IBKR - Interactive Brokers

[WneverLOSE]

IBKR has the best clients, they trade a lot, they use leverage and "expensive" products like futures and options, they trade around the world (Higher commissions), they short (and pay to borrow stock), they have big accounts and they don't need their hand held (low customer support expenses and low advertising spend since most customers come by friend reference or just doing research) the problem as I see it is now that rates are so low and brokers pushed themselves into a corner trying to match Robinhood zero commission (with payment for order flow) they have to attract clients that are IBKR's bread and butter, they need lots of traders, they need to lend money, they need big profitable accounts.

Now that everyone is using technology and lean startups like RH build great technology (yes I know it failed during the high volumes days but they built a modern micro services based back end system for clearing and regulation) I don't know what can protect IBKR, yes it might take a few years to build a fully featured trading platform with all the bells and whistles IBKR has and to expand it all over the world but it is not something impossible to do or that requires scale, just the willing to go after this client type.

 

To me it seems like they never were desperate to go after IBKR clients since they were able to charge customers 10$ a trade, sell the customer order to internalizers and earn an extra 2-3$ of that order, now they only make that 2-3$ and are trying to make money on interest and management fees, not ideal in our interest rate world and you can clearly see how they all advertise to "traders" and not "investors" in commercials.

 

[scorpioncapital]

IBKR could do well picking up a social trading platform like etorro or darwinex. I think they could develop alot in this direction and with good custody arrangements they can really supercharge those social trading platforms.

[decko]

Thank you everyone for their input.  To summarize, more importantly, is this a great business with a good future (runway), Or do we see it having more competition, lower margins, slower growth?  (the next 1-5 years)

I focus on buying great companies at a good price.  I know, cliche, but it works.  This company seems cheap right now and If IBKR will continue to grow and do well, then it seems like a good opportunity. In my 25 years of experience sometimes we focus to much time on the so-called intrinsic value instead of the business, what the business makes, provides, etc. (proprietary products or services)  It is more of an art form than science.  I digress, but my point is to focus on how good the business is... and what they will look like in a few years. 

[KCLarkin]

Thank you everyone for their input.  To summarize, more importantly, is this a great business with a good future (runway), Or do we see it having more competition, lower margins, slower growth?  (the next 1-5 years)

 

Most of the evidence points to less competition, stable margins, and strong growth. They have a very strong competitive position.

 

Is this a great business? No. The ROE is pretty modest. They are one of the the best companies in a commodity industry.

 

IBKR is a very good business, but falls short of being a great business. I am comfortable owning a sizeable position, but I'd prefer to own something else right now.

[chompsterama]

Thank you everyone for their input.  To summarize, more importantly, is this a great business with a good future (runway), Or do we see it having more competition, lower margins, slower growth?  (the next 1-5 years)

 

Most of the evidence points to less competition, stable margins, and strong growth. They have a very strong competitive position.

 

Is this a great business? No. The ROE is pretty modest. They are one of the the best companies in a commodity industry.

 

IBKR is a very good business, but falls short of being a great business. I am comfortable owning a sizeable position, but I'd prefer to own something else right now.

 

If we're defining great by ROE, then lever up and juice those ROEs!  The reason IBKR has a low ROE is because they have something like $7 billion in excess capital and they'll probably build that to $10 billion.  Peterffy refuses to risk the business in the pursuit of efficiency ratios for a short-term beauty contest.  It's a very very good business.  Valuation aside.   

[KCLarkin]

If we're defining great by ROE, then lever up and juice those ROEs!  The reason IBKR has a low ROE is because they have something like $7 billion in excess capital and they'll probably build that to $10 billion.  Peterffy refuses to risk the business in the pursuit of efficiency ratios for a short-term beauty contest.  It's a very very good business.  Valuation aside. 

 

5% of my portfolio is in IBKR. So I don't disagree with you. But (other than a token dividend), every dollar the company earns is retained on the balance sheet. So you are looking at 10-15% growth. Compare this with something like Ulta (my top position):

 

ROE: 30%

Sales/share growth: 35%

EPS Growth: 35%

 

The math makes it hard for something with <15% ROE to be a great business. Of course, having 20% ROE doesn't make a great business either. You might be levered or have flat sales.

