Business Breakdowns
· Zack Fuss
[00:00:00] S0: When you look at this business's P&L and I'm looking at 2024 as a reference, you have about $1.7 billion in commissions which results in around $2 billion of non-interest related income. And then the rest $3 billion. Is that net interest income that NIM resulting in about $5 billion of revenue? How do you think about how that should evolve over time? The mix in quality as it relates to the evolution of their customer base, which you just mentioned? And then a second question related to that: When you see a business that's as significant an earner on net interest margin, you beg the question as it relates to interest rates and how they impact the business and what would happen in an environment where rates were going down versus going up. Just curious on those two items, really. Revenue mix and NIM. As the business evolves over time.
· Freddie Lait
[00:00:00] S1: There’s quite a few ways to cut it. This is clearly a cyclical business. It grows very rapidly, and account growth that had been around 25% per year is inflecting up towards 30 and 35% per year at the moment. As the flywheel gathers ahead of steam, the most important thing that I want to compel you to understand from our perspective is that it's account growths that matter. And if you need to believe account growths are what matter, then one needs to believe there's sort of stability in the other things like the amount of trading and the revenue per account. And so when we've interrogated the sort of the number of trades that's been going on as the mix has changed and the accounts have been growing, the trades per year have been falling. And again, one would expect hedge funds are trading many times a day, but RIAs and introducing brokers in particular are probably trading less than the 200 average trades per year. So we expect, and we've observed over the last five or ten years a kind of 5 to 10% decline in trades per year. So if the growth is similarly skewed between the different cohorts over the next few years, obviously in periods of volatility, one trades more, in periods of low volatility, one trades less. But as a trend, we put a deflation, if you like, in the number of trades per year. And I think there's probably small amount of potential deflation to come through from commissions. But the management team have talked about flat average commission levels from here, and it really does depend on mix. Again, a crypto trade is a very different commission level or an option compared to trading Google shares. The way it's worked is you have that kind of average 5, $600 per account of commission, it'll probably trade a little bit lower, maybe 5% down per year on an average basis, and then be cyclical with client equity. But if account growth is 35% or anything along those lines, that will dwarf any reinvestment backing price. That's the easier one, is the commissions. And obviously you can take your own view on average client equity and average equity market performance over the long term. When you factor those things in too, they offset that reduction normally on the nim.
· Freddie Lait
And I think this is probably one of the greatest misunderstandings in the business and it was certainly what gave us the opportunity to invest in it 18 months ago is the actual sensitivity. If you think about the alternative, if you think about a business like Schwab, which only a couple of years ago almost needed effectively a wholesale rights issue because it had what was effectively a run on its funding source because they weren't paying anything on their customers cash. And customers, when interest rates went up, started saying we'd better go to a bank or we better go to a money market fund. And they robbed Schwab of that source of cash and funding. The arrangement between interactive brokers and their customers is just far more honest and it's very transparent. And it's, as I said, on any large balance, more than $10,000, which is about two thirds of their entire customer cash, they just pay the local market base rate less 50 basis points. That results in a far lower risk. Firstly, to the point about Thomas Peterffy's risk conservation, clients are probably not going to leave because they get 50bps more elsewhere, even if they could. But secondarily, it's actually less interest rate sensitive than you think because if rates go down by 50 basis points, they still just take 50 basis points on a spread. And so they do disclose that overall interest rate sensitivity and for 100 basis point move down in interest rates around the globe. And again, this is a global business, probably 40% US. Jacopo's nodding at me, but it's global in nature. But if global interest rates fell 100 basis points, NIM would fall by 10%. And again, that's NIM per account. So if you're growing your accounts at 30, 35%, it will more than offset a multiple of times that net interest sensitivity. So that's why we focus so obsessively on the business model and the potential for account growth.
· Jacopo Di Nardo
[00:00:00] S2: From a NIM perspective, Zack, what's also pretty interesting is obviously margin loans tend to be higher yielding products maybe pay 100 basis points more than what they get on cash on the asset side. And these tend to be cyclical, but move in the opposite way of interest rates. So for example, if interest rates were to go back down to levels that we observed in 2019 or 2020 or 2021, the amount of leverage that investors are usually willing to take slightly higher. So the margin loan per account was materially higher back then. And so in the mix as interest rates fall, we would also expect margin loans to pick back up, helping a little bit with a NIM fall. If you go back in time, 2019, 2020 were pretty difficult years for whoever was exposed to rising interest rates and the company was still making maybe 30 basis points less than today net interest income, they have proven themselves in a way through cycle to be able to earn fair, attractive spread on assets and liabilities.
· Zack Fuss
[00:00:00] S0: And so you guys had mentioned the international opportunity here and where some of the growth is coming from. Obviously we've seen through the COVID backdrop, participation in capital markets and investing exploding, perhaps the advent of Robinhood as an on-ramp for that, but also just the financialization of western economies. What are the growth opportunities for this business? And I ask that in the context of on their earnings calls, they're very often asked if there's any M&A opportunities. And because they operate such low costs and they provide such attractive margin loans to customers, the pro forma earnings of acquisitions make the math very difficult for them. And so I guess weighing organic versus acquisitive growth, where they're going to see their business continue to expand?
· Freddie Lait
[00:00:00] S1: Interesting, you picked up on that comment too because it's one we've discussed in the past, which is this idea that if we buy a business but then we take it to our spreads and our offering, the underlying revenue and profits would collapse in that business. So they're not able to pay what the owner thinks they can pay. Because if they give back to customers as much as they give back in their main business, it would be a very different profit level. And so that to us is incredibly telling. They are open to acquisitions. They have done them in the past, but there's nothing out there which would make sense. And so they're going to grow organically. They have one of the lowest advertising budgets of all of the online brokers. And despite that, have outgrown anyone we look at. They're growing organically. They're growing because their rates are just better than everybody else's. And if you are trading any meaningful amount of capital, I'm not here to sell it. But I'm sure some people listening to this will be trading their own shares. And it's worth a look because it's a meaningful saving to go to a business like this. And I think at the moment what they're getting asked more about is this sort of potential for growth in the more B2B channels that we've discussed, the RIAs, the hedge funds and the introducing brokers. But notwithstanding that, individual accounts are growing very rapidly too. So the mix isn't changing very quickly. And when we think about growth potential, I mentioned earlier a few different sort of big, hairy, audacious goals for the management team. Schwab have I think 25 million accounts principally in the US. I think fidelity is something around that level. They are smaller on average, so there's a tail of those accounts which would be less profitable for this business. But three and a half or four million accounts that we have today is still a fraction of that domestically. And they talk about 20 million globally as a sort of first stop in their growth story. And then at a sort of later stage they talk about this 80 million number because in a couple of countries where they operate, they are already at sort of 1% of the population. And that would be that sort of level of penetration. And the key thing to that potential is people will still continue to trade a lot.