filings.toolsItem 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
131K characters. Original on sec.gov · Markdown
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 Item 8, included elsewhere in this report. 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.
Business Overview
We are an automated global electronic broker and market maker (although, we have substantially exited the options market making business—see Note 2—Discontinued Operations and Costs Associated with Exit or Disposal Activities to the audited consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K). We custody and service accounts for hedge and mutual funds, registered investment advisers, proprietary trading groups, introducing brokers and individual investors. We specialize in routing orders and executing and processing trades in securities, futures and foreign exchange instruments on more than 120 electronic exchanges and market centers around the world. Since our inception in 1977, we have focused on developing proprietary software to automate broker-dealer functions. The proliferation of electronic exchanges in the last 27 years has provided us with the opportunity to integrate our software with an increasing number of exchanges and market centers into one automatically functioning, computerized platform that requires minimal human intervention.
In connection with our IPO priced on May 3, 2007, IBG, Inc. purchased 10.0% of the membership interests in IBG LLC, became the sole managing member of IBG LLC and began to consolidate IBG LLC's financial results into its financial statements. Our primary assets are our ownership of approximately 17.4% of the membership interests of IBG LLC, the current holding company for our businesses, and our controlling interest and related contractual rights as the sole managing member of IBG LLC. The remaining approximately 82.6% of IBG LLC membership interests are held by Holdings, a holding company that is owned by our founder, Chairman and Chief Executive Officer, Mr. Thomas Peterffy and his affiliates, management and other employees of IBG LLC, and certain other members. The IBG LLC membership interests held by Holdings will be subject to purchase by us over time in connection with offerings by us of shares of our common stock.
Business Segments
We report our results in two operating business segments, electronic brokerage and market making (being discontinued). These segments are analyzed separately as these are the two principal business activities from which we derive our revenues and to which we allocate resources.
Electronic Brokerage. We conduct our electronic brokerage business through certain Interactive Brokers ("IB") subsidiaries. As an electronic broker, we execute, clear and settle trades globally for both institutional and individual customers. Capitalizing on our proprietary technology originally developed for our market making business, IB's 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. We offer our customers access to all classes of tradable, primarily exchange-listed products, including stocks, bonds, options, futures, forex and mutual funds traded on more than 120 exchanges and market centers in 26 countries and in 23 currencies seamlessly around the world. The emerging complexity of multiple market centers has provided us with the opportunity of building and continuously adapting our order routing software to secure excellent execution prices.
Our customer base is diverse with respect to geography and segments. Currently, more than half of our customers reside outside the U.S. in over 200 countries and territories, with over 50% of new customers coming 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 capital introduction and securities lending to hedge funds; and our model portfolio technology and automated share allocation and rebalancing tools are particularly attractive to financial advisors.
We provide a host of analytical tools such as IB Investors' MarketplaceSM, which allows wealth advisors to search for money managers and assign them to customer accounts based on their investment strategy. IB EmployeeTrackSM is widely used by compliance officers of financial institutions to streamline the process of tracking their employees' brokerage activities. The Probability LabSM allows our customers to analyze option strategies under various market assumptions. IB Portfolio Builder allows our customers to set up an investment strategy based on research and rankings from top research providers and fundamental data. IB Asset Management recruits registered financial advisors, vets them, analyzes their investment track records, groups them by their risk profile, and allows retail investors to assign their accounts to be traded by one or more advisors. In addition, Greenwich Compliance offers direct expert registration and start-up compliance services, as well as answers to basic day-to-day compliance questions for experienced investors and traders looking to start their own investment advisor firms. Greenwich Compliance professionals have regulatory and industry experience, and they can help investment advisors trading on the IB platform meet their registration and compliance needs. In 2017, we launched the IB Debit Mastercard® which allows customers to spend and borrow directly against their account and to make purchases and ATM withdrawals anywhere Debit Mastercard® is accepted around the world. In 2017, we also launched our Insured Bank Deposit Sweep Program, which provides customers with up to $2,500,000 of FDIC insurance on their eligible cash balances in addition to the existing $250,000 SIPC coverage for a maximum coverage of $2,750,000.
Market Making. On March 8, 2017 we announced our intention to discontinue our options market making activities globally and we are currently in the process of winding down these operations. Additionally, as we previously announced, we entered into a definitive transaction to transfer our U.S. options market making operations to Two Sigma Securities, LLC. This transaction closed on September 29, 2017. We intend to continue conducting certain proprietary trading activities in stocks and related instruments to facilitate our electronic brokerage customers' trading in products such as ETFs, ADRs, CFDs and other financial instruments. However, we do not expect this activity to be of sufficient size as to require reporting these activities as a separate segment after we discontinue our options market making activities.
We conduct our market making business primarily through our Timber Hill subsidiaries. As a market maker we provide liquidity by offering competitively tight bid/offer spreads over a broad base of tradable, exchange-listed products. As principal, we commit our own capital and derive revenues or incur losses from the difference between the price paid when securities are bought and the price received when those securities are sold. Because we provide continuous bid and offer quotations and we are continuously both buying and selling quoted securities, we may have either a long or a short position in a particular product at a given point in time. Our entire portfolio is evaluated many times per second and continuously rebalanced throughout the trading day, thus minimizing the risk of our portfolio at all times. This real-time rebalancing of our portfolio, together with our real-time proprietary risk management system, enables us to curtail risk.
The operating business segments are supported by our corporate segment which provides centralized services and executes our currency diversification strategy.
Business Environment
Against a backdrop of a still sluggish trading environment amid historically low market volatility, we maintained our position as the largest U.S. electronic broker as measured by the number of customer revenue trades and increased our Daily Average Revenue Trades ("DARTs") by 4% from 2016. New customer account growth remained robust as total customer accounts increased 25% from 2016 to 483 thousand. Institutional customers, such as hedge funds, mutual funds, introducing brokers, proprietary trading groups and financial advisors, comprised approximately 48% of total accounts and approximately 64% of total customer equity at the end of 2017. Our customer base continues to be geographically diverse, with customers residing in over 200 countries and territories and over 50% of new customers come from outside the U.S. Average equity per account increased 16% from 2016 to $258 thousand, as we continued to attract larger customers that seek our superior technology and low costs as well as our securities finance services, including margin lending and short sale support.
Electronic brokerage net interest income grew 30%, compared to 2016. The Federal Reserve's increases in the Federal Funds target rate in December 2016, March 2017, June 2017 and December 2017, together with higher average customer credit and margin loan balances, generated significantly more net interest income than in 2016. Our low margin lending rates are tied to benchmark rates, such as the Federal Funds rate in the U.S. In 2017, our customers paid 0.8% to 2.9% for their U.S. dollar margin loans with us. Average customer credit balances rose 14% due to an inflow of new accounts, and average customer margin loan balances increased by 41% from 2016 due to customers' appetite for increased leverage, along with expanded prime broker financing.
Market making segment results decreased in 2017 on lower trading gains, as expected, reflecting the winding down of our options market making operations.
