ITEM
2
. MANAGEMENT
’
S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
un
audited
condensed
consolidated financial statements and the related notes in Item
1
, included elsewhere in this report. 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
our Annual Report on Form 10-K filed with the Securities Exchange Commission (“SEC”) on February 29, 2016 and elsewhere in this report.
Introduction
Interactive Brokers Group, Inc. (the “Company” or “IBG, Inc.”) is a holding company whose primary asset is its ownership of approximately
16.6%
of the membership interests of IBG LLC
.
The remaining approximately
83.4%
of IBG LLC membership interests are held by
IBG
Holdings
LLC (“Holdings”)
, a holding company that is owned by our founder, Chairman and Chief Executive Officer,
Mr.
Thomas Peterffy and his affiliates, management and other employees of IBG LLC, and certain other members.
The table below shows the amount of IBG LLC membership interests held by IBG, Inc. and Holdings as of September 30, 2016.
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IBG, Inc.
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Holdings
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Total
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Ownership %
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16.6%
|
|
83.4%
|
|
100.0%
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Membership interests
|
67,987,957
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|
341,444,304
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409,432,261
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We are an automated global electronic
broker and
market maker
. We custody and service accounts for hedge and mutual funds, registered investment advisers, proprietary trading groups, introducing brokers and individual investors. We
specializ
e
in routing orders
and executing
and processing trades in securities, futures
, and
foreign exchange instruments on more than
100
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 in the last
25
years 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.
When we use the terms “we,” “us,” and “our,” we mean IBG, Inc. and its subsidiaries for the periods presented.
Business Segments
We
report
our
results in two
operating
business segments, electronic brokerage and market making. 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.
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·
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Electronic Brokerage.
We conduct our electronic brokerage business through
certain
Interactive Brokers (“
IB
”)
subsidiaries. As an electronic broker, we execute, clear and settle trades globally for both institutional and individual customers. Capitalizing on the technology originally developed for our market making business, IB
’
s 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, bonds, options, futures, forex and mutual funds traded on more than
100
exchanges and market centers in
24
countries
and in
23
currencies
around the world seamlessly.
The emerging complexity of multiple market centers has provided us with the opportunity of building and continuously adapting our order routing software to secure excellent execution prices.
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Our customer base is diverse with respect to geography and segments. Currently, more than half of our customers reside outside the U.S. in over
190
countries. Approximately 63% 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 capital introduction and securities lending to hedge funds; and our model portfolio technology and automated share allocation and rebalancing tools are particularly attractive to financial advisors. We provide a host of analytical tools such as the Probability Lab
SM
, which allows our customers to analyze option strategies under various market assumptions. IB Investors’ Marketplace
SM
allows wealth advisors to search for money managers and assign them to client accounts based on their investment strategy. IB EmployeeTrack
SM
is widely used by compliance officers of financial institutions to streamline the process of tracking their employees’ brokerage activities. IB
Portfolio Builder allows our customers to set up an investment strategy based on research and rankings from top research providers and fundamental data. In addition, our RIA Compliance Center provides information to assist advisors with registration and compliance obligations.
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·
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Market Making
. We conduct our market making business primarily through our Timber Hill subsidiaries. As a market maker on many of the world’s leading exchanges, we provide liquidity by offering competitively tight bid/offer spreads over a broad base of over one million tradable, exchange
‑listed products. As principal, we commit our own capital and derive revenues or incur losses from the difference between the price paid when securities are bought and the price received when those securities are sold. Because we provide continuous bid and offer quotations and we are continuously both buying and selling quoted securities, we may have either a long or a short position in a particular product at a given point in time. Our entire portfolio is evaluated each second and continuously rebalanced throughout the trading day, thus minimizing the risk of our portfolio at all times. This real
‑time rebalancing of our portfolio, together with our real
‑time proprietary risk management system, enables us to curtail risk and to be profitable in both up
‑market and down
‑market scenarios. In the past several years our market making business has suffered from competitive pressures and along with the rapid increase of our electronic brokerage business, its significance continues to diminish.
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The operating business segments are supported by our corporate segment which provides centralized services and executes our currency diversification strategy.
Executive
Overview
Third
Quarter Results:
Diluted earnings per share were
$
0.30
for
the quarter
ended
September 30, 2016 (“current quarter”), compared to d
iluted earnings per share
of
$0.35
for the
quarter ended September 30, 2015 (“prior year quarter”)
.
The calculation of diluted earnings per share is detailed in Note 4 to the
condensed
consolidated financial statements
elsewhere in this report
.
On a comprehensive basis, which includes
other comprehensive income (“OCI”)
, diluted earnings per share were
$0.30
for
the
current quarter, compared
to diluted earnings per share of
$0.23
for the
prior year quarter
.
In connection with our currency diversification strategy, we determine our net worth in GLOBALs, a basket of 15 major currencies in which we hold our equity. As a result, as of September 30, 2016, approximately
54%
of our equity was denominated in currencies other than the U.S. dollar. In the current quarter, our currency diversification strategy increased our comprehensive earnings
by $
13 million (versus a decrease of
$
76 million in the prior year quarter), as the U.S. dollar value of the GLOBAL
increased
by approximately
0.26%
. The effects of our currency diversification strategy are reported as (1) a component of other income in the condensed consolidated statement of comprehensive income and (2) OCI in the condensed consolidated statement of financial condition and the condensed consolidated statement of comprehensive income. The full effect of the GLOBAL is captured in comprehensive income.
As a result of a periodic assessment, and in light of the increasing importance of China to our business, we
changed the composition of the GLOBAL by
adding the Chinese renminbi (specifically, the offshore currency known by the symbol CNH), removing the South Korean won (KRW) and Brazilian real (BRL) components, and realigning the relative weights of the U.S. dollar (USD) and Japanese yen (JPY) components to better reflect the global diversification of our businesses. The new composition of the GLOBAL went into effect as of the close of business on June 30, 2016.
A discussion of our approach to managing foreign currency exposure is contained in Part I, Item
3
of this
Quarterly
Report on Form 10-
Q
entitled “Quantitative and Qualitative Disclosures about Market Risk.”
Consolidated
:
For the
current quarter, our net revenues were
$345
million
and income before income taxes
was
$183
million
, compared to net revenues of
$359
million and income before income taxes of
$202
million in the prior year quarter
. The
decrease
in income before income taxes
in the current quarter
was mainly driven by
a 56% decrease in trading gains and a 14% decrease in commissions and execution fees, partially offset by higher net interest income, which
increased
28%
.
Our pre
-
tax
profit
margin
was
53%
, compared
to
56%
for the
prior year quarter
.
Electronic Brokerage
: For
the
current quarter
, income before income taxes in our electronic brokerage segmen
t
decreased $22
million, or
12%
,
compared to
the prior year quarter
.
Net revenues
decreased 4%
, mainly from a 15%
decline
in commissions and execution fees and a 53% decrease in other income, driven by net mark-to-market losses on our U.S. government securities portfolio; partially offset by higher net interest income
,
which
rose
28%
, due to higher customer cash balances, the majority of which were invested in interest-bearing U.S. government securities during the current quarter.
Pre
-
tax
profit
margin
was
56%
for the current quarter and
61%
for
the
prior year quarter
. Customer
accounts
grew
15%
and customer equity
increased
33%
from
September 30, 2015
.
For the current quarter, t
otal Daily Average Revenue Trades (“DARTs”) for cleared and execution
‑only customer
s
decreased
by
11%
to
609 thousand
, compared to
683 thousand
in
the
prior
year
quarter
.
Market Making
: For
the
current quarter
, income before income taxes in our market making
segment
decreased
$39
million, or
85%
,
compared to the prior year quarter. Trading gains decreased 56%
on lower trading volumes and decreases in volatility and in the actual-to-
implied volatility ratio compared to the prior year quarter
. Pre
-
tax
profit
margin
was
16%
for the current quarter and
51%
for the prior year quarter
.
Nine Month
Results:
Diluted earnings per share were
$1.20
for
the nine months
ended
September 30, 2016 (“current nine month period”), compared to d
iluted earnings per share
of
$0.52
for the
nine months ended September 30, 2015 (“prior year nine month period”)
.
On a comprehensive basis, which includes
OCI
, diluted earnings per share were
$1.25
for the
current nine month period, compared
to diluted earnings per share of
$0.44
for the
prior year nine month period
.
Consolidated
:
For the
current nine month period
, our net revenues were
$1,203
million and income before income taxes was
$733
million, compared to net revenues of
$918
million and
income
before income taxes of
$331
million
in the prior year nine month period
.
The increase in income before income taxes was mainly driven by gains from our currency diversification strategy in the current nine month period and the non-recurrence of customer bad debt expenses resulting from the Swiss franc event described below in the prior year nine month period; along with higher net interest income, which
increased
27%
; partially offset in the current nine month period by lower trading gains, which decreased 43%;
lower
commission
s
and execution fees, which
decreased
2%
and
higher execution and clearing expenses, which
increased
3%
.
Our pre
-
tax
profit
margin was
61%
,
compared to
36%
for the prior year nine month period
.
