(EDGAR Online via COMTEX) -- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the audited consolidated financial statements and the related notes in Part II, Item 8, of this Annual Report on Form 10-K. 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 Part I, Item 1A of this Annual Report on Form 10-K.
We are an automated global electronic broker. We custody and service accounts for hedge and mutual funds, ETFs, registered investment advisers, proprietary trading groups, introducing brokers and individual investors. We specialize in routing orders and executing and processing trades in stocks, options, futures, forex, bonds, mutual funds and ETFs on more than 135 electronic exchanges and market centers in 33 countries and in 25 currencies seamlessly around the world.
As an electronic broker, we execute, clear and settle trades globally for both institutional and individual customers. Capitalizing on our proprietary technology, our 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. The emerging complexity of multiple market centers has provided us with the opportunity to build and continuously adapt our order routing software to secure excellent execution prices.
Since our inception in 1977, we have focused on developing proprietary software to automate broker-dealer functions. The proliferation of electronic exchanges and market centers over the last three decades has allowed us to integrate our software with an increasing number of trading venues into one automatically functioning, computerized platform that requires minimal human intervention.
Our customer base is diverse with respect to geography and segments. Currently, approximately 76% of our customers reside outside the U.S. in over 200 countries and territories, and over 50% of new customers come from outside the U.S. Approximately 64% 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 financing and securities lending to hedge funds; our model portfolio technology and automated share allocation and rebalancing tools are particularly attractive to financial advisors; and our trading platform, global access and low pricing attract introducing brokers.
In March 2020, the World Health Organization recognized the outbreak of the COVID-19 caused by a novel strain of the coronavirus as a pandemic. The pandemic affects all countries in which we operate. The response of governments and societies to the COVID-19 pandemic, which includes temporary closures of certain businesses; social distancing; travel restrictions, "shelter in place" and other governmental regulations; and reduced consumer spending due to job losses, has significantly impacted market volatility in the financial, commodities and energy markets, and general economic conditions.
The COVID-19 pandemic has precipitated unprecedented market conditions with equally unprecedented social and community challenges. Amid these challenges:
?The Company is committed to ensuring the highest levels of service to its customers so they can effectively manage their assets, portfolios and risks. The Company's technical infrastructure has withstood the challenges presented by the extraordinary volatility and increased market volume.
?The Company can run its business from alternate office locations and/or remotely if a Company office must temporarily close due to the spread of the COVID-19 pandemic.
?As announced on April 9, 2020, during the second quarter of 2020 the Company donated $5 million to assist efforts to provide food and support for people affected by the COVID-19 pandemic in the United States as well as to advance medical solutions.
The effects of the COVID-19 pandemic on the Company's financial results for 2020 can be summarized as follows: (1) higher commission revenue due to increased trading activity and a higher rate of customer accounts opened during this period; and (2) lower net interest income resulting from lower benchmark interest rates.
Table of Contents
The impact of the COVID-19 pandemic on the Company's future financial results could be significant but currently cannot be quantified, as it will depend on numerous evolving factors that currently cannot be accurately predicted, including, but not limited to, the duration and spread of the pandemic; its impact on our customers, employees and vendors; governmental actions in response to the pandemic; and the overall impact of the pandemic in the economy and society; among other factors. Any of these events could have a materially adverse effect on the Company's financial results.
2020 was a unique year, as the onset of the COVID-19 pandemic, together with unpredictable geopolitical events, created great uncertainty and volatility in the world's financial markets.
U.S. market volatility rose in 2020 over the prior year, with particularly high volatility in the first half of the year as the pandemic took hold. Fears about economic collapse were especially strong in the first quarter of 2020, as global markets fell and the S&P 500 declined 20%.
Central banks turned to monetary easing to buffer their national economies from a pandemic-induced downturn. In March, the U.S. Federal Reserve adopted a near-zero interest rate policy and other countries maintained or reduced rates to zero and below.
Following on the heels of the initial panic was a worldwide surge of interest in financial markets, particularly equity markets, as people following stay-at-home guidelines opened brokerage accounts for investing and trading. Equity market indices, which had fallen in the first quarter as the scope of the pandemic became known, responded to this surge in new participants and most indices rose over the remainder of the year. North American and Asian markets recovered more strongly than those in Europe, which may have been negatively affected by the final negotiations around Brexit.
A more active trading environment worldwide coincided with higher volatility, with the average Chicago Board Options Exchange Volatility Index ("VIX(R)") up 89% in the fourth quarter of 2020, compared to the year-ago quarter. Among our customer base, volatility is highly correlated with customer trading activity across product types. In 2020, higher volatility, in combination with strong customer account growth, led to significant increases in trading volume. The resulting boost to commission revenues was tempered by a decline in net interest income. Lower benchmark interest rates, though they reduced the rate of interest paid on customer cash to zero in most currencies, also reduced the rates we earned on margin lending and gave us fewer opportunities to earn net interest income on fully interest-sensitive balances.