The following is a summary of the key profit drivers that affect our business and how they compared to 2016:
Global trading volumes. According to data received from exchanges worldwide, volumes in exchange-listed equity-based options increased by approximately 7% globally and 3% in the U.S. for the year ended December 31, 2017, compared to 2016. During 2017 we accounted for approximately 5.1% (7.9% in 2016) of the exchange-listed equity-based options volume traded worldwide (including options on ETFs and stock index products), and approximately 7.7% (10.9% in 2016) of exchange-listed equity-based options volume traded in the U.S. The decreases in both measures were driven by our pull-back in options market making. It is important to note that this metric is not directly correlated with our profits. See tables on pages 62-63 of this Annual Report on Form 10-K for additional details regarding our trade volumes, contract and share volumes and brokerage statistics.
Volatility. Since we typically maintain an overall long volatility position, our market making profits are generally correlated with market volatility, protecting us against a severe market dislocation in either direction. Based on the Chicago Board Options Exchange Volatility Index ("VIX®"), the average volatility decreased to 11.1 in 2017, down 30% from the average of 15.9 in 2016. As we had begun to wind down our market making activities, volatility had less of an impact in 2017 than in 2016. Lower volatility also impacts our electronic brokerage segment because it results in fewer trading opportunities for our customers. Despite an 8% decline in average DARTS per account, our total DARTs increased 4% compared to 2016.
Currency fluctuations. As a global electronic broker and market maker 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 14 currencies we call the "GLOBAL" in order 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 2017 the value of the GLOBAL, as measured in U.S. dollars, increased 3.06% compared to its value as of December 31, 2016, which had a positive impact on our comprehensive earnings for 2017.
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."
Financial Overview
Diluted earnings per share were $1.07 for the year ended December 31, 2017 ("current year"), compared to diluted earnings per share of $1.25 for the year ended December 31, 2016 ("prior year"). The calculation of diluted earnings per share is detailed in Note 4 to the audited consolidated financial statements, in Part II, Item 8 of this Annual Report on Form 10-K.
On a comprehensive basis, which includes other comprehensive income ("OCI"), diluted earnings per share were $1.22 for the current year, compared to diluted earnings per share of $1.19 for the prior year.
In connection with our currency diversification strategy (i.e., GLOBALs) at December 31, 2017 approximately 30% 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 $175 million (versus a decrease of $65 million in the prior year), as the U.S. dollar value of the GLOBAL increased by approximately 3.06%, compared to its value as of December 31, 2016. The effects of our currency diversification strategy are reported as (1) a component of other income in the consolidated statement of comprehensive income and (2) OCI in the consolidated statement of financial condition and the consolidated statement of comprehensive income. The full effect of the GLOBAL is captured in comprehensive income.
In light of our decision to wind down our options market making activities globally, we removed the Singapore dollar (SGD) and realigned the relative weight of the U.S. dollar (USD) versus the other currency components to better reflect our businesses going forward. The new composition, which was effective as of the close of business on March 31, 2017, contains 14 currencies, one fewer than the prior composition.
Consolidated: For the current year, our net revenues were $1,702 million and income before income taxes was $1,049 million, compared to net revenues of $1,396 million and income before income taxes of $761 million in the prior year. The increase in income before income taxes in the current year was mainly driven by a 30% increase in net interest income and a 253% increase in other income, partially offset by a 75% decrease in trading gains. Our pre-tax profit margin was 62%, compared to 55% for the prior year.
The results for the year were negatively impacted by the effects of the Tax Cuts and Jobs Act (the "Tax Act"), enacted on December 22, 2017. The Tax Act significantly revised U.S. corporate income tax law by, among other things, reducing the corporate income tax rate from 35% to 21% and implementing a modified territorial tax system that includes a one-time transition tax on deemed repatriated earnings of foreign subsidiaries. As a result of the Tax Act, the current year includes a net reduction in consolidated earnings of approximately $84 million, of which $62 million is due to the one-time repatriation tax and a net $22 million is related to the remeasurement of our U.S. deferred tax assets at lower enacted corporate tax rates. The impact of the Tax Act recognized this year may differ, possibly materially, due to, among other things, changes in interpretations and assumptions the Company has made, guidance that may be issued and actions we may take as a result of the Tax Act. The effects of the Tax Act are further detailed in Note 10 to the audited consolidated financial statements, in Part II, Item 8 of this Annual Report on Form 10-K.
Electronic Brokerage: For the current year, income before income taxes in our electronic brokerage segment increased $104 million, or 14%, compared to the prior year, driven by higher net interest income and commissions, partially offset by lower other income and higher execution and clearing, general and administrative, and employee compensation and benefits expenses. Net revenues increased 13%, mainly from a 30% increase in net interest income, driven by higher Federal Funds rates and higher average customer credit and margin loan balances, and a 6% increase in commissions, primarily driven by higher options contract and stock share volumes; partially offset by a 16% decrease in other income, driven by a $12 million net mark-to-market loss on our U.S. government securities portfolio (compared to a $26 million net mark-to-market gain in the prior year). Pre-tax profit margin was 61% for both the current year and the prior year. Customer accounts grew 25%, and customer equity increased 46% from the prior year. For the current year, total DARTs for cleared and execution-only customers increased 4% to 688 thousand, compared to 660 thousand for the prior year.
Market Making: For the current year, income before income taxes in our market making segment decreased $71 million, compared to the prior year, to a loss of $27 million. Trading gains decreased 75% on lower trading volumes, as we wind down our options market making activities. In addition, the results for the current year include approximately $25 million in one-time exit costs, primarily consisting of the write-down of the value of exchange trading rights, included in general and administrative expenses, and severance costs for employee terminations, included in employee compensation and benefits expense. These exit costs were partially offset by a $13 million net recovery of costs related to the wind-down of our U.S. options market making operations included in other income.
On March 8, 2017, the Company announced its intention to discontinue its options market making activities globally. We will continue to access the phase-out of our market making operations outside of the U.S substantially over the coming months. Consistent with earlier estimates, we recognized approximately $25 million in one-time restructuring costs in the current year. A substantial portion of these exit costs is expected to be defrayed by continuing certain market making operations until the restructuring is complete. In addition, as a result of discontinuing our options market making activities, we expect that approximately $40 million in annual net expenses will be absorbed by the electronic brokerage segment, of which approximately $11 million was absorbed during the current year. As of December 31, 2017, on a prospective basis, approximately 82% of the resources related to the $40 million in annual net expenses have been transferred to the electronic brokerage segment.
We intend to continue conducting certain proprietary trading activities in stocks and related instruments to facilitate our electronic brokerage customers' trading in products such as ETFs, ADRs, CFDs and other financial instruments. However, we do not expect this activity to be of sufficient size as to require reporting these activities as a separate segment after we discontinue our options market making activities.
Sale of U.S. Options Market Making Operations: In connection with the sale of our U.S. options market making operations to Two Sigma Securities, LLC on September 29, 2017, during the current year we recorded a gain of $11 million and consulting fees of $2 million, reflecting the recovery of costs we incurred during the transition of these operations to Two Sigma Securities, LLC. As of the end of the current year, we had discontinued nearly all of our U.S. and the majority of our non-U.S. options market making operations.
Under the agreement with Two Sigma Securities, LLC, we have the opportunity for future income from an earn-out agreement, based on the performance of the options market making business under Two Sigma Securities, LLC's control. Under the agreement, we would earn a share of any U.S. profits after variable costs and other agreed-upon costs for three years; and a separate share of any non-U.S. profits after variable costs for four years. The agreement provides Two Sigma Securities, LLC the opportunity to enter non-U.S. parts of this business and, while it does not preclude us from participating in those markets, the earn-out would be effective only in markets where we did not compete.