Electronic Brokerage
: For
the
current nine month period
, income before income taxes in our electronic brokerage segmen
t
increased
$165
million, or
39%
,
compared to
the prior year nine month period, mainly driven by the non-recurrence of $137 million in customer bad debt expenses in the prior year nine month period due to the Swiss franc event described below
.
Net revenues
increased
8%
, mainly from a
24%
increase
in net interest income due to higher customer cash balances, the majority of which were invested in interest-bearing U.S. government securities during the current nine month period; and from a 7% increase in other income, driven by higher net mark-to-market gains on our U.S. government securities portfolio; partially offset by
a
3%
decrease in c
ommissions and execution fees
due to
generally
lower
customer
contract and share
volume
s.
Pre
-
tax
profit
margin
was
62%
for the current nine month period and
48%
for
the
prior year nine month period
. Customer accounts grew
15%
and customer equity
increased
33%
from September 30, 2015
.
For the current nine month period, t
otal Daily Average Revenue Trades (“DARTs”) for cleared and execution
‑only customer
increased
3%
to
667
thousand
, compared to
649
thousand
in
the
prior
year
nine month period
.
Sudden Move in the Value of the Swiss Franc
On January 15, 2015, in an unprecedented action, the Swiss National Bank removed a previously instituted and repeatedly confirmed cap of the currency relative to the euro, causing a sudden move in the value of the Swiss franc. Several of our customers holding currency futures and spot positions suffered losses in excess of their deposits with us. We took immediate action to hedge our exposure to the foreign currency receivables from these customers.
Since January 2015,
we
have
incurred cumulative losses, net of hedging activity and debt collection efforts, of $
118
million. We continue to actively pursue collection of the debts. The ultimate effect of this incident on our results will depend upon the outcome of our debt collection efforts.
Market Making
: For
the
current nine month period
, income before income taxes in our market making segmen
t
decreased
$71
million, or
69%
,
compared to the prior year nine month period. Trading gains were negatively impacted
by lower trading volumes,
a
divergence in price behavior among a significant number of individual stocks during the first quarter of 2016, and decreases in volatility and in the actual-to-implied volatility ratio as compared to prior year
nine
month period
. Pre
-
tax
profit
margin
was
22%
for the current nine month period and
45%
for the prior year nine month period
.
Trading Volumes and Brokerage Statistics
The following tables 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 %)
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Brokerage
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Market
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Brokerage
|
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Non
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Avg. Trades
|
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|
Making
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%
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Cleared
|
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%
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Cleared
|
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%
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Total
|
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%
|
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per U.S.
|
Period
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Trades
|
|
Change
|
|
Trades
|
|
Change
|
|
Trades
|
|
Change
|
|
Trades
|
|
Change
|
|
Trading Day
|
2013
|
|
65,320
|
|
|
|
173,849
|
|
|
|
18,489
|
|
|
|
257,658
|
|
|
|
1,029
|
2014
|
|
64,530
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-1%
|
|
206,759
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|
19%
|
|
18,055
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-2%
|
|
289,344
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|
12%
|
|
1,155
|
2015
|
|
65,937
|
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2%
|
|
242,846
|
|
17%
|
|
18,769
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|
4%
|
|
327,553
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|
13%
|
|
1,305
|
|
|
|
|
|
|
|
|
|
|
|
|
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3Q2015
|
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18,696
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|
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|
65,333
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|
|
|
5,266
|
|
|
|
89,295
|
|
|
|
1,395
|
3Q2016
|
|
15,474
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-17%
|
|
61,181
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|
-6%
|
|
3,736
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|
-29%
|
|
80,391
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|
-10%
|
|
1,256
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|
|
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|
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2Q2016
|
|
16,056
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|
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|
64,531
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|
|
|
4,114
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|
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|
84,701
|
|
|
|
1,323
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3Q2016
|
|
15,474
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|
-4%
|
|
61,181
|
|
-5%
|
|
3,736
|
|
-9%
|
|
80,391
|
|
-5%
|
|
1,256
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CONTRACT AND SHARE VOLUMES:
(in 000
’
s, except %)
TOTAL
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Options
|
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%
|
|
Futures
|
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%
|
|
Stocks
|
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%
|
Period
|
|
(contracts)
|
|
Change
|
|
(contracts)
|
|
Change
|
|
(shares)
|
|
Change
|
2013
|
|
659,673
|
|
|
|
121,776
|
|
|
|
95,479,739
|
|
|
2014
|
|
631,265
|
|
-4%
|
|
123,048
|
|
1%
|
|
153,613,174
|
|
61%
|
2015
|
|
634,388
|
|
0%
|
|
140,668
|
|
14%
|
|
172,742,520
|
|
12%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3Q2015
|
|
179,786
|
|
|
|
38,960
|
|
|
|
41,999,917
|
|
|
3Q2016
|
|
138,767
|
|
-23%
|
|
32,521
|
|
-17%
|
|
38,515,753
|
|
-8%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2Q2016
|
|
140,461
|
|
|
|
35,355
|
|
|
|
36,768,094
|
|
|
3Q2016
|
|
138,767
|
|
-1%
|
|
32,521
|
|
-8%
|
|
38,515,753
|
|
5%
|
MARKET MAKING
|
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Options
|
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%
|
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Futures
|
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%
|
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Stocks
|
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%
|
Period
|
|
(contracts)
|
|
Change
|
|
(contracts)
|
|
Change
|
|
(shares)
|
|
Change
|
2013
|
|
404,490
|
|
|
|
18,184
|
|
|
|
12,849,729
|
|
|
2014
|
|
344,741
|
|
-15%
|
|
15,668
|
|
-14%
|
|
12,025,822
|
|
-6%
|
2015
|
|
335,406
|
|
-3%
|
|
14,975
|
|
-4%
|
|
15,376,076
|
|
28%
|
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|
|
|
|
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3Q2015
|
|
95,754
|
|
|
|
3,868
|
|
|
|
4,458,343
|
|
|
3Q2016
|
|
74,966
|
|
-22%
|
|
3,338
|
|
-14%
|
|
2,874,332
|
|
-36%
|
|
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|
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|
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2Q2016
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|
76,223
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|
|
|
3,042
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|
3,340,316
|
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|
3Q2016
|
|
74,966
|
|
-2%
|
|
3,338
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|
10%
|
|
2,874,332
|
|
-14%
|
Notes:
|
(1)
|
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Futures contract volume includes options on futures
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BROKERAGE TOTAL
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Options
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%
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Futures
|
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%
|
|
Stocks
|
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%
|
Period
|
|
(contracts)
|
|
Change
|
|
(contracts)
|
|
Change
|
|
(shares)
|
|
Change
|
2013
|
|
255,183
|
|
|
|
103,592
|
|
|
|
82,630,010
|
|
|
2014
|
|
286,524
|
|
12%
|
|
107,380
|
|
4%
|
|
141,587,352
|
|
71%
|
2015
|
|
298,982
|
|
4%
|
|
125,693
|
|
17%
|
|
157,366,444
|
|
11%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3Q2015
|
|
84,032
|
|
|
|
35,092
|
|
|
|
37,541,574
|
|
|
3Q2016
|
|
63,801
|
|
-24%
|
|
29,183
|
|
-17%
|
|
35,641,421
|
|
-5%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2Q2016
|
|
64,238
|
|
|
|
32,313
|
|
|
|
33,427,778
|
|
|
3Q2016
|
|
63,801
|
|
-1%
|
|
29,183
|
|
-10%
|
|
35,641,421
|
|
7%
|
BROKERAGE CLEARED
|
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Options
|
|
%
|
|
Futures
|
|
%
|
|
Stocks
|
|
%
|
Period
|
|
(contracts)
|
|
Change
|
|
(contracts)
|
|
Change
|
|
(shares)
|
|
Change
|
2013
|
|
180,660
|
|
|
|
101,732
|
|
|
|
78,829,785
|
|
|
2014
|
|
225,662
|
|
25%
|
|
106,074
|
|
4%
|
|
137,153,132
|
|
74%
|
2015
|
|
244,356
|
|
8%
|
|
124,206
|
|
17%
|
|
153,443,988
|
|
12%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3Q2015
|
|
68,018
|
|
|
|
34,635
|
|
|
|
36,475,917
|
|
|
3Q2016
|
|
55,579
|
|
-18%
|
|
28,986
|
|
-16%
|
|
34,817,202
|
|
-5%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2Q2016
|
|
53,951
|
|
|
|
32,037
|
|
|
|
32,491,500
|
|
|
3Q2016
|
|
55,579
|
|
3%
|
|
28,986
|
|
-10%
|
|
34,817,202
|
|
7%
|
Notes:
|
(1)
|
|
Futures contract volume includes options on futures
|
BROKERAGE STATISTICS:
(in 000
’
s, except % and where noted)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year over Year
|
|
3Q2016
|
|
3Q2015
|
|
% Change
|
Total Accounts
|
|
|
370
|
|
|
322
|
|
15%
|
Customer Equity (in billions) *
|
|
$
|
82.7
|
|
$
|
62.1
|
|
33%
|
|
|
|
|
|
|
|
|
|
Cleared DARTs
|
|
|
564
|
|
|
620
|
|
-9%
|
Total Customer DARTs
|
|
|
609
|
|
|
683
|
|
-11%
|
|
|
|
|
|
|
|
|
|
Cleared Customers (in $'s, except DART per account)
|
|
|
|
|
|
|
|
|
Commission per DART
|
|
$
|
3.91
|
|
$
|
4.10
|
|
-5%
|
DART per Avg. Account (Annualized)
|
|
|
390
|
|
|
493
|
|
-21%
|
Net Revenue per Avg. Account (Annualized)**
|
|
$
|
3,191
|
|
$
|
3,584
|
|
-11%
|
|
|
|
|
|
|
|
|
|
Consecutive Quarters
|
|
3Q2016
|
|
2Q2016
|
|
% Change
|
Total Accounts
|
|
|
370
|
|
|
357
|
|
4%
|
Customer Equity (in billions) *
|
|
$
|
82.7
|
|
$
|
73.7
|
|
12%
|
|
|
|
|
|
|
|
|
|
Cleared DARTs
|
|
|
564
|
|
|
597
|
|
-6%
|
Total Customer DARTs
|
|
|
609
|
|
|
648
|
|
-6%
|
|
|
|
|
|
|
|
|
|
Cleared Customers (in $'s, except DART per account)
|
|
|
|
|
|
|
|
|
Commission per DART
|
|
$
|
3.91
|
|
$
|
3.91
|
|
0%
|
DART per Avg. Account (Annualized)
|
|
|
390
|
|
|
428
|
|
-9%
|
Net Revenue per Avg. Account (Annualized)**
|
|
$
|
3,191
|
|
$
|
3,256
|
|
-2%
|
*
Excludes non
‑customers.