In this environment, with near-zero interest rates and rising asset values in actively-trading markets, customer account growth was robust. Total customer accounts increased 56% in 2020 to over 1.07 million. Inflows from new and existing customers, combined with rising securities prices that generally lifted customers' investment values, led to customer equity growth of 66% to $288.6 billion. Institutional customers, such as hedge funds, mutual funds, introducing brokers, proprietary trading groups and financial advisors, comprised approximately 43% of total accounts and approximately 64% of total customer equity at the end of 2020. Customers seek out our superior technology and execution capabilities, global market access, and low costs, as well as our securities finance services, including margin lending and short sale support.
The following is a summary of the key profit drivers that affect our business and how they compared to 2019:
Global trading volumes. According to data received from exchanges, volumes in exchange-listed equity-based options rose by approximately 93% in the U.S. for the year ended December 31, 2020, compared to 2019, while U.S. equities volumes increased by 103% and exchange-listed futures increased by 31%. See the "Trading Volumes and Brokerage Statistics" section below in this Item 7 for additional details regarding our trade volumes, contract and share volumes, and brokerage statistics.
Volatility. Based on the VIX(R), average U.S. market volatility rose to 29.2 in 2020, up 89% from the average of 15.4 in 2019. Higher volatility tends to improve our electronic brokerage performance because it generally corresponds to stronger trading volumes. In 2020, as the VIX maintained elevated levels for most of the year, we saw the impact on both customer trading activity, which more than doubled, and our commissions revenue, which rose 58%.
Interest Rates. The U.S. Federal Reserve reduced the target federal funds rate to near-zero in March of 2020, mirroring rates in most other currencies, which generally ranged from near-zero to negative. Decreases in benchmark rates can lead to lower net interest income and a narrower net interest margin. As our margin balances are tied to benchmark rates, declining U.S. interest rates reduce the interest we receive on our U.S. dollar customer margin balances. Falling rates also reduce the interest we earn on our segregated cash, the majority of which is invested in U.S. government securities and related instruments. Partially offsetting these factors in 2020 were higher average customer credit balances, up 28%, higher average margin lending, up 9%, reduced interest expense due to lower rates, and strong securities lending activity and other financing activities. In total, our net interest income fell 19% compared to 2019.
Table of Contents
Currency fluctuations. As a global electronic broker 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 10 currencies we call the "GLOBAL" 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 2020 the value of the GLOBAL, as measured in U.S. dollars, increased 1.45% compared to its value as of December 31, 2019. A discussion of our approach for managing foreign currency exposure is contained in Part II, Item 7A of this Annual Report on Form 10-K entitled "Quantitative and Qualitative Disclosures about Market Risk."
In the fourth quarter of 2019, we introduced the reporting of non-GAAP financial measures, which excludes certain items that may not be indicative of our core operating results and business outlook. We believe these non-GAAP financial measures may be useful in evaluating the operating performance of our business and provide a better comparison of our results in the current period to those in prior and future periods. See the "Non-GAAP Financial Measures" section below in this Item 7 for additional details.
Pursuant to the requirements of Financial Accounting Standards Board's ("FASB") Accounting Standards Codification ("ASC") Topic 280, "Segment Reporting," we performed a quantitative and a qualitative assessment of our business and determined that our remaining market making activities no longer support our reporting of separate business segments. Accordingly, effective the first quarter of 2020, we discontinued the reporting of separate business segments. Since our decision to wind down our market making activities, management has continued to shift its focus to growing and strengthening our electronic brokerage business. We believe the elimination of segment reporting aligns our financial reporting with our business strategy and management's focus on the electronic brokerage business. The remaining market making activity is now reported as a component of "principal transactions," which is included in other income in the consolidated statements of comprehensive income.
Effective the first quarter of 2020, we also changed the presentation of our consolidated statements of comprehensive income to better align with our business strategy. Previously reported amounts have been adjusted to conform with the new presentation. See "Consolidated Statements of Comprehensive Income and Operating Business Segment Presentation Changes" in Note 2 - "Significant Accounting Policies" to the consolidated financial statements in Part II, Item 8 of this annual report on Form 10-K.
