Interactive Brokers Update: Slightly Decreasing Fair Value Estimate to $112

Sector Director

Michael Wong

Associate Analyst

Maoyuan Chen

Interactive Brokers is a unique brokerage within our coverage. The firm serves a more niche client base. Apart from retail investors, the company also caters to the trading of institutional clients like hedge and mutual funds, proprietary trading groups, introducing brokers, and financial advisors. The commission mix between retail and institutional clients is about 55%/45%. Most of Interactive Brokers' clients still choose to pay commissions when many other retail brokerages switched to a zero-commission model for U.S. stock trading. The clients of Interactive Brokers are more sophisticated compared with the clients of Charles Schwab, TD Ameritrade, and E-Trade. To be more specific, they trade more frequently, maintain higher cash balances to make opportunistic moves, and take use leverage. These trading-savvy customers are attracted by Interactive Brokers’ low margin rates, comprehensive trading platform, sophisticated trading execution capabilities, and high interest paid on idle cash.

Interactive Brokers’ approach requires strength in its routing system. The fact that hedge funds, proprietary trading groups, and introducing brokers choose its trading platform is a demonstration of its capabilities. The trading execution technology build-up and maintenance requires huge investment, which a lot of small introducing brokers do not want to deal with. 

Another unique part of Interactive Brokers’ business is that the firm has a sizable international business, with around 80% of accounts being non-U.S. and about 50% of commissions coming from outside the Americas. The firm boasts its platform gives access to 150 electronic exchanges and market centers over 30 countries. However, we believe that the international clients are mostly attracted to its U.S. stock trading offering, not trading in their home countries. Interactive Brokers’ operating margin is around the high 60% mark, higher than the 45% to 50% margin of U.S. competitor Charles Schwab and its international competitor, Futu Holdings.

Business Strategy & Outlook

We believe Interactive Brokers warrants a narrow Morningstar economic moat rating based on cost advantage. Interactive Brokers has developed a sufficient scale to spread the fixed cost of its brokerage business to earn a cost advantage compared with its U.S.-based peers and especially its international peers. The firm has historically earned a much higher operating income margin of 60% that exceeds its U.S. peers (Charles Schwab at 40%-45%, TD Ameritrade at 40%-50%, and E-Trade at 35%-45%). A highly automated business process driven by proprietary technology allows Interactive Brokers to cut most human interfaces in terms of account opening, margin loan approval, trade execution, clearing, and compliance. The lower operational cost gives Interactive Brokers the edge on lower pricing on margin loans and high rates paid on unallocated cash balances to attract more productive clients.

Interactive Brokers generates revenue from two major sources: trading commissions and net interest income. 

Commission income is mostly driven by trading volume with lot size, trading mix (options and futures pricing higher than equities), and the complexity of execution affecting commissions. Because Interactive Brokers offers access to trading on more than 150 electronic exchanges and market centers in over 30 countries and 25 currencies, traders are attracted to the trading platform and are more likely to engage in complex trading strategies that require quick execution speed and efficiency. The movement to zero-commission trade pricing in the U.S. creates some headwinds for trading commissions, but most of its customers value the firm’s trade execution capabilities, low margin lending rates, and short-selling system, so Interactive Brokers is more insulated in this respect as compared with pure discount brokerages.

Net interest income is gaining more importance given the higher interest rate environment and headwinds from trading commissions. Interactive Brokers earns interest income by investing idle cash in client accounts into U.S. Treasuries and providing margin loans to clients. The firm pays interest on the unallocated cash of customer accounts, and Interactive Brokers earns net interest income based on the spread between interest income and interest expenses. The average client cash holding ratio over client assets is more than 20% for Interactive Brokers, as compared with 10%-12% at peers. This higher cash-holding and margin loan-using client base allows Interactive Brokers to generate more interest income over client assets and higher revenue yields over client assets.

Apart from trading commissions and net interest income, the firm also earns miscellaneous fees from clients, such as market data fees, risk exposure fees, and payment for order flow. Other fees and services together are 6% of net revenue.

Compared with the clients of Charles Schwab, TD Ameritrade (acquired by Charles Schwab in 2020), and E-Trade (acquired by Morgan Stanley in 2020), Interactive Brokers' client base skews toward active traders that generate more revenue per dollar of client assets than peers. Proprietary trading groups (3% of customer accounts and 17% of commission income) and hedge funds and mutual funds (1% of customer accounts and 8% of commission income) usually maintain a higher cash balance in their accounts to capitalize on changing market conditions. The active trader clients of Interactive Brokers not only trade more frequently but also utilize the margin lending capability more often. Interactive Brokers' clients hold 11% margin loans as a percentage of total client assets, much higher than peers with low-single-digit margin loan ratios. We believe Interactive Brokers will continue to offer attractive margin loan rates to attract these more professional trading clients. Interactive Brokers' more productive clients enable a 0.93% five-year average net revenue yield over client assets, or ROCA, 56 basis points higher than Charles Schwab and also much higher than E-Trade's ROCA at 0.60%-0.70% before being acquired by Morgan Stanley in 2020. 