 

To me, Ulta is a great business. IBKR is a good business. I happen to like it a lot, so it occupies a large chunk of my portfolio that it probably doesn't deserve.

 

 

[WneverLOSE]

Excess capital is only excess in the the sense of over regulatory requirements but it is not excess in the sense it can be freely distributed tomorrow, IBKR uses this capital buffer to signal to new and existing customer that they are a sound choice when compering them to the big investment banks, just imagine IBKR bought a brand name like "Warren Buffett Brokerage" for 7B$ that makes customers trust they will still be there tomorrow, that brand name is capital invested in the business and should be part of ROE/ROIC calculation and the same should be when its held in cash for that purpose, if IBKR removed that excess capital it would cost them current clients and future clients the same way if they raise margin rates or reduce markets, it's just part of the things that attracts customers and would hurt the business if it wasn't there.

 

IBKR is just a very different business then the Etrade / TD Ameri of the world, they don't cater to small investors that have their 30k portfolio insured by SIPC / FDIC, big proprietary traders / Hedge funds care about who they trust their holdings with and thus IBKR must be well capitalized to cater to those clients.

[scorpioncapital]

excess capital that is never distributed for reputation purposes is not excess capital.

but certainly it has intangible benefits.

Just like at Berkshire, the 20 billion minimum that needs to be lying around is not excess capital (so I would always deduct these amounts from cash available)

[vinod1]

I am seriously thinking of moving my brokerage account away from IBKR. I have been using it for more than 10 years and quite comfortable with interface and like its features and low execution costs.

 

I am starting to get just a tad uncomfortable with tail risks that clients could be exposed to if using a margin account. My understanding of this is, if you use a cash account the securities you hold are segregated from the broker dealer’s funds. In a margin account, they are held by the firm along with its own funds. In case the firm get into trouble, clients would be in line along with creditors to get back their funds.

 

These links provide a good background on the risks:

 

https://www.thebalance.com/rehypothecation-investment-disaster-357232

 

https://www.thebalance.com/securities-investor-protection-corporation-3

 

While these concerns are applicable to all brokerages, IBKR may be more exposed to this risk

 

1. Given that most of or all of IBKR’s customers are likely “sophisticated” traders, hedge funds, etc. who try to use margin, futures and are more likely to engage in riskier activities. Thus there is more of a chance of a blowup that the firm is on the hook for.  Schwab for instance is likely to have more of mom and pop investors who likely do not engage in these kinds of activities.

 

2. The firm is justifiably proud of the fact that it calculates risk in real time and that it is 100% automated. This is a good thing in general, but this exposes the company to the risk that a software defect or just very wide swings in security prices could cause large losses. The company’s recent experience with oil prices and loss could be replicated at a much greater scale causing large losses. Some level of manual processes would likely be more exposed to errors now and then, but a software one would be exposed to a cascading large scale failure if something rare happens. Markets seem to have these kinds of risks more often than seems likely on surface.

 

The firm needs a very large cushion of liquid equity capital and current levels are likely more than enough in nearly all scenarios. But then we need to keep an eye out that the $6 or $8 billion or so in excess capital continues to be there.

 

Anyway, this thing is on my mind recently and still mulling over if I should move over to Schwab or someone else. I really do not use margin or hard to trade or illiquid or international securities so not sure how much I am really gaining by staying with IBKR.

 

I know the first obvious solution is to change to a cash account and I might do that. But still that I even have to think about this with IBKR is a bit of a concern.

 

Thanks

 

Vinod

 

[rb]

I think you're seriously overthinking this. If you breach margin, IB  doesn't issue a margin call. It automatically liquidates your positions. Note that when you breach margins it doesn't mean that your equity is zero. There's still a lot of cushion. They lost a bit of money on the oil thing and that was an absolute nuts situation. For something to threaten IB that something would have to be unimaginable nuts. Like even if you have a long only cash account it doesn't matter cause your holdings aren't worth much anyways nuts. Also if IB fails you have the federal insurance for brokerage accounts. Then you also have the supplemental insurance from Lloyds in case IB fails. I actually know no other broker that buys extra protection for its account holders.

 

So in order to loose your money you need this: An event of yet unseen proportions that chews through its' clients' margins and through IB's equity - which it has a lot of. Then your account is larger than 30 million dollars (after taking losses from said event) and/or the Lloyd's syndicate is bankrupt due to said event.