Market making, by its nature, does not produce predictable earnings. Our results in any given period may be materially affected by volumes in the global financial markets, the level of competition and other factors. Electronic brokerage is more predictable, but it is dependent on customer activity, growth in customer accounts and assets, interest rates and other factors. For a further discussion of the factors that may affect our future operating results, please see the description of risk factors in Part I, Item 1A of this Annual Report on Form 10-K.
The following two tables present net revenues and income before income taxes for each of our business segments for the periods indicated.
Net revenues of each of our segments and our total net revenues are summarized below:
| Year Ended December 31, | ||||||||||
| 2017 | 2016 | 2015 | ||||||||
| (in millions) | ||||||||||
| Electronic brokerage | $ | 1,405 | $ | 1,239 | $ | 1,097 | ||||
| Market making | 86 | 190 | 298 | |||||||
| Corporate(1) | 211 | (33 | ) | (206 | ) | |||||
| | | | | | | | | | | |
| Total | $ | 1,702 | $ | 1,396 | $ | 1,189 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
(1)
The corporate segment includes corporate related activities, inter-segment eliminations, and gains and losses on positions held as part of our overall currency diversification strategy.
Income before income taxes of each of our segments and our total income before income taxes are summarized below:
| Year Ended December 31, | ||||||||||
| 2017 | 2016 | 2015 | ||||||||
| (in millions) | ||||||||||
| Electronic brokerage | $ | 860 | $ | 756 | $ | 536 | ||||
| Market making | (27 | ) | 44 | 130 | ||||||
| Corporate(1) | 216 | (39 | ) | (208 | ) | |||||
| | | | | | | | | | | |
| Total | $ | 1,049 | $ | 761 | $ | 458 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
(1)
The corporate segment includes corporate related activities, inter-segment eliminations, and gains and losses on positions held as part of our overall currency diversification strategy.
Net Revenues
Trading Gains
Trading gains are generated in the normal course of our market making business. Trading revenues are, in general, proportional to the trading activity in the markets. Trading gains accounted for approximately 2%, 12%, and 23% of our total net revenues for the years ended December 31, 2017, 2016, and 2015, respectively.
Trading gains also include revenues from net dividends. Market making activities require us to hold a substantial inventory of equity securities. We derive revenues in the form of dividend income from these equity securities. This dividend income is largely offset by dividend expense incurred when we make payments in lieu of dividends on short positions in securities in our portfolio. Dividend income and expense arise from holding market making positions over dates on which dividends are paid to
shareholders of record. When a stock pays a dividend, its market price is generally adjusted downward to reflect the value paid to the shareholders of record, which will not be received by those who purchase the stock on or after the ex-dividend date. Hence, the apparent gains and losses due to these price changes must be taken together with the dividends paid and received, respectively, to accurately reflect the results of our market making activities.
As a result of the way we have integrated our market making and securities lending systems, our trading gains and our net interest income from the market making segment are interchangeable and depend on the mix of market making positions in our portfolio. When implied interest rates in the equity and equity options and futures markets exceed the actual interest rates available to us, our market making systems tend to buy stock and sell it forward, which produces higher trading gains and lower net interest income. When these rates are inverted, our market making systems tend to sell stock and buy it forward, which produces lower trading gains and higher net interest income.
Commissions
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 accounted for 38%, 44%, and 52% of our total net revenues for the years ended December 31, 2017, 2016, and 2015, respectively.
Our commissions are geographically diversified. In 2017, 2016, and 2015 we generated 32%, 30%, and 26%, respectively, of commissions from operations conducted internationally.
Interest Income and Interest Expense
We earn interest on customer funds segregated in safekeeping accounts; on customer borrowings on margin, secured by marketable securities these customers hold with us; from our investments in U.S. and foreign government securities; from borrowing and lending securities in the general course of our brokerage and market making activities; and on deposits with banks. Interest income accounted for 53%, 43%, and 41% of our total net revenues for the years ended December 31, 2017, 2016, and 2015, respectively. Interest income is partially offset by interest expense.
We pay interest on cash balances customers hold with us; for borrowing and lending securities in the general course of our market making and brokerage activities; and on our borrowings. Interest expense accounted for 13%, 6%, and 6% of our total net revenues for the years ended December 31, 2017, 2016, and 2015, respectively.
We have automated and integrated our securities lending system with our trading system. As a result, we have been able to tailor our securities lending activity to produce more optimal results when taken together with trading gains (see description under "Trading Gains" above).
Net interest income accounted for approximately 40%, 38%, and 36% of our total net revenues for the years ended December 31, 2017, 2016, and 2015, respectively.
Other Income (Loss)
A primary component of other income (loss) is foreign currency gains and losses from our currency diversification strategy. A discussion of our approach to 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."
Other income (loss) also consists of mark-to-market gains and losses on our U.S. government securities portfolio; income from market data fees, account activity fees, risk exposure fees and payments for order flow; gains and losses on financial instruments at fair value and on other financial instruments that are not held for our market making activities. In addition, 2017 includes a net gain on the sale of the U.S. options market making operations. Other income (loss) accounted for approximately 20%, 7%, and (10%) of our total net revenues for the years ended December 31, 2017, 2016, and 2015, respectively.
Non-Interest Expenses
Execution and Clearing Expenses
Execution and clearing expenses include the costs of executing and clearing our market making and electronic brokerage trades, as well as liquidity rebates received from various exchanges and market centers, regulatory fees, market data fees, and payments for order flow. Execution fees are paid primarily to electronic exchanges and market centers on which we trade. Clearing fees are paid to clearing houses and clearing agents. Market data fees are paid to third parties to receive streaming price quotes and related information. Payments for order flow are paid primarily as part of exchange-mandated programs.
Employee Compensation and Benefits
Employee compensation and benefits include salaries, bonuses and other incentive compensation plans, group insurance, contributions to benefit programs and other related employee costs.
Occupancy, Depreciation and Amortization
Occupancy expenses consist primarily of rental payments on office and data center leases and related occupancy costs, such as utilities. Depreciation and amortization expenses result from the depreciation of fixed assets, such as computing and communications hardware, as well as amortization of leasehold improvements, capitalized in-house software development and acquired intangible assets.
Communications
Communications expenses consist primarily of the cost of voice and data telecommunications lines supporting our business, including connectivity to exchanges around the world.
General and Administrative and Customer Bad Debt
General and administrative expenses consist primarily of advertising, professional services expenses, such as legal and audit work, and other operating expenses. Customer bad debt expenses consist primarily of losses incurred by customers in excess of their assets with us, net of amounts recovered by us.
Income Tax Expense
We pay U.S. federal, state and local income taxes on our taxable income, which is proportional to the percentage we own of IBG LLC. Also, our subsidiaries are subject to income tax in the respective jurisdictions in which they operate.