Diluted earnings per share were $2.42 for the year ended December 31, 2020 ("current year"), compared to diluted earnings per share of $2.10 for the year ended December 31, 2019 ("prior year"). Adjusted diluted earnings per share were $2.49 for the current year, compared to adjusted diluted earnings per share of $2.27 for the prior year. The calculation of diluted earnings per share is detailed in Note 4 - "Equity and Earnings Per Share" to the audited consolidated financial statements, in Part II, Item 8 of this Annual Report on Form 10-K.
For the current year, our net revenues were $2,218 million and income before income taxes was $1,256 million, compared to net revenues of $1,937 million and income before income taxes of $1,157 million in the prior year. Adjusted net revenues were $2,204 million and adjusted income before income taxes was $1,346 million, compared to adjusted net revenues of $1,984 million and adjusted income before income taxes of $1,246 million in the prior year.
The financial highlights for the current year were:
?Commission revenue showed strong growth, increasing $406 million, or 58%, from the prior year on higher customer trading volume within an active trading environment worldwide.
?Net interest income decreased $211 million, or 19%, from the prior year as the average federal funds effective rate, which, in part, drives the rates we earn on our interest-earning assets, decreased to an average of 0.38% from 2.16% in the prior year.
?Other income increased $52 million from the prior year. This increase was mainly comprised of (1) $41 million related to our currency diversification strategy, which lost $19 million in the current year compared to a loss of $60 million in the prior year; (2) $35 million related to our strategic investment in Up Fintech Holding Limited ("Tiger Brokers"), which increased to a $44 million mark-to-market gain in the current year from a $9 million mark-to-market gain in the prior year; partially offset by (3) $16 million related to our principal trading activities which gained $40 million in the current year compared to $56 million in the prior year; and (4) a $13 million impairment loss on our investment in OneChicago Exchange, as it ceased operations, during the current year.
?Pretax profit margin was 57% for the current year, down from 60% in the prior year. Adjusted pretax profit margin for the current year was 61%, down from 63% in the prior year.
Table of Contents
In connection with our currency diversification strategy as of December 31, 2020, approximately 27% of our equity was denominated in currencies other than the U.S. dollar. In the current year, our currency diversification strategy increased our comprehensive earnings by $105 million (compared to a decrease of $36 million in the prior year), as the U.S. dollar value of the GLOBAL increased by approximately 1.45%, compared to its value as of December 31, 2019. The effects of our currency diversification strategy are reported as (1) a component of other income (loss of $19 million) in the consolidated statements of comprehensive income and (2) other comprehensive income ("OCI") (gain of $124 million) in the consolidated statements of financial condition and the consolidated statements of comprehensive income. The full effect of the GLOBAL is captured in comprehensive income.
West Texas Intermediate Crude Oil Event
On April 20, 2020 the energy markets exhibited extraordinary price activity in the New York Mercantile Exchange ("NYMEX") West Texas Intermediate Crude Oil futures contract. The price of the May 2020 physically-settled futures contract dropped to an unprecedented negative price. This price was the basis for determining the settlement price for cash-settled futures contracts traded on the CME Globex and also for a separate, expiring cash-settled futures contract listed on the Intercontinental Exchange Europe ("ICE Europe"). Several of the Company's customers held long positions in these CME and ICE Europe contracts, and as a result they incurred losses, including losses in excess of the equity in their accounts. The Company fulfilled the required variation margin settlements with the respective clearinghouses on behalf of its customers. The Company subsequently compensated certain affected customers in connection with their losses resulting from the contracts settling at a price below zero. As a result, the Company recognized an aggregate loss of approximately $104 million, of which $103 million is included in general and administrative expenses and $1 million in customer bad debt expense in the consolidated statements of comprehensive income.
Certain Trends and Uncertainties
We believe that our current operations may be favorably or unfavorably impacted by the following trends that may affect our financial condition and results of operations:
?The COVID-19 pandemic has precipitated unprecedented market conditions with equally unprecedented social and community challenges. The impact of the COVID-19 pandemic on the Company's future financial results could be significant but currently cannot be quantified, as it will depend on numerous evolving factors that currently cannot be accurately predicted, including, but not limited to the duration and spread of the pandemic; its impact on our customers, employees and vendors; governmental regulations in response to the pandemic; and the overall impact of the pandemic on the economy and society; among other factors.
?Retail 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.
?Additional consolidation among market centers may adversely affect the value of our IB SmartRoutingSM software.
?Benchmark interest rates have fluctuated over the past years due to economic conditions. Changes in interest rates may not be predictable.
?Fiscal and/or monetary policy may change and impact the financial services business and securities markets.
?Price competition among broker-dealers may continue to intensify.
?Scrutiny of equity and options market makers, hedge funds, and soft dollar and payment for order flow practices by regulatory and legislative authorities has increased. New legislation or modifications to existing regulations and rules could occur in the future.