 

I actually feel pretty good about having the IB accounts. If events come to pass to put IB in insolvency i can see a lot of other brokers being insolvent before IB is.

[KJP]

I think you're seriously overthinking this. If you breach margin, IB  doesn't issue a margin call. It automatically liquidates your positions. Note that when you breach margins it doesn't mean that your equity is zero. There's still a lot of cushion. They lost a bit of money on the oil thing and that was an absolute nuts situation. For something to threaten IB that something would have to be unimaginable nuts. Like even if you have a long only cash account it doesn't matter cause your holdings aren't worth much anyways nuts. Also if IB fails you have the federal insurance for brokerage accounts. Then you also have the supplemental insurance from Lloyds in case IB fails. I actually know no other broker that buys extra protection for its account holders.

 

So in order to loose your money you need this: An event of yet unseen proportions that chews through its' clients' margins and through IB's equity - which it has a lot of. Then your account is larger than 30 million dollars (after taking losses from said event) and/or the Lloyd's syndicate is bankrupt due to said event.

 

I actually feel pretty good about having the IB accounts. If events come to pass to put IB in insolvency i can see a lot of other brokers being insolvent before IB is.

 

I suspect a backup insurance policy is more common than you think.  BofA/Merrill has one.  From its website:

 

Your brokerage accounts are not FDIC insured, but rather accounts held with Merrill are SIPC insured. SIPC insurance covers your account up to $500,000 in equity with up to $250,000 in cash. Coverage above SIPC limits is covered by Lloyd's of London. Customers who have exceeded the full SIPC limits have further protection provided by the Lloyd's policy, subject to an aggregate loss limit of $1 billion for all customer claims, and includes up to $1.9 million cash per customer (excluding any FDIC eligible products within the account). 

 

Of course, if a true cataclysm occurs, they might blow through the aggregate loss limit . . . .

[bizaro86]

I think if you lose money from IBKR failing Schwab will be gone as well. I suspect it would take something like Apple trading at minus $300/share somehow.

 

In a quick move their automated system is way better, because it's faster than the manual systems the other brokers use. So if it was just apple going to zero, they would be more likely to liquidate customer accounts on the way down.

 

 

[WneverLOSE]

I agree with rb, I have my entire net worth with IBKR and I sleep very (very) well.

 

Margin account is protected the same way as a cash account, you just have to pay the loan in case the broker fails, nothing else is different

 

from the SIPC website :

How are margin accounts protected?

 

Under the Securities Investor Protection Act, what is owed to a customer is based on the customer’s “net equity.” “Net equity” generally is the cash and securities owed to the customer by the brokerage firm minus any indebtedness owed by the customer to the brokerage firm. For purposes of computing a customer’s “net equity,” cash and securities that are collateral for a margin balance in a customer’s account are amounts owed to the customer by the brokerage firm. To arrive at the customer’s “net equity,” however, the amount of the margin balance in the account – which represents a customer debt to the brokerage firm - is subtracted from the total cash and securities owed to the customer by the firm.

 

If I have a margin account, what can I do to get my securities back?

 

A customer who has a margin balance in an account must pay the margin balance before any cash or securities otherwise owed to the customer can be returned. Any such payment must be approved by the trustee for the liquidation of the brokerage firm and must be made within the time period specified by the trustee.

 

IBKR is a very sound company that you can sleep well at night with your money there, not only they have large excess capital no other company has (and the banks actually are more risky since during financial stress other areas of the bank compete for capital with the brokerage arm), unlike the banks and discount brokers they don't buy agency securities with customer cash (ie fannie mae freddie mac bonds and asset backed securities) that have higher yield but carry much more risks than very short term US treasuries that IBKR holds (and customer cash accounts are multiplies of each broker equity so a small drop in value of the bonds or payments can wipe out equity), IBKR also has excess coverage it buys to protect investors and margin is only around 15% of client equity so it is very manageable even under extreme circumstances.

 

Actually the main reason I am not as enthusiastic about IBKR stock is because of their extreme conservatism, they can easily double net income but they don't do it (and will not do it so don't get your hopes up) because they want to be the last company standing.

[bizaro86]

I agree with rb, I have my entire net worth with IBKR and I sleep very (very) well.