*
* The calculation has been revised to exclude components of other income that are not direct revenues from customers
.
Prior period amounts have been recalculated to conform to the current methodology.
Business Environment
Against a backdrop of global declines in trading volumes, w
e maintained our position as the largest U.S. electronic broker as measured by the number of customer revenue trades, despite a
decrease
of
11%
from
the prior year quarter. New customer account growth remained robust as total customer accounts increased
15%
to
370
thousand from September 30, 2015. Institutional customers, such as hedge funds, mutual funds, introducing brokers, proprietary trading groups and financial advisors, comprised approximately
43%
of total accounts and approximately 63% of total customer equity at the end of the current quarter. Our customer base continues to be geographically diverse, with customers residing in over
190
countries and over
50%
of new customers coming from outside the U.S. Average equity per account increased
by
16%
, to
$224
thousand, compared to the prior year quarter.
Our low margin lending rates, are tied to benchmark rates, such as the Federal Funds rate in the U.S. In the current quarter, our customers paid
0.5%
to
1.
9
%
for their U.S. dollar margin loans with us. Customer margin loans increased by
15%
from the prior year quarter, due to customers’ appetite for increased risk, along with expanded prime broker financing. Electronic brokerage net interest income grew
28%
compared to the prior year quarter, as average customer credit balances rose
17%
for the current quarter.
Market making segment results decreased in the current quarter, as trading gains were dampened by lower trading volumes and decreases in volatility and in the actual-to-implied volatility ratio as compared to
the
prior year quarter.
The following is a summary of the key profit drivers that affect our business and how they compared to the prior year
quarter
:
Global trading volumes.
According to data received from exchanges worldwide, volumes in exchange
‑listed equity
‑based options
decreased
by
approximately
25%
globally
and
15%
in the
U.S. for the
current quarter
, compared to
the prior year quarter
. During
the current quarter,
we accounted for
approximately
8.0%
(
7.8
%
in the prior year quarter
) of the exchange
‑listed equity
‑based options
volume traded worldwide (including options on ETFs and stock index products)
,
and approximately
11.2%
(
11.5
%
in the prior year quarter
) of
exchange
‑listed equity
‑based options volume traded in the U.S. It is important to note that this metric is not directly correlated with our profits.
Volatility.
Since
we typically maintain an overall long volatility position
,
o
ur market making profits are generally correlated with market volatility,
protect
ing
us against a severe market dislocation in either direction. Based on the Chicago Board Options Exchange Volatility Index (“VIX
®
”), the average volatility
decreased to
13.3
in
the current quarter,
down 31%
from the average of
19.2
in
the prior year quarter
.
The ratio of actual to implied volatility is also meaningful to our results. Because the cost of hedging our positions is based on
implied volatility, while our trading profits are, in part, based on actual market volatility, a higher ratio
has a
generally favorable
impact on our trading gains
and a lower ratio generally has a negative effect. This ratio averaged approximately
74%
during
the current quarter
,
compared to an
average of
approximately
109%
in
the prior year quarter
.
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
15
currencies we call the “GLOBAL” in order 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 in U.S. dollars, the change in the value of the GLOBAL
versus
the U.S. dollar affects our earnings.
During the current quarter, t
he value of the GLOBAL, as measured in U.S. dollars,
increased
0.26%
compared to
its value
as of
June 30
,
2016, which had a positive impact
on
our comprehensive earnings
for the current quarter
.
A discussion of our approach
for
managing foreign currency exposure is contained in Part
I
, Item
3
of this
Quarterly
Report on Form 10
‑
Q
entitled
“
Quantitative and Qualitative Disclosures about Market Risk.
”
See the tables on pages
34
-
35
of this Quarterly Report on Form 10-Q for additional details regarding our trade volumes, contract and share volumes and brokerage statistics.
Certain Trends and Uncertainties
We believe that our continuing operations may be favorably or unfavorably impacted by the following trends that may affect our financial condition and results of operations.
•
Over the past several years, 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.
•
Retail broker
‑dealer 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.
•
In recent years, 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.
•
Scrutiny of equity and option 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.
•
Additional consolidation among market centers may adversely affect the value of our smart routing software.
•
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
our
Annual Report on Form 10
‑K
, filed with the SEC on February 29, 2016, and elsewhere in this report
for a discussion of other risks that may affect our financial condition and results of operations.
Results of Operations
The tables in the period comparisons below provide summaries of our consolidated results of operations. The period
‑to
‑period comparisons below of financial results are not necessarily indicative of future results.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions, except share and per share data)
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Trading gains
|
|
$
|
38
|
|
$
|
87
|
|
$
|
124
|
|
$
|
216
|
Commissions and execution fees
|
|
|
144
|
|
|
167
|
|
|
462
|
|
|
473
|
Interest income
|
|
|
157
|
|
|
122
|
|
|
446
|
|
|
356
|
Other income
|
|
|
27
|
|
|
(1)
|
|
|
228
|
|
|
(78)
|
Total revenues
|
|
|
366
|
|
|
375
|
|
|
1,260
|
|
|
967
|
Interest expense
|
|
|
21
|
|
|
16
|
|
|
57
|
|
|
49
|
Total net revenues
|
|
|
345
|
|
|
359
|
|
|
1,203
|
|
|
918
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Execution and clearing
|
|
|
62
|
|
|
63
|
|
|
183
|
|
|
177
|
Employee compensation and benefits
|
|
|
58
|
|
|
56
|
|
|
174
|
|
|
171
|
Occupancy, depreciation and amortization
|
|
|
13
|
|
|
12
|
|
|
38
|
|
|
33
|
Communications
|
|
|
7
|
|
|
6
|
|
|
23
|
|
|
19
|
General and administrative
|
|
|
19
|
|
|
13
|
|
|
46
|
|
|
42
|
Customer bad debt
|
|
|
3
|
|
|
7
|
|
|
6
|
|
|
145
|
Total non-interest expenses
|
|
|
162
|
|
|
157
|
|
|
470
|
|
|
587
|
Income before income taxes
|
|
|
183
|
|
|
202
|
|
|
733
|
|
|
331
|
Income tax expense
|
|
|
15
|
|
|
20
|
|
|
55
|
|
|
37
|
Net income
|
|
|
168
|
|
|
182
|
|
|
678
|
|
|
294
|
Less net income attributable to noncontrolling interests
|
|
|
148
|
|
|
160
|
|
|
598
|
|
|
262
|
Net income available for common stockholders
|
|
$
|
20
|
|
$
|
22
|
|
$
|
80
|
|
$
|
32
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.30
|
|
$
|
0.35
|
|
$
|
1.22
|
|
$
|
0.53
|
Diluted
|
|
$
|
0.30
|
|
$
|
0.35
|
|
$
|
1.20
|
|
$
|
0.52
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
67,083,654
|
|
|
62,458,655
|
|
|
65,351,842
|
|
|
60,152,525
|
Diluted
|
|
|
68,470,224
|
|
|
64,028,731
|
|
|
66,738,754
|
|
|
61,646,928
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income available for common stockholders
|
|
$
|
20
|
|
$
|
22
|
|
$
|
80
|
|
$
|
32
|
Other comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative translation adjustment, before income taxes
|
|
|
-
|
|
|
(8)
|
|
|
3
|
|
|
(5)
|
Income taxes related to items of other comprehensive income
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
Other comprehensive income (loss), net of tax
|
|
|
-
|
|
|
(8)
|
|
|
3
|
|
|
(5)
|
Comprehensive income available for common stockholders
|
|
$
|
20
|
|
$
|
14
|
|
$
|
83
|
|
$
|
27
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income attributable to noncontrolling interests
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income attributable to noncontrolling interests
|
|
$
|
148
|
|
$
|
160
|
|
$
|
598
|
|
$
|
262
|
Other comprehensive income (loss) - cumulative translation adjustment
|
|
|
2
|
|
|
(44)
|
|
|
19
|
|
|
(29)
|
Comprehensive income attributable to noncontrolling interests
|
|
$
|
150
|
|
$
|
116
|
|
$
|
617
|
|
$
|
233
|
Three Months Ended
September
30, 2016 (“current quarter”) compared to the Three Months Ended
September
30, 2015 (“prior year quarter”)
Net Revenues
Total net revenues, for the current
quarter,
decreased
$14
million, or
4%
, compared to the prior year quarter
,
to
$345
million. The decrease in net revenues was primarily due to lower trading gains
and commissions and execution fees, partially offset by higher net interest income and other income
.