Noncontrolling Interest
We are the sole managing member of IBG LLC and, as such, operate and control all of the business and affairs of IBG LLC and its subsidiaries and consolidate IBG LLC's financial results into our financial statements. As of December 31, 2017, we held approximately 17.4% ownership interest in
IBG LLC. Holdings is owned by the original members of IBG LLC and holds approximately 82.6% ownership interest in IBG LLC. We reflect Holdings' ownership as a noncontrolling interest in our consolidated statement of financial condition, consolidated statement of comprehensive income, consolidated statement of changes in equity and consolidated statement of cash flows. Our share of IBG LLC's net income, excluding Holdings' noncontrolling interest, for the current year was approximately 17.0%, compared to approximately 16.2% for the prior year.
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:
Our market making activities will continue to be impacted by the following trends until we complete its wind-down.
Over the past several years, the effects of market structure changes, competition (in particular, from high frequency traders) and market conditions have, during certain periods, exerted downward pressure on bid/offer spreads realized by market makers.
In recent years, in an effort to improve the quality of their executions as well as to increase efficiencies, market makers have increased the level of automation within their operations, which may allow them to compete more effectively with us.
A driver of our market making profits is the relationship between actual and implied volatility in the equities markets. The cost of maintaining our conservative risk profile is based on implied volatility, while our profitability, in part, is based on actual volatility. Hence, our profitability is increased when actual volatility runs above implied volatility and it is decreased when actual volatility falls below implied volatility. Implied volatility tends to lag actual volatility.
Retail broker-dealer 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.
Scrutiny of equity and option market makers, hedge funds and soft dollar practices by regulatory and legislative authorities has increased. New legislation or modifications to existing regulations and rules could occur in the future.
Additional consolidation among market centers may adversely affect the value of our SmartRoutingSM software.
Benchmark interest rates have fluctuated over the past years due to economic conditions. Changes in interest rates may not be predictable.
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.
Results of Operations
The tables in the period comparisons below provide summaries of our consolidated results of operations. The period-to-period comparisons below of financial results are not necessarily indicative of future results.
| Year Ended December 31, | ||||||||||
| 2017 | 2016 | 2015 | ||||||||
| (in millions, except share and per share amounts) | ||||||||||
| Revenues | ||||||||||
| Trading gains | $ | 40 | $ | 163 | $ | 269 | ||||
| Commissions | 647 | 612 | 617 | |||||||
| Interest income | 908 | 606 | 492 | |||||||
| Other income (loss) | 332 | 94 | (122 | ) | ||||||
| | | | | | | | | | | |
| Total revenues | 1,927 | 1,475 | 1,256 | |||||||
| Interest expense | 225 | 79 | 67 | |||||||
| | | | | | | | | | | |
| Total net revenues | 1,702 | 1,396 | 1,189 | |||||||
| | | | | | | | | | | |
| Non-interest expenses | ||||||||||
| Execution and clearing | 241 | 244 | 231 | |||||||
| Employee compensation and benefits | 249 | 242 | 227 | |||||||
| Occupancy, depreciation and amortization | 47 | 51 | 44 | |||||||
| Communications | 28 | 30 | 25 | |||||||
| General and administrative | 86 | 62 | 58 | |||||||
| Customer bad debt | 2 | 6 | 146 | |||||||
| | | | | | | | | | | |
| Total non-interest expenses | 653 | 635 | 731 | |||||||
| | | | | | | | | | | |
| Income before income taxes | 1,049 | 761 | 458 | |||||||
| Income tax expense | 256 | 62 | 43 | |||||||
| | | | | | | | | | | |
| Net income | 793 | 699 | 415 | |||||||
| Less net income attributable to noncontrolling interests | 717 | 615 | 366 | |||||||
| | | | | | | | | | | |
| Net income available for common stockholders | $ | 76 | $ | 84 | $ | 49 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Earnings per share | ||||||||||
| Basic | $ | 1.09 | $ | 1.28 | $ | 0.80 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Diluted | $ | 1.07 | $ | 1.25 | $ | 0.78 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Weighted average common shares outstanding | ||||||||||
| Basic | 69,926,933 | 66,013,247 | 61,043,071 | |||||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Diluted | 70,904,921 | 67,299,413 | 62,509,796 | |||||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Comprehensive income | ||||||||||
| Net income available for common stockholders | $ | 76 | $ | 84 | $ | 49 | ||||
| | | | | | | | | | | |
| Other comprehensive income | ||||||||||
| Cumulative translation adjustment, before income taxes | 11 | (4 | ) | (10 | ) | |||||
| Income taxes related to items of other comprehensive income | — | — | — | |||||||
| | | | | | | | | | | |
| Other comprehensive income (loss), net of tax | 11 | (4 | ) | (10 | ) | |||||
| | | | | | | | | | | |
| Comprehensive income available for common stockholders | $ | 87 | $ | 80 | $ | 39 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Comprehensive income attributable to noncontrolling interests | ||||||||||
| Net income attributable to noncontrolling interests | $ | 717 | $ | 615 | $ | 366 | ||||
| Other comprehensive income—cumulative translation adjustment | 54 | (21 | ) | (53 | ) | |||||
| | | | | | | | | | | |
| Comprehensive income attributable to noncontrolling interests | $ | 771 | $ | 594 | $ | 313 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
The following table sets forth our consolidated results of operations as a percent of our total net revenues for the indicated periods:
| Year Ended December 31, | ||||||||||
| 2017 | 2016 | 2015 | ||||||||
| Revenues | ||||||||||
| Trading gains | 2 | % | 12 | % | 23 | % | ||||
| Commissions | 38 | % | 44 | % | 52 | % | ||||
| Interest income | 53 | % | 43 | % | 41 | % | ||||
| Other income (loss) | 20 | % | 7 | % | (10 | )% | ||||
| | | | | | | | | | | |
| Total revenues | 113 | % | 106 | % | 106 | % | ||||
| Interest expense | 13 | % | 6 | % | 6 | % | ||||
| | | | | | | | | | | |
| Total net revenues | 100 | % | 100 | % | 100 | % | ||||
| | | | | | | | | | | |
| Non-interest expenses | ||||||||||
| Execution and clearing | 14 | % | 17 | % | 19 | % | ||||
| Employee compensation and benefits | 15 | % | 17 | % | 19 | % | ||||
| Occupancy, depreciation and amortization | 3 | % | 4 | % | 4 | % | ||||
| Communications | 2 | % | 2 | % | 2 | % | ||||
| General and administrative | 5 | % | 4 | % | 5 | % | ||||
| Customer bad debt | 0 | % | 0 | % | 12 | % | ||||
| | | | | | | | | | | |
| Total non-interest expenses | 38 | % | 45 | % | 61 | % | ||||
| | | | | | | | | | | |
| Income before income taxes | 62 | % | 55 | % | 39 | % | ||||
| Income tax expense | 15 | % | 4 | % | 4 | % | ||||
| Net Income | 47 | % | 50 | % | 35 | % | ||||
| Less net income attributable to noncontrolling interests | 42 | % | 44 | % | 31 | % | ||||
| | | | | | | | | | | |
| Net income available for common stockholders | 4 | % | 6 | % | 4 | % | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Year Ended December 31, 2017 ("current year") compared to the Year Ended December 31, 2016 ("prior year")
Net Revenues
Total net revenues, for the current year, increased $306 million, or 22%, compared to the prior year, to $1,702 million. The increase in net revenues was primarily due to higher net interest income, other income and commissions, partially offset by lower trading gains. Trading volume is an important driver of revenues and costs for both our electronic brokerage and market making segments. During the current year, our electronic brokerage options contract and stock share volumes increased 11% and 50% (largely driven by low-priced U.S. and Hong Kong shares), respectively, while futures contract volume decreased 8%, compared to the prior year. Market making trading volumes were significantly down as we began to wind down our market making activities globally during the current year.
