfect, we couldn't expect much improvement, but now, if they just fix this, they can accelerate growth.

 

And while IBKR is mostly aiming for the most profitable people (large AUM, lots of trades, sophisticated investments), they also offer back-end for other brokers. Over time, these others - if they can win enough of them - can have the simple interfaces and spend their own marketing dollars attracting more 'regular' people while IBKR focuses on a different slice of the market.