Trading volume is an important driver of revenues and costs for both our electronic brokerage and market making segments. During the current quarter, our options
and futures
contract and stock share volume
s
decreased
23%, 17%,
and
8%
, respectively, compared to the prior year quarter.
Trading Gains
Trading gains, for the current quarter,
decreased
$49
million, or
56%
,
compared
to the prior year quarter,
to
$38
million
. As market makers, we provide liquidity by buying from sellers and selling to buyers. During the
current quarter
, our market making operations executed
15.5
million trades, a
decrease
of
17%
compared to the number of trades executed in the
prior year quarter
. Market making
options and
futures contract and stock share volumes
decreased 22%,
14%,
and
36%
, respectively,
compared
to the
prior year quarter
.
Trading gains were
unfavorably
impacted by
lower trading volumes and decreases in volatility and in the actual-to-implied volatility ratio as compared to the prior year quarter
.
The
VIX
®
, which measures perceived U.S. equity market volatility
,
decreased
31%
to an average of
13.3
for
the
current quarter,
compared to
an average of
19.2
for the prior year quarter
.
The ratio of actual to implied volatility
decreased to an average of
74%
for
the current quarter,
compared to
an average of
approximately
109%
for
the prior year quarter
.
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 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 operations.
Commissions and Execution Fees
Commissions and execution fees
,
for the
current quarter,
decreased $23
million
,
or
14%
,
compared to the
prior year quarter
,
to
$144
million
,
on
lower
trading volumes
. Cleared customer
option
s
and futures
contract
and stock share
volume
s
decreased
18%, 16%,
and
5%
, respectively,
from
the
prior year quarter
. Total DARTs for cleared and execution-only customers
,
for the
current quarter,
decreased by
11%
to
609 thousand
, compared
to
683
thousand
during the
prior year quarter
. DARTs for cleared customers, i.e., customers for whom we execute trades
,
as well as
,
clear and carry positions,
for the current quarter,
decrea
sed by 9% to 564 thousand, compared to 620 thousand for
the
prior year quarter
. Average commission per DART for cleared customers, for the
current quarter
,
decreased
by
5%
to
$3.91
, compared to
$4.10
for the
prior year quarter, reflecting smaller average order sizes across most product types.
Interest Income and Interest Expense
Net interest income (interest income less interest expense)
,
for the
current quarter,
increased $30
million, or
28%
,
compared to the
prior year quarter,
to
$136
million. The increase in net interest income was driven by higher
average
customer
cash balances
.
Net interest income on customer balances
, for the current quarter,
increased
$27
million
,
compared to the
prior year quarter, driven by a
$5.7
billion increase in average customer cash balances, the majority of which were invested in interest-bearing U.S. government securities, partially offset by a
$1.4
billion decrease in average customer margin borrowings. In addition, the average Fed Funds effective rate increased by approximately 23 basis points to
0.37%
for the current quarter, compared to the prior year quarter.
We earn fees 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. In exchange for lending out their stock, our customers generally receive 50% of the stock loan fees. We place cash collateral securing the loans in the customer’s account.
In the market making segment, as a result of the way we have integrated our market making and securities lending systems, our trading income and our net interest income are interchangeable and depend on the mix of market making positions in our portfolio. When implied interest rates in the equity and equity options and futures markets exceed the actual interest rates available to us, our market making systems tend to buy stock and sell it forward, which produces higher trading gains and lower net interest income. When these rates are inverted, our market making systems tend to sell stock and buy it forward, which produces lower trading gains and
higher net interest income.
In the current quarter, a
verage securities borrowed
increased
by
27%
, to
$4.3
billion and average securities loaned
increased
by
2%
, to
$3.1
billion,
compared to
the
prior year quarter
. Net interest earned from securities lending is also affected by the level of demand for securities positions
in
our market making
business
and
held by
our customers. During the
current quarter
, net fees earned by our
electronic
brokerage and market making segments from securities lending transactions
increased $5
million or
13%
, compared to the
prior year quarter
. The
increase
in
net interest income from
securities lending transactions
was attributable to primarily the electronic
brokerage segment.
Other Income
Other income, for the
current quarter
,
increased
$28
million
,
compared to
the
prior year quarter,
to
$
27
million,
mainly driven by
an
$
11
million
gain
from
our currency diversification strategy
for the current quarter, compared to a $24 million loss in the prior year quarter, as the U.S. dollar value of the GLOBAL increased 0.26% in the current quarter; partially offset by a $15 million net
mark-to-market
loss
on our U.S. government securities portfolio
compared to a $5 million net
mark-to-market
gain in the prior year quarter and $9 million higher net mark-to market gains on other investments.
In general, mark-to-market gains and losses on U.S. government securities are expected to reverse when, as intended, these securities are held to maturity. A discussion of our approach to managing foreign currency exposure is contained in Part II, Item 3 of this Quarterly Report on Form 10-Q entitled “Quantitative and Qualitative Disclosures about Market Risk.
Non
‑Interest Expenses
Non-interest expenses, for the
current quarter
,
increased
$5
million, or
3%
,
compared to
the
prior year quarter,
to
$162
million
,
mainly due to higher general and administrative and employee compensation and benefits expenses; partially offset by lower customer bad debt expenses.
As a percentage of total net revenues, non-interest expenses
were
47%
for the
current quarter
and
44%
for
the
prior year quarter
.
Execution and Clearing
Execution and clearing expenses
, for the current quarter, decreased $1 million, or 2%, compared to
the
prior year quarter, to
$62
million
,
as trading volumes were lower across product types. Execution and clearing expenses decreased $3 million in our market making segment, but were partially offset by an increase of $1 million in our electronic brokerage segment
.
Employee Compensation and Benefits
Employee compensation and benefits expense
s
, for the
current quarter
,
increased $2 million, or 4%,
compared to the
prior year quarter, to
$58
million,
mainly due to a
13%
increase
in the number of employees
to
1,194
, compared to
1,052
at September 30, 2015, as expenses increased by
$4
million in our electronic brokerage segment but were partially offset by decreases in our market making segment.
Within the operating
business
segments, we continued to add staff in electronic brokerage and 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 expense
s were
17% for t
he current quarter and 16%
for the
prior year quarter.
General and Administrative
General and administrative expenses, for the
current quarter
,
increased $6
million, or
46%
,
compared to the
prior year quarter,
to
$19
million,
mainly due to higher professional services fees and expenses related to legal and regulatory matters.
As a percentage of total net revenues,
g
eneral and administrative
expense
s
were
6%
for the current quarter and
4%
for the prior year quarter.
Customer Bad Debt
Customer bad debt expense, for the current quarter
,
decreased
$4
million,
or 57%,
compared to the prior year quarter
, to $3 million, primarily due to the non-recurrence of $7 million in customer related losses in the prior year quarter related to the market volatility in the late-August 2015 period.
Our operating results, for the current quarter, excluding the effects of our currency diversification strategy and the mark-to-market gains from our U.S. government securities portfolio were as follows
: net revenues were
$
349
million, down
8%
; non-interest expenses were
$162
million, up
3%
; income before income taxes was
$
187
million, down
15%
; and pre-tax profit margin
decreased
to
54%
for the current quarter
,
compared to
58%
for the prior year quarter.
Nine Months Ended
September
30, 2016 (“current nine month period”) compared to the Nine Months Ended
September
30, 2015 (“prior year nine month period”)
Net Revenues
Total net revenues, for the
current
nine month period
,
increased $285
million, or
31%
, compared to the prior year
nine month period,
to
$1,203
million. The increase in net revenues was primarily due to higher other income
(driven by gains on our currency diversification strategy and net mark-to-market gains on our U.S. government securities portfolio)
,
and
net interest income
;
partially offset by lower trading gains and
commissions and execution fees. Trading volume is an important driver of revenues and costs for both our electronic brokerage and market making segments. During the current
nine month period
, our futures contract volume
increased
2%
while options contract and stock share volumes
decreased
10%
and 17%
,
respectively,
compared to the prior year
nine month period
.
Trading Gains
Trading gains
f
or the current
nine month period
,
decreased
$92
million, or
43%
, compared to the prior year
nine month period,
to
$124
million. As market makers, we provide liquidity by buying from sellers and selling to buyers. During the current
nine month period
, our market making operations executed
48.8
million trades, compared to
49.0 million
trades executed in the prior year
nine month period
. Market making
options and futures contract and stock share volumes, decreased
8%,
2%
and 7%
, respectively,
compared to the prior year
nine month period
.