Trading Gains
Trading gains, for the current year, decreased $123 million, or 75%, compared to the prior year, to $40 million. Reflecting the wind-down of our options market making activities during the current year, our market making operations executed 31.3 million trades compared to 64.0 million trades executed in the prior year. In addition, market making options and futures contract and stock share volumes decreased 67%, 60%, and 45%, respectively, compared to the prior year.
Trading gains were also unfavorably impacted by decreases in volatility and in the actual-to-implied volatility ratio as compared to the prior year. Through our announcement on March 8, 2017, the market making segment had incurred net losses and the segment was not expected to return to meaningful profitability; however, the rate of continuing losses was substantially reduced after we began curtailing these activities.
The VIX®, which measures perceived U.S. equity market volatility, decreased 30% to an average of 11.1 for the current year, compared to an average of 15.9 for the prior year. The ratio of actual to implied volatility decreased to an average of 60% for the current year, compared to an average of 83% for the prior year. Both of these were negative trends for market making performance, but had less of an impact in the current year than in the prior year as we curtailed our market making activities.
Included in trading gains are net dividends. Dividend income and expense arise from holding market making positions over dates on which dividends are paid to shareholders of record. When a stock pays a dividend, its market price is generally adjusted downward to reflect the value paid, which will not be received by those who purchase stock on or after the ex-dividend date. Hence, the apparent gains and losses due to these price changes, reflecting the value of dividends paid to shareholders, must be taken together with the dividends paid and received, respectively, to accurately reflect the results of our market making activities.
Commissions
Commissions, for the current year, increased $35 million, or 6%, compared to the prior year, to $647 million, driven by higher customer trading volumes in options and stocks, continued customer account growth and higher average commission per customer order. Cleared customer options contract and stock share volumes increased 11% and 51%, respectively, while futures contract volume decreased 9%, compared to the prior year. Total DARTs for cleared and execution-only customers, for the current year, increased 4% to 688 thousand, compared to 660 thousand for the prior year. DARTs for cleared customers, i.e., customers for whom we execute trades, as well as, clear and carry positions, for the current year, increased 5% to 639 thousand, compared to 609 thousand for the prior year. Average commission per DART for cleared customers, for the current year, increased by 1% to $3.97, compared to $3.92 for the prior year, reflecting larger average order sizes in stocks.
Interest Income and Interest Expense
Net interest income (interest income less interest expense), for the current year, increased $156 million, or 30%, compared to the prior year, to $683 million. The increase in net interest income was driven by higher average customer credit and margin loan balances and higher benchmark interest rates.
Net interest income on customer balances, for the current year, increased $141 million, compared to the prior year, driven by a $5.5 billion increase in average customer credit balances, a portion of which were invested in interest-bearing U.S. government securities, a $6.8 billion increase in average customer margin loans, and a 61 basis point increase in the average Federal Funds effective rate to 1.00%, compared to the prior year. As a result of the increases in the Federal Funds effective rate since December 2016, interest expense on customer credit balances increased from the prior year, in part, as certain customer credit balances that were not eligible to earn interest in the prior year became eligible to earn interest in the current year. The increase in benchmark rates also drove higher interest income earned on the investment of customer segregated cash and on margin lending to customers.
We earn income on securities loaned and borrowed to support customer long and short stock holdings in margin accounts. In addition, our Stock Yield Enhancement Program provides an opportunity for customers with fully-paid stock to allow us to lend it out. We pay customers a rebate on the cash collateral generally equal to 50% of the income we earn from lending the shares. We place cash collateral securing the loans in the customer's account.
In the current year, average securities borrowed decreased 5%, to $4.0 billion and average securities loaned increased 35%, to $3.9 billion, compared to the prior year. Net interest earned from securities lending is also affected by the level of demand for securities positions held by our customers and in our market making business. During the current year, net fees earned by our electronic brokerage and market making segments from securities lending transactions increased $5 million, or 3%, compared to the prior year. The increase in net interest income from securities lending transactions was attributable to the electronic brokerage segment. It should be noted that securities lending transactions entered into to support customer activity may produce interest income (expense) that is offset by interest expense (income) related to customer balances.
The Company measures return on interest-earning assets using net interest margin ("NIM"). NIM is computed by dividing the annualized net interest income by the average interest-earning assets for the period. Interest-earning assets consist of cash and securities segregated for regulatory purposes (including U.S. government securities and securities purchased under agreements to resell), customer margin loans, securities borrowed and other interest-earning assets (solely firm assets).
The following table presents net interest income information corresponding to interest-earning assets and interest-bearing liabilities for the three years ended December 31, 2017, 2016 and 2015:
| Year Ended December 31, | ||||||||||
| 2017 | 2016 | 2015 | ||||||||
| (in millions) | ||||||||||
| Average interest-earning assets | ||||||||||
| Segregated cash and securities | $ | 23,824 | $ | 24,134 | $ | 18,314 | ||||
| Customer margin loans | 23,289 | 16,506 | 17,247 | |||||||
| Securities borrowed | 3,964 | 4,155 | 3,511 | |||||||
| Other interest-earning assets | 2,930 | 2,495 | 2,004 | |||||||
| | | | | | | | | | | |
| $ | 54,007 | $ | 47,290 | $ | 41,076 | |||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Average interest-bearing liabilities | ||||||||||
| Customer credit balances | $ | 45,515 | $ | 39,980 | $ | 34,276 | ||||
| Securities loaned | 3,917 | 2,897 | 3,000 | |||||||
| | | | | | | | | | | |
| $ | 49,432 | $ | 42,877 | $ | 37,276 | |||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Net Interest income | ||||||||||
| Segregated cash and securities, net | $ | 226 | $ | 149 | $ | 68 | ||||
| Customer margin loans | 392 | 217 | 199 | |||||||
| Securities borrowed and loaned, net | 161 | 156 | 149 | |||||||
| Customer credit balances | (123 | ) | (12 | ) | (11 | ) | ||||
| Other net interest income(1) | 32 | 17 | 20 | |||||||
| | | | | | | | | | | |
| Net interest income | $ | 688 | $ | 527 | $ | 425 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Net interest margin ("NIM") | 1.27 | % | 1.11 | % | 1.03 | % | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Annualized Yields | ||||||||||
| Segregated cash and securities | 0.95 | % | 0.62 | % | 0.37 | % | ||||
| Customer margin loans | 1.68 | % | 1.31 | % | 1.15 | % | ||||
| Customer credit balances | 0.27 | % | 0.03 | % | 0.03 | % |
(1)
Includes income from financial instruments which has the same characteristics as interest, but is reported in other income.
