IBKR - Interactive Brokers

[KJP]

If you spend time on IBKR, let me know what you conclude on the appropriate tax rate. I could never figure it out to a degree that I could get comfortable - though I know others have...

 

For public shareholders, it's basically a full US corporate tax payer.  Low 30s rate.

 

That's it.  The rest of the operating company is owned by a pass through entity, so the income taxes attributable to its ownership are not recorded anywhere in the financial statements.  You can see the reconciliation in footnote 11 of the 2016 annual report, which shows why the tax rate you get from dividing operating income by the recorded tax expense does not reflect the actual corporate tax rate attributable to the public company.

 

The public company also has some public company costs that it bears, which also pushes its net income lower than its proportional share of underlying operating income.

[Travis Wiedower]

For public shareholders, it's basically a full US corporate tax payer.  Low 30s rate. 

 

Low 30s is the answer I've come to as well.

 

glory,

 

I responded to your email, but TwoCitiesCapital brought up another important aspect that I forgot to mention. Low volatility in the markets has also pushed down trades per day per client.

[Spekulatius]

For public shareholders, it's basically a full US corporate tax payer.  Low 30s rate. 

 

Low 30s is the answer I've come to as well.

 

glory,

 

I responded to your email, but TwoCitiesCapital brought up another important aspect that I forgot to mention. Low volatility in the markets has also pushed down trades per day per client.

 

Bear markets will lead to higher volatility and probably more trading and higher profits for IBKR, but likely the stock will be cheaper.

 

IBKR's profits basically went nowhere for 10 years or so, because the main profit generator at that time - the marketmaker faltered and the profits were replaced by brokerage segment, leading to more or less flat overall profits.

[Guest roark33]

Another reasons for lower trading per account is the early accounts signing up for IB had a heavy algo/trading bent and each additional account has far lower turnover. 

[KCLarkin]

Why has the massive growth in # of accounts and total client equity not translated into improved financial performance? Accounts have doubled since 2013 and client equity has almost tripled, yet revenue has only increased by ~30%.  Revenue per average account has been declining YoY for well over a year now.

 

I'd have to do some work to reconcile your numbers (e.g. are you excluding Market Maker). But in addition to lower DART per account (due to low volatility and mix shift). There is also some pressure on revenue per DART (due to mix shift, for example introducing brokers).

 

Anyway, the real question: is this pressure on revenue per account cyclical or secular? If it is cyclical, then the stock might be mis-priced. I assume a mix of secular and cyclical.

[Travis Wiedower]

I expect introducing brokers will continue to be a growing and meaningful part of their business, which means trades per day and commissions per order will decline in step (to a certain point obviously, I suspect the worst hit is already behind us). The big question is if they can move upmarket among professional investors. More hedge fund and professional trader clients will counteract the decline from introducing brokers.

[glorysk87]

Anyway, the real question: is this pressure on revenue per account cyclical or secular? If it is cyclical, then the stock might be mis-priced. I assume a mix of secular and cyclical.

 

I think this is the main question that needs to be answered, and most people unfortunately tend to gloss over it, focusing exclusively on the long-term potential.

 

I do think Travis makes a good point about the mix shift to introducing brokers being a driver behind the DART/account declines.

[Guest roark33]

Ok, thought I would share an experience re: IBKR.  For some unknown reason, IB calculated March as only having 30 days, so the fluctuations in your account on March 31 did not get entered into the calculations for performance fees for the first Q.  So, if March 31 was a down day, you were overpaid and vice versa.  I have talked to an IB representative about this and their explanation makes no sense.  How can their tech change each year, such that they have to change the calendar dates for March?  It isn't like March just got its 31st day this year. 

 

My experience with IB is that their tech claims seem completely hogwash when it is about something I can see, fee calculations, customer linking, enrollment process, and there are so many things that I can't see, trading execution, that those same tech claims are seriously in question. 

[maybe4less]

Ok, thought I would share an experience re: IBKR.  For some unknown reason, IB calculated March as only having 30 days, so the fluctuations in your account on March 31 did not get entered into the calculations for performance fees for the first Q.  So, if March 31 was a down day, you were overpaid and vice versa.  I have talked to an IB representative about this and their explanation makes no sense.  How can their tech change each year, such that they have to change the calendar dates for March?  It isn't like March just got its 31st day this year. 

 

My experience with IB is that their tech claims seem completely hogwash when it is about something I can see, fee calculations, customer linking, enrollment process, and there are so many things that I can't see, trading execution, that those same tech claims are seriously in question.

 

100% agree with you. It's amazing how many "features" don't work right half the time, how they can't explain simple things like fee calculations, or simple requests (i.e., linking of accounts of married couples) can't be accommodated. I've been seriously wondering recently if I made a mistake going with them for my RIA business.

[Guest roark33]

I am not sure your size, but IB basically has a monopoly on RIA businesses under about 10-15m, so out of the gate a lot of people are selecting IB, but I don't know how long these people stick around. 

[atbed]

I am not sure your size, but IB basically has a monopoly on RIA businesses under about 10-15m, so out of the gate a lot of people are selecting IB, but I don't know how long these people stick around.