Trading gains were
negatively
impacted by
lower trading volumes, a divergence in price behavior among a significant number of individual stocks during the first quarter of 2016, and decreases in volatility and in the actual-to-implied volatility ratio as compared to the prior year nine month period
.
The VIX
®
, which measures perceived U.S. equity market volatility,
decreased
1%
to an average of
16.
4
for the current
nine month period
, compared to an average of
16.5
for the prior year
nine month period
. The ratio of actual to implied volatility
decreased
to an average of
approximately
84%
for the current
nine month period
, compared to an average of
approximately 8
9%
for the prior year
nine month period
.
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 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 operations.
Commissions and Execution Fees
Commissions and execution fees, for the current
nine month period
,
decreased
$11
million, or
2%
, compared to the prior year
nine month period
, to
$462
million, driven by
mixed customer trading volumes and
lower average commission per customer order
, but moderated by continued customer account growth
. Cleared customer
options contract and stock share volumes decreased 9% and
19%
, respectively,
while
futures contract volume
increased
3%
, compared to
the prior year
nine month period
. Total DARTs for cleared and execution-only customers, for the current
nine month period
,
increased
3%
to
667
thousand, compared to
649
thousand during the prior year
nine month period
. DARTs for cleared customers, i.e., customers for whom we execute trades, as well as, clear and carry positions, for the current quarter,
increased
4%
, to
615
thousand, compared to
592
thousand for the prior year
nine month period
. Average commission per DART for cleared customers, for the current
nine month period
,
decreased
by
6%
to
$3.89
, compared to
$4.15
for the prior year
nine month period
.
Interest Income and Interest Expense
Net interest income (interest income less interest expense), for the current
nine month period
,
increased
$82
million, or
27%
, compared to the prior year
nine month period
, to
$389
million. The increase in net interest income was driven by higher customer
cash balances
and higher net fees earned from securities lending
transactions.
Net interest income on customer balances, for the current
nine month period
,
increased
$77
million,
compared to the prior year nine month period,
driven by a
$5.3
billion increase in average customer cash balances, the majority of which were invested in interest-bearing U.S. government securities, partially offset by a
$2.6
billion decrease in average customer margin borrowings. In addition, the average Fed Funds effective rate increased by approximately
24
basis
points to
0.37%
for the
current
nine month period
, compared
to the prior year nine month period.
We earn fees 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. In exchange for lending out their stock, our customers generally receive 50% of the stock loan fees. We place cash collateral securing the loans in the customer’s account.
In the market making segment, as a result of the way we have integrated our market making and securities lending systems, our trading income and our net interest income are interchangeable and depend on the mix of market making positions in our portfolio. When implied interest rates in the equity and equity options and futures markets exceed the actual interest rates available to us, our market making systems tend to buy stock and sell it forward, which produces higher trading gains and lower net interest income. When these rates are inverted, our market making systems tend to sell stock and buy it forward, which produces lower trading gains and
higher net interest income.
In the current nine month period, a
verage securities borrowed
increased
by
20%
, to
$4.1
billion
and average securities loaned
decreased
by
10%
, to
$2.8
billion
,
compared to
the
prior year nine month period
. Net interest earned from securities lending is also affected by the level of demand for securities positions
in
our market making
business
and
held by
our customers. During the
current nine month period
, net fees earned by our
electronic
brokerage and market making segments from securities lending
transactions
increased
$10
million
,
or
9%
, compared
to the
prior year nine month period
. The
majority
of the increase in
net interest income from
securities lending
transactions
was attributable to the electronic brokerage
segment.
Other Income
Other income, for the
current nine month
period,
increased
$306
million to $
228
million
, compared to
a loss of
$78
million in
the
prior year nine month period
, mainly driven by $
113
million gain on our currency diversification strategy in the current
nine
month period as compared to a loss of $
186
million in the prior year
nine
month period and $
18
million higher
net
mark-to-market gains on our U.S. government securities portfolio, due to a
decline
in medium-term interest rates during the current
nine
month period. In
general, mark-to-market gains and losses on U.S. government securities are expected to reverse when, as intended, these securities are held to maturity.
A discussion of our approach to managing foreign currency exposure is contained in Part II, Item
3
of this
Quarterly
Report on Form 10-
Q
entitled “Quantitative and Qualitative Disclosures about Market Risk.”
Non
‑Interest Expenses
Non-interest expenses, for the
current nine month period
,
decreased
$117
million, or
20%
,
compared to
the
prior year nine month period,
to
$470
million
,
mainly
due to
the non-recurrence of $137 million in customer bad debt expense due to the Swiss franc event in the prior year nine month period, as described above.
As a percentage of total net revenues,
non-interest expenses
were
39%
for the current
nine month period
and
64%
for the prior year
nine month period
.
Execution and Clearing
Execution and clearing expenses
,
for the
current nine month period
,
increased
$6
million, or
3%
,
compared to the
prior year nine month period,
to
$183
million
,
driven by higher trading volumes in futures in the electronic brokerage
segment
.
Employee Compensation and Benefits
Employee compensation and benefits expense
s
, for the
current nine month period
,
increased
$3
million, or
2%
, compared
to the
prior year nine month period
,
to
$174
million,
mainly
due to a
13%
increase
in the number of employees to
1,194
, compared to
1,052
as of September 30, 2015.
With
in the operating
business
segments, we continued to add staff in electronic brokerage and 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
14%
for the current
nine
month period
and
19%
for the prior year
nine month period.
General and Administrative
General and administrative expenses,
for the current
nine
month period,
increased
$4
million, or
10%
,
compared to the
prior year nine month period,
to
$46
million
,
mainly due to higher professional services fees and expenses related to legal and regulatory matters.
As a percentage of total net revenues,
g
eneral and administrative
exp
enses were
4%
for the current
nine month period
and
5%
for the
prior year nine month period.
Customer Bad Debt
Customer bad debt expense, for the current nine month period, decreased
$139 million, or 96%, compared to the prior year nine month period, primarily due
to the non-recurrence of unsecured customer losses of $137 million caused by the sudden move in the value of the Swiss franc in the prior year nine month period
as described above in the
“
Financial Over
view” section.
Our operating results, for the current
nine
month period, excluding the effects of our currency diversification strategy and the
net
mark-to-market gains from our U.S. government securities portfolio, and the Swiss franc related customer losses from the prior year
nine month period
were as follows: net revenues were
$
1,053
million,
down 1%
; non-interest expenses were
$470
million, up
4%
; income before income taxes was
$
583
million
, down 6%
; and pre-tax profit margin
decreased
to
55
%
for the current
nine
month period
compared to
58
%
for the prior year
nine
month period.
Business Segments
The following table sets forth the net revenues, non-interest expenses and income before income taxes of our business segments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
Electronic Brokerage
|
Net revenues
|
|
$
|
288
|
|
$
|
300
|
|
$
|
945
|
|
$
|
878
|
|
Non-interest expenses
|
|
|
126
|
|
|
116
|
|
|
357
|
|
|
455
|
|
Income before income taxes
|
|
$
|
162
|
|
$
|
184
|
|
$
|
588
|
|
$
|
423
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax profit margin
|
|
|
56%
|
|
|
61%
|
|
|
62%
|
|
|
48%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Market Making
|
Net revenues
|
|
$
|
43
|
|
$
|
90
|
|
$
|
145
|
|
$
|
229
|
|
Non-interest expenses
|
|
|
36
|
|
|
44
|
|
|
113
|
|
|
126
|
|
Income before income taxes
|
|
$
|
7
|
|
$
|
46
|
|
$
|
32
|
|
$
|
103
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax profit margin
|
|
|
16%
|
|
|
51%
|
|
|
22%
|
|
|
45%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
(1)
|
Net revenues
|
|
$
|
14
|
|
$
|
(31)
|
|
$
|
113
|
|
$
|
(189)
|
|
Non-interest expenses
|
|
|
-
|
|
|
(3)
|
|
|
-
|
|
|
6
|
|
Income (loss) before income taxes
|
|
$
|
14
|
|
$
|
(28)
|
|
$
|
113
|
|
$
|
(195)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
Net revenues
|
|
$
|
345
|
|
$
|
359
|
|
$
|
1,203
|
|
$
|
918
|
|
Non-interest expenses
|
|
|
162
|
|
|
157
|
|
|
470
|
|
|
587
|
|
Income before income taxes
|
|
$
|
183
|
|
$
|
202
|
|
$
|
733
|
|
$
|
331
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax profit margin
|
|
|
53%
|
|
|
56%
|
|
|
61%
|
|
|
36%
|
|
(1)
|
|
The corporate segment includes corporate related activities, inter-segment eliminations and gains and losses on positions held as part of our overall currency diversification strategy.
|
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 and clearing expenses, which are the main cost driver for both the market making and the electronic brokerage segments, 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.