Other Income
Other income, for the current year, increased $238 million, or 253%, compared to the prior year, to $332 million, mainly driven by a gain of $110 million from our currency diversification strategy for the current year, compared to a loss of $40 million for the prior year, a gain of $93 million from the remeasurement of our Tax Receivable Agreement liability, payable to Holdings, as a result of the Tax Act, and a $13 million recovery of costs related to the wind-down of our U.S. options market making operations, partially offset by a $12 million net mark-to-market loss on our U.S. government securities portfolio in the current year, compared to $26 million net mark-to-market gain in the prior year. Despite an increase in average medium term interest rates during the current year, the net mark-to-market loss on our U.S. government securities portfolio was only $12 million, reflecting a reduction in the size and average duration of the portfolio. In general, mark-to-market gains and losses on U.S. government securities are expected to reverse when, as intended, these securities are held to maturity. A discussion of our approach to 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.
Non-Interest Expenses
Non-interest expenses, for the current year, increased $18 million, or 3%, compared to the prior year, to $653 million, mainly due to a $24 million increase in general and administrative expenses and a $7 million increase in employee compensation and benefits, partially offset by a $4 million decrease in occupancy expenses and a $4 million decrease in customer bad debt, compared to the prior year. As a percentage of total net revenues, non-interest expenses were 38% for the current year and 45% for the prior year.
Execution and Clearing
Execution and clearing expenses, for the current year, decreased $3 million, or 1%, compared to the prior year, to $241 million, driven by lower trading volume in our market making segment as we began to wind down our market making activities globally. Market making options and futures contract and stock share volumes decreased 67%, 60% and 45%, respectively, from the prior year. This was largely offset by higher execution and clearing expenses in our electronic brokerage segment, where customer options contract and stock share volumes increased 11% and 50%, respectively. In addition, the electronic brokerage segment received lower liquidity rebates from exchanges operating a make-or-take pricing model, in which we are paid for adding liquidity and charged for removing liquidity, as trading volume shifted away from orders that added liquidity to orders that removed liquidity in the current year compared to the prior year.
Employee Compensation and Benefits
Employee compensation and benefits expenses, for the current year, increased $7 million, or 3%, compared to the prior year, to $249 million, mainly due to one-time exit costs related to the wind-down of our options market making activities and a 5% increase in the average number of employees to 1,213, for the current year, compared to 1,154 for the prior year. Within the operating business segments, we continued to add staff in customer service, legal and compliance, and software development to support electronic brokerage and reduce staff in market making. As we continue to grow, our focus on automation has allowed us to maintain a relatively small staff. As a percentage of total net revenues, employee compensation and benefits expenses were 15% for the current year and 17% for the prior year.
Occupancy, Depreciation and Amortization
Occupancy, depreciation and amortization expenses, for the current year, decreased $4 million, or 8%, compared to the prior year, to $47 million, mainly due to lower office rent expenses and equipment related costs. As a percentage of total net revenues, occupancy, depreciation and amortization expenses were 3% for the current year and 4% for the prior year.
Communications
Communications expenses, for the current year, decreased $2 million, or 7%, compared to the prior year, to $28 million, mainly due to lower costs of data lines to exchanges during the current year as we wound down our market making activities. As a percentage of total net revenues, communications expenses were 2% for both the current year and the prior year.
General and Administrative
General and administrative expenses, for the current year, increased $24 million, or 39%, compared to the prior year, to $86 million, mainly due to a $21 million write-down of the value of exchange trading rights related to the wind-down of our U.S. options market making operations and higher advertising expenditures. As a percentage of total net revenues, general and administrative expenses were 5% for the current year and 4% for the prior year.
Customer Bad Debt
Customer bad debt expense, for the current year, decreased $4 million, or 67%, compared to the prior year, to $2 million.
Income Tax Expense
Income tax expense, for the current year, increased $194 million, or 313%, to $256 million, compared to the prior year, primarily due to the effects of the Tax Act, which was enacted on December 22, 2017. The Tax Act significantly revised U.S. corporate income tax law by, among other things, reducing the corporate income tax rate from 35% to 21% and implementing a modified territorial tax system that includes a one-time transition tax on deemed repatriated earnings of foreign subsidiaries. See Note 10 to the audited consolidated financial statements, in Part II, Item 8 of this Annual Report on Form 10-K.
As a result of the Tax Act, the current year results include a net reduction of approximately $84 million related to the following: (1) the one-time transition tax on deemed repatriation of earnings on some of our foreign subsidiaries resulted in an additional income tax expense of $62 million, to be paid over an eight-year period, (2) the remeasurement of deferred tax assets and liabilities at the reduced corporate income tax rate of 21% resulted in additional income tax expense of $115 million, and (3) in connection with the remeasurement of our deferred tax asset arising from the acquisition of interests in IBG LLC, we also remeasured the related Tax Receivable Agreement liability, payable to Holdings, resulting in the recognition of a $93 million gain, which is reported in other income in the consolidated statements of comprehensive income (see Note 4 to the audited consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K).
The following table presents information about our income tax expense for the three years ended December 31, 2017, 2016 and 2015.
| Year Ended December 31, | ||||||||||
| 2017 | 2016 | 2015 | ||||||||
| (in millions, except %) | ||||||||||
| Consolidated | ||||||||||
| Consolidated income before income taxes | $ | 1,049 | $ | 761 | $ | 458 | ||||
| IBG, Inc. stand-alone income before income taxes | 92 | (1) | (1 | ) | — | |||||
| Gains (losses) on the Company's common stock held by Operating Companies | — | (1 | ) | 4 | ||||||
| | | | | | | | | | | |
| Operating Companies income before income taxes | $ | 957 | $ | 761 | $ | 462 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Operating Companies | ||||||||||
| Income before income taxes | $ | 957 | $ | 761 | $ | 462 | ||||
| Income tax expense | 31 | 30 | 25 | |||||||
| Income tax expense—effect of the Tax Act | 62 | — | — | |||||||
| | | | | | | | | | | |
| Net income available to members | $ | 864 | $ | 731 | $ | 437 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| IBG, Inc. | ||||||||||
| Average ownership percentage in IBG LLC | 17.0 | % | 16.2 | % | 15.1 | % | ||||
| | | | | | | | | | | |
| Net income available to IBG, Inc. from Operating Companies | $ | 147 | $ | 117 | $ | 67 | ||||
| IBG, Inc. stand-alone income before income taxes | 92 | (1) | (1 | ) | — | |||||
| | | | | | | | | | | |
| Income before income taxes | 239 | 116 | 67 | |||||||
| | | | | | | | | | | |
| Income tax expense | 48 | 32 | 18 | |||||||
| Income tax expense—effect of the Tax Act | 115 | — | — | |||||||
| | | | | | | | | | | |
| Net income available to common stockholders | $ | 76 | $ | 84 | $ | 49 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Consolidated income tax expense | ||||||||||
| Income tax expense attributable to Operating Companies | $ | 93 | $ | 30 | $ | 25 | ||||
| Income tax expense attributable IBG, Inc. | 163 | 32 | 18 | |||||||
| | | | | | | | | | | |
| Consolidated income tax expense | $ | 256 | $ | 62 | $ | 43 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Consolidated effects of the Tax Act | ||||||||||
| One-time repatriation tax expense | $ | 62 | $ | — | $ | — | ||||
| Remeasurement of U.S. deferred tax assets | 115 | — | — | |||||||
| Remeasurement of liability under the Tax Receivable Agreement | (93 | ) | — | — | ||||||
| | | | | | | | | | | |
| Total decrease in earnings resulting from the Tax Act | $ | 84 | $ | — | $ | — | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
(1)
Includes a $93 million gain from the remeasurement of the Tax Receivable Agreement liability as a result of the Tax Act, included in other income.