?Our remaining market making activities will continue to be impacted by market structure changes, market conditions, the level of automation of competitors, and the relationship between actual and implied volatility in the equities markets.
See "Risk Factors" in Part I, Item 1A of this Annual Report on Form 10-K for a discussion of other risks that may affect our financial condition and results of operations.
Table of Contents
Results of Operations
The table below presents our consolidated results of operations for the periods indicated. The period-to-period comparisons below of financial results are not necessarily indicative of future results.
Year-Ended December 31, 2020 2019 2018 (in millions, except share and per share amounts) Revenues Commissions $ 1,112 $ 706 $ 777 Other fees and services 175 141 148 Other income 59 7 49 Total non-interest income 1,346 854 974 Interest income 1,133 1,726 1,392 Interest expense (261) (643) (463) Total net interest income 872 1,083 929 Total net revenues 2,218 1,937 1,903 Non-interest expenses Execution, clearing and distribution fees 293 251 269 Employee compensation and benefits 325 288 264 Occupancy, depreciation and amortization 69 60 49 Communications 26 25 25 General and administrative 236 112 96 Customer bad debt 13 44 4 Total non-interest expenses 962 780 707 Income before income taxes 1,256 1,157 1,196 Income tax expense 77 68 71 Net income 1,179 1,089 1,125 Less net income attributable to noncontrolling interests 984 928 956 Net income available for common stockholders $ 195 $ 161 $ 169 Earnings per share Basic $ 2.44 $ 2.11 $ 2.30 Diluted $ 2.42 $ 2.10 $ 2.28 Weighted average common shares outstanding Basic 79,939,289 76,121,570 73,438,209 Diluted 80,638,908 76,825,863 74,266,370 Comprehensive income Net income available for common stockholders $ 195 $ 161 $ 169 Other comprehensive income Cumulative translation adjustment, before income taxes 26 4 (14) Income taxes related to items of other comprehensive income - - (1) Other comprehensive income (loss), net of tax 26 4 (13) Comprehensive income available for common stockholders $ 221 $ 165 $ 156 Comprehensive income attributable to noncontrolling interests Net income attributable to noncontrolling interests $ 984 $ 928 $ 956 Other comprehensive income - cumulative translation adjustment 98 20 (66) Comprehensive income attributable to noncontrolling interests $ 1,082 $ 948 $ 890
Table of Contents
The table below presents our consolidated results of operations as a percent of our total net revenues for the periods indicated.
Year Ended December 31, 2020 2019 2018 Revenues Commissions 50% 36% 41% Other fees and services 8% 7% 8% Other income 3% 0% 3% Total non-interest income 61% 44% 51% Interest income 51% 89% 73% Interest expense -12% -33% -24% Total net interest income 39% 56% 49% Total net revenues 100% 100% 100% Non-interest expenses Execution, clearing and distribution fees 13% 13% 14% Employee compensation and benefits 15% 15% 14% Occupancy, depreciation and amortization 3% 3% 3% Communications 1% 1% 1% General and administrative 11% 6% 5% Customer bad debt 1% 2% 0% Total non-interest expenses 43% 40% 37% Income before income taxes 57% 60% 63% Income tax expense 3% 4% 4% Net income 53% 56% 59% Less net income attributable to noncontrolling interests 44% 48% 50% Net income available for common stockholders 9% 8% 9%
Year Ended December 31, 2020 ("current year") compared to the Year Ended December 31, 2019 ("prior year")
Total net revenues, for the current year, increased $281 million, or 15%, compared to the prior year, to $2,218 million. The increase in net revenues was primarily due to higher commissions, other fees and services, and other income partially offset by lower net interest income.
We earn commissions from our cleared customers for whom we act as an executing and clearing broker and from our non-cleared customers for whom we act as an execution-only broker. We have a commission structure that allows customers to choose between an all-inclusive fixed, or "bundled", rate and a tiered, or "unbundled", rate that offers lower commissions for high volume customers. For "unbundled" commissions, we pass through regulatory and exchange fees separately from our commissions, adding transparency to our fee structure. Commissions also include payments for order flow income received from IBKR LiteSM liquidity providers. Our commissions are geographically diversified. In 2020, 2019, and 2018 we generated 29%, 33%, and 32%, respectively, of commissions from operations conducted internationally.
Commissions, for the current year, increased $406 million, or 58%, compared to . . .
Mar 01, 2021
Is there a problem with this press release? Contact the source provider Comtex at firstname.lastname@example.org. You can also contact MarketWatch Customer Service via our Customer Center.
(c) 1995-2021 Cybernet Data Systems, Inc. All Rights Reserved