Electronic Brokerage
The following table sets forth the results of our electronic brokerage operations for the indicated periods:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and execution fees
|
|
$
|
143
|
|
$
|
168
|
|
$
|
462
|
|
$
|
474
|
Interest income
|
|
|
141
|
|
|
109
|
|
|
397
|
|
|
319
|
Other income
|
|
|
14
|
|
|
30
|
|
|
114
|
|
|
107
|
Total revenues
|
|
|
298
|
|
|
307
|
|
|
973
|
|
|
900
|
Interest expense
|
|
|
10
|
|
|
7
|
|
|
28
|
|
|
22
|
Total net revenues
|
|
|
288
|
|
|
300
|
|
|
945
|
|
|
878
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Execution and clearing
|
|
|
46
|
|
|
45
|
|
|
135
|
|
|
125
|
Employee compensation and benefits
|
|
|
28
|
|
|
24
|
|
|
82
|
|
|
72
|
Occupancy, depreciation and amortization
|
|
|
6
|
|
|
5
|
|
|
16
|
|
|
12
|
Communications
|
|
|
3
|
|
|
3
|
|
|
11
|
|
|
9
|
General and administrative
|
|
|
40
|
|
|
32
|
|
|
107
|
|
|
92
|
Customer bad debt
|
|
|
3
|
|
|
7
|
|
|
6
|
|
|
145
|
Total non-interest expenses
|
|
|
126
|
|
|
116
|
|
|
357
|
|
|
455
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
$
|
162
|
|
$
|
184
|
|
$
|
588
|
|
$
|
423
|
Three Months Ended
September
30, 2016 (“current quarter”) compared to the Three Months Ended
September
30, 2015 (“prior year quarter”)
Electronic brokerage total net revenues, for the current quarter,
decreased
$12
million, or
4%
,
compared to the prior year quarter,
to
$288
million, primarily due to
lower commissions and execution fees
and other income
, partially offset by higher net interest income
.
Commissions and execution fees, for the current quarter,
decreased
$25
million, or
15%
,
compared to the prior year quarter,
to
$143
million,
resulting from lower
customer trading volume
. Cleared customer
option
s
and futures
contract
and stock share
volume
s
decreased 18%, 16%
,
and 5%, respectively.
Total DARTs for cleared and execution-only customers, for the current quarter,
decreased by 11%
to
609 thousand
, compared to
683 thousand
during the prior year quarter. DARTs for cleared customers, i.e., customers for whom
we execute trades, as well as, clear and carry positions, for the current quarter,
decreased by
9%
to
564 thousand
, compared to
620 thousand
for the prior year quarter. Average commission per DART for cleared customers, for the current quarter,
decreased
by
5%
to
$3.91
, compared to
$4.10
for the prior year quarter
, reflecting smaller average order sizes across product types.
Net interest income, for the current quarter,
increased
$29
million, or
28%,
compared to the prior year quarter,
to
$131
million. The increase in net interest income was
attributable to
higher net customer interest of
$27
million,
driven by
a
$5.7
billion increase in average customer cash balances, the majority of which were invested in interest-bearing U.S. government securities,
partially offset by
a
$1.4
billion decrease in average customer margin borrowings.
In addition, the average Fed Funds effective rate increased by approximately
23
basis points to
0.37%
for the current quarter, compared to the prior year quarter.
Other income, for the current quarter,
decreased
$16
million, or
53%
, compared to the prior year quarter, to
$14
million, mainly
driven by
$
15
million
net
mark-to-market
losses
on our U.S. government securities portfolio
due to a rise in average medium-term interest rates during the current quarter
.
Non-interest expenses, for the current quarter,
increased
$10
million, or
9%
,
compared to the prior year quarter,
to
$126
million. Within non-interest expenses, execution and clearing expenses
increased
$1
million, or
2%
. A
20%
increase in the number of employees providing services to the electronic brokerage segment led to increases in employee compensation and benefits expenses of
$4
million, or
17%, and in g
eneral and administrative expenses
of
$8
million,
where the latter mainly represents software development provided by the corporate segment on a consulting basis. In addition, general and administrative expenses for the current quarter include higher professional fees and expenses related to legal and regulatory matters, compared to the prior year quarter.
As a percentage of total net revenues, non-interest expenses were
44%
for the current quarter and
39%
for the prior year quarter.
Income before income taxes, for the current quarter,
decreased
$22
million, or
12%
,
compared to the prior year quarter,
to
$162
million. As a percentage of total net revenues for the electronic brokerage segment, income before income taxes was
56%
for the current quarter and
61%
for the prior year quarter.
Our operating results, for the current quarter, excluding the
net
mark-to-market gains and losses from our U.S. government securities portfolio and the
Swiss franc related customer losses from the prior year quarter were as follows: income before income taxes was
$177
million,
down
1%
; and pre-tax profit margin
decreased
to
58%
for the current year quarter compared to
60%
for the prior year quarte
r
.
Nine Months Ended
September
30
,
2016
(“current nine month period”) c
ompared to the
Nine Months Ended
September
30
,
2015 (“prior year nine month period”)
Electronic brokerage total net revenues, for the current nine month period,
increased
$67
million, or
8%
, compared to the prior year nine month period, to
$945
million, primarily due to higher net interest income and other income.
Commissions and execution fees, for the current nine month period,
decreased
$12
million, or
3%
, compared to the prior year nine month period, to
$462
million,
driven by
mixed customer trading volumes and
lower
average
commission per customer order
, but moderated by continued customer account growth
. Cleared customer
options
contract and stock share volume
s
decreased
9% and
19%
, respectively
,
while futures contract volume increased 3%, compared to
the
prior year nine month period
. Total DARTs for cleared and execution-only customers
,
for the
current nine month period,
increased
3%
to
667
thousand
, compared to
649
thousand
during the
prior year nine month period
. DARTs for cleared customers, i.e., customers for whom we execute trades
,
as well as
,
clear and carry positions,
for the
current nine month period
,
increased
4%
to
615
thousand
, compared to
592
thousand
for the
prior year nine month period
. Average commission per DART for cleared customers, for the
current nine month period
,
decreased
by
6%
to
$3.89
, compared to
$4.15
for the
prior year nine month period
.
Net interest income, for the current nine month period,
increased
$72
million, or
24%
,
compared to the prior year nine month period,
to
$369
million. The increase in net interest income was attributable to higher net customer interest, mainly driven by a
$5.3
billion increase in average customer cash balances, the majority of which were invested in interest-bearing U.S. government securities. In addition, the average Fed Funds-effective rate increased by approximately 24 basis points to
0.37%
for the current nine month period, compared to the prior year nine month period.
Other income, for the current nine month period,
increased
$7
million, or
7%
, compared to the prior year nine month period, to
$114
million,
mainly
driven by
$
18
million
net
mark-to-market
gains
on our U.S. government securities portfolio
due to a decline in average medium-term interest rates and $5 million higher market data fee income; partially offset by the non-recurrence of $18 million in gains from our hedging activities to offset our losses related to the Swiss franc event in the prior year nine month period. In general, mark-to-market gains and losses on U.S. government securities are expected to reverse when, as intended, these securities are held to maturity.
Non-interest expenses, for the current nine month period,
decreased
$98
million, or
22%
, compared to the prior year nine month period, to
$357
million, mainly due to the non-recurrence of $137 million in customer bad debt expense on the Swiss franc event in the prior year nine month period. Within non-interest expenses, execution and clearing expenses
increased
$10
million, or
8%
, due to higher trading volume in futures contracts
. A
20%
increase
in the number of employees providing services to the electronic brokerage segment led to
increased
employee compensation and benefits expenses
of
$10
million, or
14%
,
and
in general and administrative expenses of
$15
million, where the latter represents software development provided by the corporate segment on a consulting basis. As a percentage of total net revenues, non-interest expenses were
38%
for the current nine month period and
52%
for the prior year nine month period.
I
ncome before income taxes
, for the current nine month period,
increased
$165
million, or
39%
,
compared to the prior year nine month period,
to
$588
million. As a percentage of total net revenues for the electronic brokerage segment, income before income taxes was
62%
for the current nine month period
and
48%
for the
prior year nine month period.
Our operating results, for the current
nine
month period, excluding
the net mark-to-market gains from our U.S. government securities portfolio and
the Swiss franc related customer losses from the prior year
nine
month period were as follows: income before income taxes was
$551
million, up
5%
; and pre-tax profit margin
decreased
to
61%
for the current year
nine
month period compared to
62%
for the prior year nine month period.
