The first quarter of this year has been challenging for many banks and brokers, with some, such as Charles Schwab, struggling to maintain deposits. One reason for this trend is a rise in interest rates, allowing customers to shift funds from low-yielding accounts to higher-yielding ones.
One platform bucking the trend and increasing its client cash balance in the first quarter was Interactive Brokers (IBKR 1.71%). Unlike other brokers, Interactive Brokers has taken steps to ensure clients keep this cash with it. Here's what it did and why it could be a solid investment for your portfolio.
Deposit outflows hurt banks and brokers in Q1
Last month, investors witnessed SVB Financial's Silicon Valley Bank and Signature Bank collapse. Driving the failure was a decline in deposits at the two niche banks, most of which exceeded the Federal Deposit Insurance Corp.'s insurance limit.
Investor concerns shifted to other financial institutions, which have experienced deposit declines over the last year. One stock that was the subject of concern was the broker Charles Schwab, which saw deposits decline 17% last year and another 11% in the first quarter. Morgan Stanley was another broker whose deposits fell, down 3% from the previous quarter. Interactive Brokers bucked the trend and boosted its client cash balances by 11% from the prior quarter.
How Interactive Brokers attracted client money
Part of the struggle at banks concerns the amount of interest they pay customers for their deposits. For example, Charles Schwab pays a lower interest rate on cash in bank accounts than others and has dealt with so-called client cash sorting in previous years.
Interactive Brokers took a different approach, aiming to pay higher rates than competitors on uninvested cash balances. It currently pays 4.33% on client cash balances. This, coupled with its ultra-low commissions, has made Interactive Brokers an appealing platform for investors.
Even though it pays a higher rate than others, its net interest income, or the difference in interest earned and interest paid out to customers, still grew 126% in the quarter from last year to $637 million. This helped it increase its diluted earnings per share by 92% from last year to $1.42.
Image source: Getty Images.
Its high-margin business is flush with cash
Interactive Brokers' secret to success is its automated trading platform that caters to tech-savvy investors. Most of the company's senior managers are software engineers whose primary job is to automate as much of the business as possible.
As a result of this automation, Interactive Brokers has some of the highest margins compared to other financial companies, allowing it to run an asset-light business that generates healthy cash flow. The company is on firm financial footing. Interactive Brokers closed the first quarter with $3.2 billion in cash and cash equivalents with no long-term debt on its balance sheet.
Why it can keep winning
Interactive Brokers has done a solid job of attracting investors to its platform over the years. It enjoys big profit margins thanks to its commitment to automating its platform.
The company also has a conservative balance sheet with an asset mix that has short duration -- the opposite of what happened at Silicon Valley Bank. This short duration gives it flexibility to adjust to rising interest rates, letting it support its high deposit rates and low commissions.
Interactive Brokers is on sound footing and continues growing at a nice clip. It has taken prudent measures to stay nimble and offers some of the highest interest rates in the industry, making the broker a sound stock to consider buying today.