Our operating results, for the current year, excluding the effects of our currency diversification strategy, the net mark-to-market gains and losses from our U.S. government securities portfolio, the one-time net costs related to the wind-down of our options market making activities, and the remeasurement gain on our Tax Receivable Agreement liability due to the Tax Act, compared to the prior year, were as follows: net revenues were $1,500 million, up 6%; non-interest expenses were $628 million, down 1%; income before income taxes was $872 million, up 13%; and pre-tax profit margin increased to 58% for the current year, from 55% for the prior year.
Year Ended December 31, 2016 compared to the Year Ended December 31, 2015
Net Revenues
Total net revenues, in 2016, increased $207 million, or 17%, compared to 2015, to $1,396 million. The increase in net revenues was primarily due to higher other income (driven by lower losses on our currency diversification strategy and net mark-to-market gains on our U.S. government securities portfolio), and net interest income; partially offset by lower trading gains and commissions. Trading volume is an important driver of revenues and costs for both our electronic brokerage and market making segments. During 2016, our futures contract volume increased 2%, while options contract and stock share volumes each decreased 10%, compared to 2015.
Trading Gains
Trading gains, in 2016, decreased $106 million, or 39%, compared to 2015, to $163 million. As market makers, we provide liquidity by buying from sellers and selling to buyers. During 2016, our market making operations executed 64.0 million trades compared to 65.9 million trades executed in 2015. Market making options and futures contract and stock share volumes decreased 8%, 5%, and 15%, respectively, compared to 2015.
Trading gains were unfavorably impacted by lower trading volumes, a divergence in price behavior among a significant number of individual stocks during the first quarter of 2016, and decreases in volatility and in the actual-to-implied volatility ratio as compared to 2015. The VIX®, which measures perceived U.S. equity market volatility, decreased 5% to an average of 15.9 in 2016, compared to an average of 16.7 in 2015. The ratio of actual to implied volatility decreased to an average of 83% in 2016, compared to an average of 88% in 2015.
Included in trading gains are net dividends. Dividend income and expense arise from holding market making positions over dates on which dividends are paid to shareholders of record. When a stock pays a dividend, its market price is generally adjusted downward to reflect the value paid, which will not be received by those who purchase stock on or after the ex-dividend date. Hence, the apparent gains and losses due to these price changes, reflecting the value of dividends paid to shareholders, must be taken together with the dividends paid and received, respectively, to accurately reflect the results of our market making operations.
Commissions
Commissions, in 2016, decreased $5 million, or 1%, compared to 2015, to $612 million, driven by mixed customer trading volumes and lower average commission per customer order, but moderated by continued customer account growth. Cleared customer options contract and stock share volumes decreased 7% and 10%, respectively, while futures contract volume increased 3%, compared to 2015. Total DARTs for cleared and execution-only customers, in 2016, increased 2% to 660 thousand, compared to 647 thousand during 2015. DARTs for cleared customers, i.e., customers for whom we execute trades, as well as, clear and carry positions, in 2016, increased 3% to 609 thousand, compared to 589 thousand in 2015. Average commission per DART for cleared customers, in 2016, decreased by 4% to $3.92, compared to $4.07 in 2015, reflecting smaller average order sizes across most product types.
Interest Income and Interest Expense
Net interest income (interest income less interest expense), in 2016, increased $102 million, or 24%, compared to 2015, to $527 million. The increase in net interest income was driven by higher customer cash balances and higher net fees earned from securities lending transactions.
Net interest income on customer balances, in 2016, increased $100 million, compared to 2015, driven by a $5.3 billion increase in average customer cash balances, the majority of which were invested in interest-bearing U.S. government securities, while average customer margin borrowings decreased $1.5 billion. In addition, the average Fed Funds effective rate increased by approximately 26 basis points to 0.39% in 2016, compared to 2015.
We earn income on securities loaned and borrowed to support customer long and short stock holdings in margin accounts. In addition, our Stock Yield Enhancement Program provides an opportunity for customers with fully-paid stock to allow us to lend it out. We pay customers a rebate on the cash collateral generally equal to 50% of the income we earn from lending the shares. We place cash collateral securing the loans in the customer's account.
In the market making segment, as a result of the way we have integrated our market making and securities lending systems, our trading income and our net interest income are interchangeable and depend on the mix of market making positions in our portfolio. When implied interest rates in the equity and equity options and futures markets exceed the actual interest rates available to us, our market making systems tend to buy stock and sell it forward, which produces higher trading gains and lower net interest income. When these rates are inverted, our market making systems tend to sell stock and buy it forward, which produces lower trading gains and higher net interest income.
In 2016, average securities borrowed increased by 19%, to $4.2 billion and average securities loaned decreased by 3%, to $2.9 billion, compared to 2015. Net interest earned from securities lending is also affected by the level of demand for securities positions in our market making business and held by our customers. During 2016, net fees earned by our electronic brokerage and market making segments from securities lending transactions increased $6 million or 4%, compared to 2015. The increase in net interest income from securities lending transactions was attributable to the market making segment.
Other Income
Other income, in 2016, increased $216 million, to $94 million, compared to a loss of $122 million in 2015, mainly driven by $166 million lower losses on our currency diversification strategy (loss of $40 million in 2016, compared to a loss of $206 million in 2015), and $26 million net mark-to-market gains on our U.S. government securities portfolio in 2016, compared to $33 million net mark-to-market losses in 2015 due to a decline in average medium term interests rates during 2016; partially offset by the non-recurrence of an $18 million gain from hedging activities related to the Swiss franc event in 2015. In general, mark-to-market gains and losses on U.S. government securities are expected to reverse when, as intended, these securities are held to maturity. A discussion of our approach to 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.
Non-Interest Expenses
Non-interest expenses, in 2016, decreased $96 million, or 13%, compared to 2015, to $635 million, mainly due to the non-recurrence of $137 million in customer bad debt expense due to the Swiss franc event in 2015, as described above; partially offset by higher execution and clearing expenses and fixed expenses. As a percentage of total net revenues, non-interest expenses were 45% in 2016 and 61% in 2015.
Execution and Clearing
Execution and clearing expenses, in 2016, increased $13 million, or 6%, compared to 2015, to $244 million, driven by higher trading volume in futures in the electronic brokerage segment and a reduction in liquidity rebates from exchanges operating a make-or-take pricing model, in which we are paid for adding liquidity and charged for removing liquidity, as the options trading volume shifted away from orders that added liquidity to orders that removed liquidity in 2016 compared to 2015.
Employee Compensation and Benefits
Employee compensation and benefits expenses, in 2016, increased $15 million, or 7%, compared to 2015, to $242 million, mainly due to an 11% increase in the number of employees to 1,204, compared to 1,087 as of December 31, 2015. Within the operating business segments, we continued to add staff in customer service, legal and compliance, and software development to support electronic brokerage and reduce staff in market making. As we continue to grow, our focus on automation has allowed us to maintain a relatively small staff. As a percentage of total net revenues, employee compensation and benefits expenses were 17% in 2016 and 19% in 2015.