Market Making
The following table sets forth the results of our market making operations for the indicated periods:
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Three Months Ended September 30,
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|
Nine Months Ended September 30,
|
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
|
|
|
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|
|
(in millions)
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Trading gains
|
|
$
|
38
|
|
$
|
87
|
|
$
|
124
|
|
$
|
216
|
Interest income
|
|
|
18
|
|
|
13
|
|
|
51
|
|
|
37
|
Other income
|
|
|
-
|
|
|
1
|
|
|
4
|
|
|
7
|
Total revenues
|
|
|
56
|
|
|
101
|
|
|
179
|
|
|
260
|
Interest expense
|
|
|
13
|
|
|
11
|
|
|
34
|
|
|
31
|
Total net revenues
|
|
|
43
|
|
|
90
|
|
|
145
|
|
|
229
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|
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Non-interest expenses
|
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|
|
|
|
|
|
|
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Execution and clearing
|
|
|
17
|
|
|
20
|
|
|
49
|
|
|
54
|
Employee compensation and benefits
|
|
|
7
|
|
|
9
|
|
|
23
|
|
|
30
|
Occupancy, depreciation and amortization
|
|
|
1
|
|
|
1
|
|
|
3
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|
|
3
|
Communications
|
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|
2
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|
2
|
|
|
8
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|
|
7
|
General and administrative
|
|
|
9
|
|
|
12
|
|
|
30
|
|
|
32
|
Total non-interest expenses
|
|
|
36
|
|
|
44
|
|
|
113
|
|
|
126
|
|
|
|
|
|
|
|
|
|
|
|
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|
Income before income taxes
|
|
$
|
7
|
|
$
|
46
|
|
$
|
32
|
|
$
|
103
|
Three Months Ended
September
30
,
2016
(“current quarter”) c
ompared to the
Three Months Ended
September
30
,
2015 (“prior year quarter”)
Market making total net revenues, for the current quarter,
decreased
$47
million, or
52%
, compared to the prior year quarter, to
$43
million, primarily due to lower trading gains, partially offset by higher net interest income.
Trading gains, for the current quarter,
decreased
$49
million, or
56% from the
prior year quarter, unfavorably
impacted by
lower trading volumes and decreases in volatility and in the actual-to-implied volatility ratio as compared to the prior year quarter
.
The
VIX
®
, which measures perceived U.S. equity market volatility
,
decreased
31%
to an average of
13.3
for
the
current quarter,
compared to
an average of
19.2
for the prior year quarter
.
The ratio of actual to implied volatility
decreased
to an average of
74%
for
the current quarter,
compared to
an average of
109%
for
the prior year quarter
.
Options and futures contract and stock share volumes
decreased
22%
,
14%
, and
36%
, respectively,
compared to the
prior year quarter
.
Net interest income, for the current quarter,
increased
$3
million, or
150%
, compared to the prior year quarter, to
$5
million. As described above, our trading gains and our net interest income are interchangeable and depend on the mix of market making positions in our portfolio and on relative interest rates in the stock and options markets. In the current quarter, these factors, together with an increase in net securities lending interest, produced more net interest income than in the prior year quarter.
Non-interest expenses, for the current quarter,
decreased
$8
million, or
18%
, compared to the prior year quarter, to
$36
million. Within non-interest expenses, execution and clearing fees decreased $3 million, or 15%, on lower trading volumes across product types. Employee compensation and benefits expenses decreased $2 million, or 22%, driven by continued reductions in staff. General and administrative expense decreased
$3
million, or
25%
, due to lower consulting expenses. As a percentage of total net revenues, non-interest expenses were
84%
for the current quarter and
49%
for the prior year quarter.
I
ncome before income taxes
, for the current quarter,
decreased
$39
million, or
85%
,
compared to the prior year quarter,
to
$7
million. As a percentage of total net revenues for the market making segment, income before income taxes was
16%
for the current quarter
and
51%
for the
prior year quarter.
Nine Months Ended
September
30
,
2016
(“current nine month period”) c
ompared to the
Nine Months Ended
September
30
,
2015 (“prior year nine month period”)
Market making total net revenues, for the current nine month period,
decreased
$84
million, or
37%
, compared to the prior year nine
month period, to
$145
million, primarily due to lower trading gains, partially offset by higher net interest income.
Trading gains, for the current nine month period,
decreased
$92
million, or
43%
,
compared to the prior year nine month period,
to
$124
million,
unfavorably
impacted by
lower trading volumes, a divergence in price behavior among an unusually large number of individual stocks during the first quarter of 2016, and decreases in volatility and in the actual-to-implied volatility ratio as compared to the prior year nine month period. The
VIX
®
, which measures perceived U.S. equity market volatility
,
decreased
1%
to an average of
16.4
for
the
current nine month period,
compared to
an average
of
16.5
for
the prior year nine month period
.
The ratio of actual to implied volatility
decreased
to an average of
84%
for
the current nine month period,
compared to
an average of
89%
for
the prior year nine month period
.
Options and futures contract and stock share volumes
decreased
8%
, 2%, and 7%
respectively,
compared to the
prior year nine month period
.
Net interest income, for the current nine month period,
increased
$11
million, or
183%
, compared to the prior year nine month period, to
$17
million. As described above, our trading gains and our net interest income are interchangeable and depend on the mix of market making positions in our portfolio and on relative interest rates in the stock and options markets. In the current nine month period, these factors, together with an increase in net securities lending interest, produced more net interest income than in the prior year nine month period.
Non-interest expenses, for the current nine month period,
decreased
$13
million, or
10%
, compared to the prior year nine month period, to
$113
million. Within non-interest expenses, execution and clearing fees decreased $5 million, or 9%, on lower trading volumes across product types. Employee compensation and benefits expenses decreased $7 million, or 23%, driven by continued reductions in staff. General and administrative expense decreased $2 million, or 6%, due to lower consulting expenses. As a percentage of total net revenues, non-interest expenses were
78%
for the current nine month period and
55%
for the prior year nine month period.
I
ncome before income taxes
, for the current nine month period,
decreased
$71
million, or
69%
,
compared to the prior year nine month period,
to
$32
million. As a percentage of total net revenues for the market making segment, income before income taxes was
22%
for the current nine month period
and
45%
for the
prior year nine month period.
Liquidity and Capital Resources
We maintain a highly liquid balance sheet. The majority of our assets consist of investment
s
of customer funds
,
collateralized receivables arising from customer
‑related and proprietary securities transactions
, and
exchange
‑listed marketable securities
,
which are marked
‑to
‑market dail
y
. Collateralized receivables consist primarily of customer margin loans, securities borrowed, and, to a lesser extent receivables from clearing houses for settlement of securities transactions, and securities purchased under agreements to resell.
As of
September 30
,
2016
, total assets
were
$55.1
billion of which approximately
$54.5
billion, or
98.9%
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. Our ability to quickly reduce funding needs by balance sheet contraction without adversely affecting our core businesses and to pledge additional collateral in support of secured borrowings is continuously evaluated to ascertain the adequacy of our capital base.
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.
Liability balances
, as of September 30, 2016,
in connection with our securities loaned and payables to customers were
higher
than their respective average monthly balances during the
current quarter
. Liability balances
, as of September 30, 2016,
in connection with our
short-term borrowings
were
higher
than their respective average monthly balances during the
current quarter
. 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.
Cash and cash equivalents held by
our
non
‑U.S. operating companies
as of
September 30
,
2016
were
$397
million
($
382
million
as of
December 31,
2015
). These funds are primarily intended to finance each individual operating company
’
s local operations, and thus would not be available to fund U.S. domestic operations unless repatriated through payment of dividends to IBG LLC.
In December 2015 and June 2016, dividends of $80 million and $40 million, respectively, were paid to IBG LLC from two of our non-U.S. subsidiaries. As of September 30, 2016, we had no
intention to repatriate further amounts from non
‑U.S. operating companies. In the event dividends were to be paid to the Company in the future by a non
‑U.S. operating company, the Company would be required to accrue and pay income taxes on such dividends to the extent that U.S. income taxes had not been paid previously on the income of the paying company.
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
$5.9
billion
as of
September 30,
2016
from
$5.3
billion
as
of
September 30
,
2015
. This
increase
is attributable to total comprehensive income
, partially
offset by
distributions and
dividends paid during
the last four quarters
.
Cash Flows
The following table sets forth our cash flows from operating activities, investing activities and financing activities for the periods indicated:
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Nine Months Ended September 30,
|
|
|
2016
|
|
2015
|
|
|
|
|
|
|
|
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|
(in millions)
|
Net cash provided by operating activities
|
|
$
|
114
|
|
$
|
627
|
Net cash provided by (used in) investing activities
|
|
|
11
|
|
|
(26)
|
Net cash used in financing activities
|
|
|
(198)
|
|
|
(248)
|
Effect of exchange rate changes on cash and cash equivalents
|
|
|
22
|
|
|
(34)
|
(Decrease) increase in cash and cash equivalents
|
|
$
|
(51)
|
|
$
|
319
|
Our cash flows from operating activities are largely a reflection of the size and composition of trading positions held by our market making subsidiaries, and of the
changes in customer cash and margin 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, or create new opportunities for ourselves as market makers or where we can influence exchanges to provide competing products at better prices using sophisticated technology. Our cash flows from financing activities are comprised of short
‑term borrowings and capital transactions. 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 cash distributions paid to Holdings.
Nine Months
Ended
September
30
,
2016
:
Our cash and cash equivalents
decreased
by
$51
million to
$1.6
billion
for the nine months ended September 30, 2016
. We
raised
$114
million in net cash from operating activities. We
used
net cash of
$187
million
in our investing and financing activities
, primarily
for
distributions to noncontrolling interests, dividends paid to our common stockholders, the repurchase of our common stock for employee tax withholdings under our stock incentive plans, and payments made under the Tax Receivable Agreement. Under investing activities, purchases and sales of other investments mainly consisted of transactions in marketable securities held for investment purposes, and distributions received from investments.