Apart from the all-inclusive product offerings to worldwide exchanges and securities, Interactive Brokers also offers low margin rates to all account-size tiers to attract shrewd traders. Specifically, the firm's most expensive tier (smallest account-size tier) on its website for margin loans in June 2023 was 6.58%, against 12.83% at Fidelity and Schwab, 13.45% at E*TRADE, and 14.00% at TD Ameritrade. 

Interactive Brokers has gained strong momentum in providing prime brokerage for small hedge fund clients. Per financial data provider Preqin, Interactive Brokers had the highest market share for hedge funds with under $50 million in assets and ranked fourth among prominent prime brokers servicing hedge funds launched in 2020 to first-half 2021.

We think Interactive Brokers has developed a scale large enough to spread its fixed costs over its brokerage clients that gives it a competitive advantage compared with other brokerage firms. Variable costs for discount brokerage come primarily from execution, clearing, and distribution fees that grow with trading volumes. Interest expenses and customer bad debt expenses also grow with the scale of customer assets. Online brokerages do not have brick-and-mortar branches, so gaining additional client assets on their trading platform requires less expenditure. Stringent cost control and highly automated business procedures in the account opening process, margin lending approval, and short-selling lists display also contribute to bringing down noninterest expenses for Interactive Brokers. 

While funding cost is a common source of cost advantage for financial services companies within our coverage, we don't think Interactive Brokers qualifies in this respect. In order to attract clients, Interactive Brokers pays a relatively high interest rate on idle cash in client accounts, recently 50 basis points under the federal-funds rate. However, retail brokers like Charles Schwab and wealth management firms that sweep client cash into deposit accounts at banking partners may pay interest rates a couple hundred basis points less than the fed-funds rate. Per company disclosure and our estimates, over half of client cash balances are fully interest-bearing, meaning that Interactive Brokers will increase its interest expenses in line with each rate hike by the Fed. Interactive Brokers also maintains ultrashort duration in its investment portfolio—only three to four weeks—while Charles Schwab maintains a duration of around four years. This short-duration strategy is beneficial to the company in the high-rate environment and helps to match asset and liability maturities but can lead to a lower revenue yield than peers when the yield curve is upward sloping. Interactive Brokers also invests primarily in U.S. government Treasuries, so it has little credit risk in its investment portfolio. 

We believe that Interactive Brokers has built a size that is large enough to earn a cost advantage in its U.S. business segment in a highly competitive and consolidated brokerage industry. The movement to zero-commission pricing further accelerated the pace of consolidation. In 2020, Charles Schwab acquired TD Ameritrade and Morgan Stanley acquired E-Trade. According to our calculations, the largest retail brokers (Charles Schwab, Fidelity, Interactive Brokers, Robinhood, and E-Trade) contribute about 21% of 548 billion shares of average U.S. equity daily trading volume in 2022.

The noninterest expenses over client assets, or EOCA, ratio is a useful metric to measure and compare the cost level of different brokers. Intuitively, the larger the client assets base, the lower the expense ratio due to the fixed-cost nature of the brokerage business. Certain security types like options and futures carry high execution and clearing costs, so it’s also useful to exclude the trading expenses from the noninterest expenses to make it more comparable between different brokers. Interactive Brokers’ U.S. brokerage segment’s 0.39% EOCA in 2022 is much lower than Robinhood’s 3.23% EOCA from 2020 to 2022. After excluding trading expenses, Interactive Broker’s U.S. brokerage EOCA scores 0.27%, which is still lower than Robinhood’s 3.00% EOCA. Interactive Brokers’ EOCA ratio excluding trading expenses is comparable with E-Trade (before acquisition) and TD Ameritrade (before acquisition) but is higher than Charles Schwab.

Unlike the U.S. brokerage industry, the international brokerage space is far more fragmented and faces less competition in pricing. This is largely driven by smaller stock market sizes, market liquidity, and regulations. The U.S. stock exchanges take the lion’s share of market value, roughly 41% of global equities. Relatively small domestic stock markets, population, and wealth create obstacles for non-U.S. brokerages to grow their sizes and spread fixed costs. Different countries’ regulatory requirements and compliance efforts also add more difficulty for small brokerages to grow outside their domestic markets. With 12% of global equity market capitalization, China is the second largest stock market, but its stringent capital control makes it impossible for outsiders to build and grow a brokerage business. The EU is another large market, with 11% of global equity market capitalization, but the EU is not a large unified market. Thus, equity markets outside the U.S. often prevent the emergence of brokerages comparable in size with Interactive Brokers. Global investment banks offer brokerage services to institutional clients, while the retail space consists of small local brokers and domestic banks.