 

Margin account is protected the same way as a cash account, you just have to pay the loan in case the broker fails, nothing else is different

 

from the SIPC website :

How are margin accounts protected?

 

Under the Securities Investor Protection Act, what is owed to a customer is based on the customer’s “net equity.” “Net equity” generally is the cash and securities owed to the customer by the brokerage firm minus any indebtedness owed by the customer to the brokerage firm. For purposes of computing a customer’s “net equity,” cash and securities that are collateral for a margin balance in a customer’s account are amounts owed to the customer by the brokerage firm. To arrive at the customer’s “net equity,” however, the amount of the margin balance in the account – which represents a customer debt to the brokerage firm - is subtracted from the total cash and securities owed to the customer by the firm.

 

If I have a margin account, what can I do to get my securities back?

 

A customer who has a margin balance in an account must pay the margin balance before any cash or securities otherwise owed to the customer can be returned. Any such payment must be approved by the trustee for the liquidation of the brokerage firm and must be made within the time period specified by the trustee.

 

IBKR is a very sound company that you can sleep well at night with your money there, not only they have large excess capital no other company has (and the banks actually are more risky since during financial stress other areas of the bank compete for capital with the brokerage arm), unlike the banks and discount brokers they don't buy agency securities with customer cash (ie fannie mae freddie mac bonds and asset backed securities) that have higher yield but carry much more risks than very short term US treasuries that IBKR holds (and customer cash accounts are multiplies of each broker equity so a small drop in value of the bonds or payments can wipe out equity), IBKR also has excess coverage it buys to protect investors and margin is only around 15% of client equity so it is very manageable even under extreme circumstances.

 

Actually the main reason I am not as enthusiastic about IBKR stock is because of their extreme conservatism, they can easily double net income but they don't do it (and will not do it so don't get your hopes up) because they want to be the last company standing.

 

The things that make IBKR great as a custodian of your money (fanatical about keeping extra capital on the books for safety) make it a worse investment for sure. If they did a $5 B buyback (say taking out some of Peterffy's stake) this would probably double instantly. I agree that is unlikely, which makes it more of a slow and steady compounder.

[kab60]

If anything the oil-related losses, the handling of the recent 35 pct drop and the swiss franc debacle comforts me that IBKR have solid processes and a fat buffer. If one compares the swiss event to say Saxo Bank, it's not even close (they had no clue how much they'd lost).

[vinod1]

Thank guys! Great feedback. This gives me a lot more comfort.

 

The scenario I am thinking about is if prices for certain securities fall to stupid levels for a few minutes for technical reasons. Say Apple, Google, FB and Amazon to a $1 for a few minutes. Do the automated risk management quickly liquidate their customers holdings to meet the required margin levels? Even Apple at -$300 for a couple of minutes let us say. Would IBKR be liable to clients? Just trying to think of scenarios that are very unlikely but would still be possible to trip up an automated risk management software.

 

Their customer's equity is $160 billion, their cash/investments is $8 billion. So I see there is a lot of equity that needs to be wiped out before it gets to start impacting clients.

 

(I do realize this might be at the level of bleach injection to cure Covid.)

 

Vinod

[rb]

Wouldn't you have circuit breakers tripping way before any of that happens? Even before circuit breakers trip you'd have price and volatility halts all over the damn place.

[Gregmal]

I hate IBKR but keep most of my stuff there because its got the best margin rates. Nothing else. If Fidelity lent at 1% I'd have all my assets and AUM there.

 

And FWIW, almost all firms have additional coverage(most actually use Lloyds as well), and when you sign the margin agreement, you basically acknowledged the firm can do whatever it wants with your securities. You have no recourse during a flash crash.

[vinod1]

Wouldn't you have circuit breakers tripping way before any of that happens? Even before circuit breakers trip you'd have price and volatility halts all over the damn place.

 

Good point. Makes sense. Thanks!

 

Vinod

[KCLarkin]

Most likely scenario is that feds facilitate a take under by another brokerage a la Bear Stearns.

 

IIRC, some of the silly trades during the flash crash were cancelled?

 

There is a small risk but this is true no matter your broker. I split between IBKR and a Big 5 Canadian bank. Bank might be safer but IBKR has much better security (2 factor). The risk of my bank brokerage account being hacked seems much higher than IBKR going insolvent.