Nine Months
Ended
September
30
,
2015
:
Our cash and cash equivalents
increased
by
$319
million to $1.6 billion for the nine months ended September 30, 2015. We raised
$627
million in net cash from operating activities. We used net cash of
$274
million in our investing and financing activities, primarily for dividends paid to our common stockholders and distributions noncontrolling interests.
Regulatory Capital Requirements
Our principal operating
companies
are subject to separate regulation and capital requirements in the
U.S.
and other jurisdictions.
IB LLC
and
TH LLC are registered U.S. broker
‑dealers and their primary regulators include the SEC
,
the
CFTC,
the Chicago Board Options Exchange, the Chicago Mercantile Exchange
and
FINRA
. IB LLC
is also a
registered U.S. futures commission merchant,
as such it is regulated by
the
NFA
. THE is registered to do business in Switzerland as a securities dealer and is regulated by the Swiss Financial Market Supervisory Authority. Our various other operating
companies
are similarly regulated. See the notes to the
condensed
consolidated financial statements in Part
I
, Item
1
of this
Quarterly
Report on Form 10
‑
Q
for further information regarding our regulated
operating companies
.
As of
September 30
,
2016
, aggregate excess regulatory capital for all of the operating companies was
$4.2
billion, and all of the operating companies were in compliance with their respective regulatory capital requirements.
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|
Net Capital/
|
|
|
|
|
|
|
|
|
Eligible Equity
|
|
Requirement
|
|
Excess
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
IB LLC
|
|
$
|
3,217
|
|
$
|
325
|
|
$
|
2,892
|
TH LLC
|
|
|
318
|
|
|
1
|
|
|
317
|
THE
|
|
|
603
|
|
|
181
|
|
|
422
|
Other regulated Operating Companies
|
|
|
679
|
|
|
79
|
|
|
600
|
|
|
$
|
4,817
|
|
$
|
586
|
|
$
|
4,231
|
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. These expenditure items are reported as property and equipment. Capital expenditures for property
and
equipment were
approximately
$21
million
and
$23
million for the
nine
months
ended
September 30
,
2016 and
2015
, respectively. In the future
, we plan meet capital expenditure needs as we continue our focus on technology infrastructure initiatives to further enhance our competitive position. We anticipate that we will fund capital expenditures with cash from operations and cash on hand. 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 strategic acquisitions, we may incur additional capital expenditures.
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 effect
s
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.
Investments in U.S. government securities
We invest in U.S. government securities for the purpose of satisfying U.S. regulatory requirements. Sudden increases in interest rates will cause mark-to-market losses on these securities which are recovered if we hold them to maturity, as currently intended. The impact of changes in interest rates is further described in Part I, Item 3 of this Quarterly Report on Form 10-Q entitled “Quantitative and Qualitative Disclosures about Market Risk.”
Strategic Investments and Acquisitions
We
regularly
evaluat
e
potential strategic investments and acquisitions.
We
hold strategic investments in electronic trading exchanges including: Boston Options Exchange, LLC; OneChicago LLC and CBOE Stock Exchange, LLC.
We intend to continue making acquisitions on an opportunistic basis, generally only when the acquisition candidate will, in our opinion, enable us to acquire either technology or customers faster than we could develop them on our own.
As of
September 30
,
2016
, there were no 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 condensed
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
condensed
consolidated statements of financial condition.
Critical Accounting
Policies
Principles of Consolidation, including Noncontrolling Interests
The
condensed
consolidated financial statements include the accounts of IBG, Inc. and its majority and wholly owned subsidiaries. As sole managing member of IBG LLC,
we
exert control over the Group
’
s operations. In accordance with
Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”)
ASC
Topic
810,
“
Consolidation
”
,
we
consolidate the Group
’
s consolidated financial statements and record as noncontrolling interest the interests in the Group that
we
do not own.
We are the sole managing member of IBG LLC and, as such, operate and control all of the business and affairs of IBG LLC and its subsidiaries and
as such,
consolidate IBG LLC
’
s financial results into our financial statements. We hold
approximately
16.6%
ownership interest in IBG LLC. Holdings is owned by the original members of IBG LLC and holds approximately
83.4%
ownership
interest in IBG LLC. Our
current
share
of IBG LLC’s net income is approximately
16.6%
.
Our
policy is to consolidate all
other
entities
in
which
we
own more than 50% unless
we
do not have control. All inter
‑company balances and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts and disclosures in the
condensed
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. Such estimates include the allowance for doubtful accounts,
valuation of certain investments,
compensation accruals, current and deferred income taxes
,
and contingency reserves.
Valuation of Financial Instruments
Due to the nature of our operations, substantially all of our financial instrument assets, comprised of financial instruments owned, securities purchased under agreements to resell, securities borrowed
, receivable from customers,
and receivables from brokers, dealers and clearing organizations are carried at fair value based on published market prices and are marked to market daily, or are assets which are short
‑term in nature and are reported at amounts
that
approximat
e
fair value. Similarly, all of our financial instrument liabilities that arise from financial instruments sold but not yet purchased, securities sold under agreements to repurchase, securities loaned
, payables to customers,
and payables to brokers, dealers and clearing organizations are
carried at fair value based on published market prices and are marked to market daily, or are liabilities which are short-term in nature and are reported at amounts that approximate fair value
. Our long and short positions are
mainly
valued at the last consolidated trade price at the close of regular trading hours, in their respective markets. Given that we manage a globally integrated market making portfolio, we have large and substantially offsetting positions in securities and commodities that trade on different exchanges that close at different times of the trading day. As a result, there may be large and anomalous swings in the value of our positions daily and, accordingly, in our earnings in any period. This is especially true on the last business day of each calendar quarter
or year
, although such swings tend to come back into equilibrium on the first business day of the succeeding calendar quarter
or year
.
Earnings per Share
Earnings per share (
“
EPS
”
) are computed in accordance with
FASB
ASC
Topic
260,
“
Earnings per Share
.
” Basic EPS is computed by dividing the net income available for common stockholders by the weighted average number of shares outstanding for that period. Diluted EPS is calculated by dividing the net income available for common stockholders by the diluted weighted average shares outstanding for that period. Diluted EPS includes the determinants of the basic EPS and, in addition, reflects the dilutive effect of shares of common stock estimated to be distributed in the future under our stock-based compensation plans, with no adjustments to net income available for common stockholders for dilutive potential common shares.
Stock
‑Based Compensation
We
follow
FASB
ASC
Topic
718,
“
Compensation
-
Stock Compensation
” (“ASC Topic 718”)
, to account for
our
stock
‑based compensation plans. ASC
Topic
718 requires all share
‑based payments to employees to be recognized in the
condensed
consolidated financial statements using a fair value
‑based method. Grants, which are denominated in U.S. dollars, are communicated to employees in the year of grant, thereby establishing the fair value of each grant. The fair value of awards granted to employees are generally expensed as follows
:
50% in the year of grant in recognition of plan forfeiture provisions (described below) and the remaining 50% over the related vesting period utilizing the
“
graded vesting
”
method permitted under ASC
Topic
718. In the case of
“
retirement eligible
”
employees (those employees older than 59), 100% of awards are expensed when granted.
Awards granted under the stock
‑based compensation plans are subject to forfeiture in the event an employee ceases employment with
us
. The plans provide that employees who discontinue employment with
us
without cause and continue to meet the terms of the plans
’
post
‑employment provisions will forfeit 50% of unvested previously granted awards unless the employee is over the age of 59, in which case the employee would be eligible to receive 100% of unvested awards previously granted.
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, in accordance with
FASB
ASC
Topic
450,
“
Contingencies
.
”
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.
We have been from time to time subject to certain pending and legal actions which arise out of the normal course of business. Litigation is inherently unpredictable, particularly in proceedings where claimants seek substantial or indeterminate damages, or which are in their early stages. We cannot predict with certainty the actual loss or range of loss related to such legal proceedings, the manner in which they will be resolved, the timing of final resolution or the ultimate settlement. Consequently, we cannot estimate losses or ranges of losses related to such legal matters, even in instances where it is reasonably possible that a future loss will be incurred. As of
September 30
,
2016
, we, along with certain of our subsidiaries, have been named parties to legal actions, which we and/or such subsidiaries intend to defend vigorously. Although the results of legal actions cannot be predicted with certainty, it is the opinion of management that the resolution of these actions is not expected to have a material adverse effect, if any, on our business or financial condition, but may have a material impact on the results of operations for a given period. As of
September 30
,
2016
and December 31,
2015
, reserves provided for potential losses related to litigation matters were not material.
Income Taxes
We
account for income taxes in accordance with
FASB
ASC
Topic
740
, “
Income Taxes”
(“ASC Topic 740”).
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 the
U.S.
and numerous foreign jurisdictions. Determining income tax expense requires significant judgments and estimates.
We recognize interest related to income tax matters as interest income or interest expense and penalties related to income tax matters as income tax expense.
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 jurisdiction
s
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
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 for U.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. Management is not aware of any such changes that would have a material effect on
our
results of operations, cash flows, or financial position.
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.
We
record tax liabilities in accordance with 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.