After the global financial crisis in 2008, scrutinization and regulation in each country strengthened and added a compliance burden to brokers, and thus most U.S. brokers simply exited international brokerage. Interactive Brokers’ automation reduced the cost of duplicate development and allows it to grow outside the U.S. Interactive Brokers' international clients represent about 31% of revenue and 21% of operating income. European clients generate about 19% of total commission revenue, and Asia-Pacific contributes 30%. International clients value the low-cost access to trade U.S. stocks and other nondomestic securities via Interactive Brokers' platform as well as its low foreign exchange fees.

We think Interactive Brokers’ international business has a cost advantage, as demonstrated by its low EOCA ratio over client assets when compared with many European and Asian brokers. For example, Futu Holdings is an Asia broker that offers trading access to U.S. and Hong Kong markets, while Swissquote and Saxo Bank are European retail brokers that provide access to pan-European markets and U.S. markets. After excluding trading expenses, Interactive Brokers’ international brokerage segment’s 0.17% EOCA is much lower than Futu Holding’s 0.87%, Saxo Bank's 0.74%, and Swissquote’s 0.56% over the last five years. ICICI Securities is an India domestic-only broker (11% of India active equity trading clients) whose EOCA is also higher than that of Interactive Brokers.

Interactive Brokers' investment in automation allows it to run a global business efficiently. The company offers its trading platform to many international introducing brokers that don’t want to set up trading platforms and only want to deal with selling, marketing, and customer service. Moreover, operating an international business that serves clients from 200 different countries and territories also requires satisfying various regulatory and compliance requirements that is difficult for peers to duplicate.

Interactive Brokers' comprehensive trading platform arguably gives it some pricing power, as is demonstrated by its higher revenue yield over client assets ratio when compared with U.S. peers. Most retail brokers in the U.S. don’t charge commissions on U.S. equity trading, and more than 90% of Interactive Broker’s clients choose an Interactive Brokers trading plan that requires commissions.

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Economic Moat

Interactive Brokers

Interactive Brokers Group, Inc. operates as an investment holding company, which engages in broker or dealer and proprietary trading businesses. It operates through the following segments: Electronic Brokerage and Corporate. The Electronic Brokerage segment is a direct market access broker, which serves the customers of both traditional brokers and prime brokers. The company was founded by Thomas Pechy Peterffy in 1977 and is headquartered in Greenwich, CT.

Earnings data Q1 2024

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GREENWICH, Conn.--(BUSINESS WIRE)---- $IBKR #IBKR--Interactive Brokers Group, Inc. (Nasdaq: IBKR) an automated global electronic broker, today reported its Electronic Brokerage monthly performance metrics for November. Brokerage highlights for the month included: 1.898 million Daily Average Revenue Trades (DARTs)1, 3% lower than prior year and 2% lower than prior month. Ending client equity of $404.3 billion, 27% higher than prior year and 10% higher than prior month. Ending client margin loan balances of $42.

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GREENWICH, Conn.--(BUSINESS WIRE)---- $IBKR #IBKR--Interactive Brokers Group, Inc. (Nasdaq: IBKR) an automated global electronic broker, today reported its Electronic Brokerage monthly performance metrics for October. Brokerage highlights for the month included: 1.934 million Daily Average Revenue Trades (DARTs)1, 2% lower than prior year and 8% higher than prior month. Ending client equity of $367.2 billion, 24% higher than prior year and 1% lower than prior month. Ending client margin loan balances of $42.1.

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GREENWICH, Conn.--(BUSINESS WIRE)---- $IBKR #Earnings--Interactive Brokers Group, Inc. (Nasdaq: IBKR) announces that its Chairman Thomas Peterffy will speak at the Wolfe Research Wealth Symposium on Thursday, November 9th at 9:20 a.m. ET. Mr. Peterffy's presentation can be heard live via webcast on the Internet accessible from the company's website, www.interactivebrokers.com/ir-events. Participants should log in approximately 10 minutes prior to the start of the presentation. A replay will also be available on th.

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Interactive Brokers Group, Inc. (NASDAQ:IBKR ) Q3 2023 Earnings Call Transcript October 17, 2023 4:30 PM ET Company Participants Nancy Stuebe - Director, IR Paul Brody - CFO Thomas Peterffy - Chairman Milan Galik - CEO Conference Call Participants Craig Siegenthaler - Bank of America Benjamin Budish - Barclays Patrick Moley - Piper Sandler Brennan Hawken - UBS Daniel Fannon - Jefferies Chris Allen - Citi James Yaro - Goldman Sachs Kyle Voigt - KBW Operator Good day, and thank you for standing by. Welcome to the Interactive Brokers Group Third Quarter 2023 Earnings Conference Call.

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