How Interactive Brokers Is Reinventing Itself in the Robinhood Era

Interactive Brokers (IBKR 1.71%) was once the low-cost provider among financial brokerages, but Robinhood's entry and no-fee trading commissions going mainstream have forced the company to adjust its business model.

In this episode of "Beat and Raise" recorded on Jan. 21, Fool.com contributors Toby Bordelon and Brian Withers discuss how Interactive Brokers is turning to sources like margin lending and how it still delivered strong growth in 2021.

Toby Bordelon: Let's start with Interactive Brokers. Lets see what we got here. Here is Interactive Brokers, Brian. Pretty good. They missed on revenue, but it was up 22 percent year-over-year. Meet on those earnings-per-share, which is nice to see. Net income, I don't have the number off here, but net income was up 39 percent to $1.64 billion, which is fairly astonishing for them. What I have here are full-year numbers, by the way. For the fourth quarter, that revenue number was up only 0.7 percent to $603 million. Net income for the fourth quarter was actually down 11 percent for $338 million, but not too bad. Earnings per share, you see they're up 34 percent. For the quarter, again down 17 percent, 67 cents a share for the quarter, meeting expectations there.

You see the stock chart here. They've been lagging the S&P 500 for about a year. I don't know. I think with companies like Robinhood, there's been a lot of pressure on brokerages, especially discount brokerages. If you remember, years ago when Interactive Brokers first came onto the scene, their whole deal was like way low commissions. You can trade stocks like for a dollar a trade. Well, what happens if that's what you build your business on, when companies like Schwab, which we talked about yesterday, go no commissions and they have all the other services they rely on for fees and Interactive Brokers doesn't quite do as much. There's pressure there. There's pressure on them.

But one thing Interactive Brokers does do very well, margin loans, that's pretty much what to do. They pride themselves on low interest margin loans, thereby encouraging their customers to take on margin to trade, and so that was pretty good. The net interest income was up 31 percent for the quarter, it says seven billion dollars for the quarter, 295 billion for the year, and then net interest income for a large part of that is those margin loans they got going on. They make a lot of money off of that. Margin loans were actually up 40 percent to almost $55 billion in total outstanding by the end of the quarter. That business is still doing quite nice. Customer accounts up 56 percent, they have 1.68 billion now customer accounts. Customer equity up 30 percent. You think of this as their assets under management. They are not an asset manager, but the value in their accounts up 30 percent to almost $375 billion. They are quite good there. Commission revenue was up 11 percent. They still do charge commission in some cases, they are still getting a lot of money for that, so 32 million for the fourth quarter. Interestingly, they introduced crypto trading this past quarter in the United States.

Brian Withers: I think they had to.

Toby Bordelon: Well, they had to do something. They got that going now. It's a partnership with Paxos. They have to do that and they say they're rolling out  Crypto trading to other countries. Assume Interactive Brokers has operations all over the place. They're in a lot of different countries. They also introduced spot gold trading in the US. They're trying to move beyond equities and into other things customers might be interested in. This was fascinating to me. In the conference call, the CEO made a point of saying they don't sell their order flow for their Interactive Brokers pro customers, which is a nice little dig at Robinhood there. [laughs] He made a point of being clear about that. That's not our business. Pretty good, I would say. Overall pretty good. All things considered. They are in a spot. With the pressure on commissions and with interest rates being so low and make being careful themselves not to charge not much more than the prime rate for their margin loans. There's two big sources of income for them traditionally, commissions and that interest, it's just been not high at all.

Brian Withers: They're known for options trading.

Toby Bordelon: They are.

Brian Withers: Not having the most user-friendly interface. I don't know if they have an app. You're a customer, I assume, right?

Toby Bordelon: I'm actually not. I used to be, but I don't have an account anymore. They do have an app. I don't know what the state of it is now. But it's certainly not that gamified version you've seen with Robinhood, right?

Brian Withers: Right.

Toby Bordelon: They're not attracting that younger crowd as much as Robinhood is. That's an issue for them. They're not like Schwab. They don't have that bank aspect. They don't have the wealth management services that they offer to provide that source of revenue. They're in a tough spot in the current environment. They did say that as interest rates increase, that should be good for them in theory. They should be able to expand their margins a bit off of that. They are looking for that. The concern you have with the market you can have it in the falling market may be a slowing economy. Same issue I consider having with Schwab. Does that mean people save less invest less, do they trade less because they lose interest? It's less exciting to trade in a falling market than in a rising market.

They start to lose some customers, their customer acquisition slows down. That could weigh on them, the environment we're moving into. On the other hand, if we do get rising interest rates, that could be a risk for the economy. It could be good for them to the extent that they are able to expand that margin of interest they charge, maybe get a little more revenue there. I don't know. You can see the chart. It's not great compared to the S&P 500. I think they're doing fairly good often considered. They did have a good year. The numbers were good. Everything looks good for them in terms of growth. But we just want to see some expansion business a little bit, I think, and try to hopefully inch those margin rates up a little bit.

Brian Withers: It'll be interesting to see. It sounds like they're making the right moves and recognizing the position that they're in. But I look back. This is a stock advisor rec from 2014. It's done pretty well. It's up 164 percent since then. But over that long period of time, certainly the competitive dynamics have changed a bit.

Toby Bordelon: Yeah, definitely has. It'll be interesting to watch them over the next couple of years to see where they fit. Where do they fit? Is there really a place for them to carve out between these newer Robinhood type brokerages out there versus the more full service, but still discount and cheap Schwab type companies. Keep an eye on them. But I can't say I'm super excited about what I'm seeing just yet.