[benhacker]

Most likely scenario is that feds facilitate a take under by another brokerage a la Bear Stearns.

 

IIRC, some of the silly trades during the flash crash were cancelled?

 

There is a small risk but this is true no matter your broker. I split between IBKR and a Big 5 Canadian bank. Bank might be safer but IBKR has much better security (2 factor). The risk of my bank brokerage account being hacked seems much higher than IBKR going insolvent.

 

The above I think is the biggest issue.  You are more likely to get your assets stolen than your broker to fail.

 

on failure, IBKR has a CEO / management with their net worth on the line ahead of you for losses, most mega-brokerages can't say the same (though I would still say IB's riks is "above average" vs. Fido or a Big bank).  On security, IB is lowest risk IMO.

[WneverLOSE]

From IBKR website :

 

Broker-dealers affiliated with banks are subject to further supervision by banking regulators, which results in additional uncertainty as to who has rights to the assets in the event of a bankruptcy. Since IBKR is not a bank, we believe clients' assets would be returned in a more timely fashion than for bank- owned broker-dealers. Moreover, in a financial crises scenario, IBKR’s financial resources would be dedicated solely to ensuring the continued smooth operations of the broker-dealer. Bank-affiliated broker-dealers, on the other hand, are capitalized by their bank affiliate, and are generally set-up as a subsidiary of a bank holding company affiliate. Unlike IBKR these bank-affiliated broker-dealers are not independent, self-capitalized entities adding a layer of additional risk for their clients. In a financial crisis those broker-dealers are competing with their banking affiliates for capital and liquidity. This could result in the capital being pulled out of the broker-dealer and funds being deployed at the affiliated banking entity to the detriment of brokerage clients. Lehman Brothers, and Bear Stearns are historical examples of entities that raided their broker-dealer affiliates for capital to try to save the banks, which were the root cause of their financial troubles. Both entities filed for bankruptcy. As a result, their clients experienced significant delays in accessing their assets and transferring them to an operational broker-dealer.

 

Indeed, during the height of the financial crisis, while clients were removing funds and equity from these bank- affiliated broker-dealers, those clients were depositing their assets with IBKR as a safe haven. As a result of IBKR's strong financial position, client equity and client cash increased by 77% and 65% respectively from November 2008-November 2009.

 

Don't forget that almost every big bank you guys are talking about was basically insolvent just a few years ago (and banks are experiencing financial strains once again)

[fareastwarriors]

Oil Crash Busted Broker’s Computers and Inflicted Big Losses

 

Interactive Brokers users couldn’t trade when oil broke zero

Incident will cost firm more than $100 million, chairman says

 

https://www.bloomberg.com/amp/news/articles/2020-05-08/oil-crash-busted-a-broker-s-computers-and-inflicted-huge-losses

[patientcapital]

Top comment from YC Hacker News related to the Bloomberg article (https://news.ycombinator.com/item?id=23116898):

 

"On another aside, I have known folks who have worked at IB in the past, and their systems absolutely suck dead goats. Huge masses of legacy C++ code with poor testing. Most of these brokerage firms have legacy code base from the 90s that is poorly understood. They also have nonexistent organizational quotient around code validation, correctness and testing their risk models. A futures margin model is not something one can whip up over a weekend but a good CS undergraduate can program one over a couple months.

 

Sorry for the IB customers but I have zero sympathy for IB or should I say negative ;)"

[fareastwarriors]

Top comment from YC Hacker News related to the Bloomberg article (https://news.ycombinator.com/item?id=23116898):

 

"On another aside, I have known folks who have worked at IB in the past, and their systems absolutely suck dead goats. Huge masses of legacy C++ code with poor testing. Most of these brokerage firms have legacy code base from the 90s that is poorly understood. They also have nonexistent organizational quotient around code validation, correctness and testing their risk models. A futures margin model is not something one can whip up over a weekend but a good CS undergraduate can program one over a couple months.

 

Sorry for the IB customers but I have zero sympathy for IB or should I say negative ;)"

 

As markets keep doing things they have never done before, things tend to break.

 

Having worked in buy side in the past, most of tech is dated and buggy in the best of times... The companies were making upgrades and moving to new software but it takes many, many years to implement.

 

 

Side note, continued good employment opportunities for programmers since so many sectors besides finance need to upgrade their software.