 

+1

[abyli]

I am not sure your size, but IB basically has a monopoly on RIA businesses under about 10-15m, so out of the gate a lot of people are selecting IB, but I don't know how long these people stick around.

 

+1

+2

[Spekulatius]

I am not sure your size, but IB basically has a monopoly on RIA businesses under about 10-15m, so out of the gate a lot of people are selecting IB, but I don't know how long these people stick around.

 

+1

 

Until their account RIA business reaches $15000001 in size probably  :P

 

[KCLarkin]

If you spend time on IBKR, let me know what you conclude on the appropriate tax rate. I could never figure it out to a degree that I could get comfortable - though I know others have...

 

For public shareholders, it's basically a full US corporate tax payer.  Low 30s rate.

 

They actually broke this down on yesterday's call:

 

Starting with income before income taxes of $213 million, we deducted $8 million for income taxes paid by our operating companies which are predominantly foreign taxes. That leaves us with $205 million of which 83.4% or about $171 million reported on our income statement is attributable to the non-controlling interest. 16.6% or $34 million is available to the public company stockholders.

 

GAAP accounting presents us in putting the $34 million on our income statement. As you can see, after we expense the remaining taxes of $10 million owed on the $34 million as the public Company's net income is $24 million and is reported on our income statement. Total income tax expense $18 million consist of this $10 million, plus the $8 million paid by the operating companies.

 

Based on my math, public shareholders paid 33% in foreign and U.S. income tax this quarter.

[atbed]

Does anyone mind helping out an unenlightened peon with IBKR?

 

The company has maintained a position on my watchlist for quite some time, but I have thus far shied away from diving in deep. I reconsidered today and began researching in earnest.

 

However, I have a high level question:

 

Why has the massive growth in # of accounts and total client equity not translated into improved financial performance? Accounts have doubled since 2013 and client equity has almost tripled, yet revenue has only increased by ~30%.  Revenue per average account has been declining YoY for well over a year now.

 

Curious what the driver here is.

 

I would expect lower volatility leads to less trading

 

Petterfy mentioned this video on the call. Thought it was interesting

 

http://video.cnbc.com/gallery/?video=3000608157&play=1

[Philip Morris IV]

I am not sure your size, but IB basically has a monopoly on RIA businesses under about 10-15m, so out of the gate a lot of people are selecting IB, but I don't know how long these people stick around.

 

+1

 

Until their account RIA business reaches $15000001 in size probably  :P

 

We joke but this is very difficult to model.  For RIAs, changing custodians is a huge PITA because every client account has to be closed, re-opened and transferred, and at the risk of attrition.  You could say there is a high switching cost involved and most RIAs generally do not switch custodians unless they feel especially compelled.  (While RIAs can certainly use multiple custodians, for small advisers you can assume they will only use one to meet minimum AUM requirements.)

 

I like this name overall but strongly feel IB needs to up their game in this space for me to be comfortable buying.  The minimum AUM requirements for most other custodians (Schwab, Fidelity, TD etc.) are around the $10-15 million mark as noted - not especially high for this business - and advisers breaking away from wirehouses will overwhelmingly meet those requirements and go with the more well-known custodians.  As well, most RIAs passthrough the ticket charges onto clients and therefore are not very cost-conscious, so the key to competing in this space is advisory software, service and brand name - all of which they appear to be trailing peers on.  It is an attractive market since RIAs are effectively a cost-free salesforce for accounts and assets, so this should be a serious area of focus for them, but it doesn't appear to be.

[Travis Wiedower]

Petterfy mentioned this video on the call. Thought it was interesting

http://video.cnbc.com/gallery/?video=3000608157&play=1

 

Thanks for posting, I couldn't find the interview. He does a better job of explaining it there than on the call. Interesting stuff.

 

We joke but this is very difficult to model.  For RIAs, changing custodians is a huge PITA because every client account has to be closed, re-opened and transferred, and at the risk of attrition.  You could say there is a high switching cost involved and most RIAs generally do not switch custodians unless they feel especially compelled.  (While RIAs can certainly use multiple custodians, for small advisers you can assume they will only use one to meet minimum AUM requirements.)

 

RIAs should be extremely sticky customers. I only have 11 accounts and it pains me just to think about what that process would entail. Hedge fund clients are also sticky, but obviously switching is easier for them (a little over 50% of hedge funds only use one prime broker by the way). I met with a manager several months ago (mid-ten figure AUM hedge fund) who switched from IB to a mini-prime and he said it was a pretty meaningful disruption to his business for a couple weeks. He also admitted he's getting worse pricing now (which should probably be a concern for his clients but whatever).

[Spekulatius]

Petterfy mentioned this video on the call. Thought it was interesting

http://video.cnbc.com/gallery/?video=3000608157&play=1

 

Thanks for posting, I couldn't find the interview. He does a better job of explaining it there than on the call. Interesting stuff.

 

We joke but this is very difficult to model.  For RIAs, changing custodians is a huge PITA because every client account has to be closed, re-opened and transferred, and at the risk of attrition.  You could say there is a high switching cost involved and most RIAs generally do not switch custodians unless they feel especially compelled.  (While RIAs can certainly use multiple custodians, for small advisers you can assume they will only use one to meet minimum AUM requirements.)

 

RIAs should be extremely sticky customers. I only have 11 accounts and it pains me just to think about what that process would entail. Hedge fund clients are also sticky, but obviously switching is easier for them (a little over 50% of hedge funds only use one prime broker by the way). I met with a manager several months ago (mid-ten figure AUM hedge fund) who switched from IB to a mini-prime and he said it was a pretty meaningful disruption to his business for a couple weeks. He also admitted he's getting worse pricing now (which should probably be a concern for his clients but whatever).

 

It would be interesting to know why he switched?

 

As a client that has just a few 100k with them, I feel IB has advantages, but also serious drawbacks. There is not one broker, that meets all my demands, but Fidelity and IB probably come closest.

 

If Fidelity makes their international trading  and more competitive and allow trading for dark stocks again or IB fixes their reporting and their punitive commissions for lower priced shares, I could envision myself to move completely to either one.

[sae85400]

Being in the RIA space and using IB, formerly used TD:

 

1. Custodian have begun to compete with RIAs for clients(Schwab, TDA and Fidelity mostly)

2. Investment mixture matters: A lot breakaway advisors use Funds or ETFs that are free to trade on the other platforms

3. Peformance reporting, soft dollars, client referral: 3 big issues for RIAs. I have a friend who hates TD, but they refer him close to $10mm AUM per year, so he won't risk leaving.

[Guest roark33]

I don't understand, they are referral sources, but they also compete with the RIA?  I know the competing part, but don't understand the referral source part.

[Philip Morris IV]

Yeah I can't recall ever hearing of a discount broker-custodian referring clients to an RIA.  With thousands of RIAs on their platform, how would they choose?  Maybe if a client asks TD customer service and is in the same local area, but I can't imagine that happening often, and $10M AUM/year is not insubstantial to receive via referral.

[sae85400]

It's real..

 

They even have a webpage advertising it

 

https://www.tdameritrade.com/investment-guidance/advisor-referral.page

 

Here is a more elaborate explanation

 

http://riabiz.com/a/2017/4/12/td-ameritrade-shocks-rias-most-accustomed-to-its-largesse-with-a-letter-a-contract-and-a-tight-deadline-to-sign

[cmlber]

Yeah I can't recall ever hearing of a discount broker-custodian referring clients to an RIA.  With thousands of RIAs on their platform, how would they choose?  Maybe if a client asks TD customer service and is in the same local area, but I can't imagine that happening often, and $10M AUM/year is not insubstantial to receive via referral.

 

Schwab February 2015 Investor Day:

 

<A - Bernard J. Clark>: So, we've had, I would say, loosely three generations of a referral program that you were describing. This is where someone in the retail network, someone in the branch has a need that seemingly we're not meeting at that point in time or they want some additional sophistication. They want maybe an advisor. They get referred to two advisors or three advisors. The advisors then determine with the client whether there is a good match there for them to become a client of the advisors. We call it our Schwab Advisor Network. And in fact, last year, we put $5 billion into – we put more into it, $5 billion closed into that network, and we have over $50 billion in total now within the Schwab Advisor Network. So, it's incredibly important.

[abyli]

IB changed the market data bundle. Anyone knows which one should we subscribe now? Thanks.

[flesh]

After reading a wsj article this morning about what happens when cap gains taxes are reduced it made me think this would benefit IB's trading volume.

 

Essentially, when cap gains taxes are lowered, naturally you'd have increased selling of long term holdings increasing trading volume plus bringing in more tax rev to the gov.

 

Longer term, one would think that there would be more churn in general. IG, if cap gains rates are zero, holding periods should shorten. Therefore, if rates go from say 20% to 15% or a 25% reduction in any related cases, there should be some degree of shortening of holding periods resulting in more trade volume sustain-ably, or as long as rates are held at the newly lowered rate.

 

Long term, I suppose there would be less total tax revenue generated, however, if you're Trump, likely thinking in 4 year time horizons, it's a no braina. You'd get more tax revenue and fulfill the lower tax promise championed by his side. Perhaps, you're buddies would be happy as well. Considering the other side left Trump with few levers to pull, they've been pulled already, it seems unlikely he would miss this opportunity to assuredly bring in more tax revenue while optically lowering tax rates. From what I can surmise, this will likely happen quite quickly.

 

Edit: New info.

 

http://money.cnn.com/2017/05/04/news/economy/tax-cuts-obamacare-repeal/index.html

 

"Get rid of the Medicare tax on investments: In addition to the surtax on wages, high-income earners making more than $200,000 ($250,000 if married filing jointly) are subject to a 3.8% Medicare tax on a portion of their investment income, which is determined by formula. Investment income includes money from capital gains, dividends, interest, rental income and annuities.

The revised House bill would eliminate this so-called net investment income tax in 2017."

 

This is apparently happening. Should cause some incremental volume. Certainly seems possible there could be more to come in the form of lowered cap gains rates.