Occupancy, Depreciation and Amortization
Occupancy, depreciation and amortization expenses, in 2016, increased $7 million, or 16%, compared to 2015, to $51 million, mainly due to higher office rent expenses during 2016 as we continue to increase the number of employees and expand into other regions. As a percentage of total net revenues, occupancy, depreciation and amortization expenses were 4% for both 2016 and 2015.
Communications
Communications expenses, in 2016, increased $5 million, or 20%, compared to 2015, to $30 million, mainly due to higher costs of data lines to exchanges during 2016. As a percentage of total net revenues, communications expenses were 2% for both 2016 and 2015.
General and Administrative
General and administrative expenses, in 2016, increased $4 million, or 7%, compared to 2015, to $62 million, mainly due to higher professional services fees and expenses related to legal and regulatory matters. As a percentage of total net revenues, general and administrative expenses were 4% in 2016 and 5% in 2015.
Customer Bad Debt
Customer bad debt expense, in 2016, decreased $140 million, or 96%, compared to 2015, to $6 million, primarily due to the non-recurrence of unsecured customer losses of $137 million caused by the sudden move in the value of the Swiss franc in 2015, as described below.
Sudden Move in the Value of the Swiss Franc
On January 15, 2015, in an unprecedented action, the Swiss National Bank removed a previously instituted and repeatedly confirmed cap of the currency relative to the euro, causing a sudden move in the value of the Swiss franc. Several of our customers holding currency futures and spot positions suffered losses in excess of their deposits with us. We took immediate action to hedge our exposure to the foreign currency receivables from these customers. As of December 31, 2017, we have incurred cumulative losses, net of hedging activity and debt collection efforts, of $116 million. We continue to actively pursue collection of the debts. The ultimate effect of this incident on our results will depend upon the outcome of our debt collection efforts.
Income Tax Expense
Income tax expense, in 2016, increased $19 million, or 44%, to $62 million, compared to 2015, as income before taxes increased $303 million, or 66%, during the same period.
Our operating results, in 2016, excluding the effects of our currency diversification strategy, the net mark-to-market gains and losses from our U.S. government securities portfolio and the Swiss franc related customer losses in 2015 were as follows: net revenues were $1,410 million, unchanged from 2015; non-interest expenses were $635 million, up 7%; income before income taxes was $775 million, down 5%; and pre-tax profit margin decreased to 55% in 2016, from 58% in 2015.
Trading Volumes and Brokerage Statistics
The following tables present historical trading volumes and brokerage statistics for our business. However, volumes are not the only drivers in our business.
**TRADE VOLUMES: **(in 000's, except %)
| Period | Market Making Trades | % Change | Brokerage Cleared Trades | % Change | Brokerage Non Cleared Trades | % Change | Total Trades | % Change | Avg. Trades per U.S. Trading Day | |||||||||||||||||||
| 2013 | 65,320 | 173,849 | 18,489 | 257,658 | 1,029 | |||||||||||||||||||||||
| 2014 | 64,530 | (1 | )% | 206,759 | 19 | % | 18,055 | (2 | )% | 289,344 | 12 | % | 1,155 | |||||||||||||||
| 2015 | 65,937 | 2 | % | 242,846 | 17 | % | 18,769 | 4 | % | 327,553 | 13 | % | 1,305 | |||||||||||||||
| 2016 | 64,038 | (3 | )% | 259,932 | 7 | % | 16,515 | (12 | )% | 340,485 | 4 | % | 1,354 | |||||||||||||||
| 2017 | 31,282 | (51 | )% | 265,501 | 2 | % | 14,835 | (10 | )% | 311,618 | (8 | )% | 1,246 |
**CONTRACT AND SHARE VOLUMES: **(in 000's, except %)
TOTAL
| Period | Options (contracts) | % Change | Futures(1) (contracts) | % Change | Stocks (shares) | % Change | |||||||||||||
| 2013 | 659,673 | 121,776 | 95,479,739 | ||||||||||||||||
| 2014 | 631,265 | (4 | )% | 123,048 | 1 | % | 153,613,174 | 61 | % | ||||||||||
| 2015 | 634,388 | 0 | % | 140,668 | 14 | % | 172,742,520 | 12 | % | ||||||||||
| 2016 | 572,834 | (10 | )% | 143,287 | 2 | % | 155,439,227 | (10 | )% | ||||||||||
| 2017 | 395,885 | (31 | )% | 124,123 | (13 | )% | 220,247,921 | 42 | % |
MARKET MAKING
| Period | Options (contracts) | % Change | Futures(1) (contracts) | % Change | Stocks (shares) | % Change | |||||||||||||
| 2013 | 404,490 | 18,184 | 12,849,729 | ||||||||||||||||
| 2014 | 344,741 | (15 | )% | 15,668 | (14 | )% | 12,025,822 | (6 | )% | ||||||||||
| 2015 | 335,406 | (3 | )% | 14,975 | (4 | )% | 15,376,076 | 28 | % | ||||||||||
| 2016 | 307,377 | (8 | )% | 14,205 | (5 | )% | 13,082,887 | (15 | )% | ||||||||||
| 2017 | 102,025 | (67 | )% | 5,696 | (60 | )% | 7,139,622 | (45 | )% |
BROKERAGE TOTAL
| Period | Options (contracts) | % Change | Futures(1) (contracts) | % Change | Stocks (shares) | % Change | |||||||||||||
| 2013 | 255,183 | 103,592 | 82,630,010 | ||||||||||||||||
| 2014 | 286,524 | 12 | % | 107,380 | 4 | % | 141,587,352 | 71 | % | ||||||||||
| 2015 | 298,982 | 4 | % | 125,693 | 17 | % | 157,366,444 | 11 | % | ||||||||||
| 2016 | 265,457 | (11 | )% | 129,082 | 3 | % | 142,356,340 | (10 | )% | ||||||||||
| 2017 | 293,860 | 11 | % | 118,427 | (8 | )% | 213,108,299 | 50 | % |
(1)
Futures contract volume includes options on futures.
BROKERAGE CLEARED
| Period | Options (contracts) | % Change | Futures(1) (contracts) | % Change | Stocks (shares) | % Change | |||||||||||||
| 2013 | 180,660 | 101,732 | 78,829,785 | ||||||||||||||||
| 2014 | 225,662 | 25 | % | 106,074 | 4 | % | 137,153,132 | 74 | % | ||||||||||
| 2015 | 244,356 | 8 | % | 124,206 | 17 | % | 153,443,988 | 12 | % | ||||||||||
| 2016 | 227,413 | (7 | )% | 128,021 | 3 | % | 138,523,932 | (10 | )% | ||||||||||
| 2017 | 253,304 | 11 | % | 116,858 | (9 | )% | 209,435,662 | 51 | % |
(1)
Futures contract volume includes options on futures.
**BROKERAGE STATISTICS: **(in 000's, except % and where noted)
| 4Q2017 | 4Q2016 | % Change | ||||||||
| Year over Year | ||||||||||
| Total Accounts | 483 | 385 | 25 | % | ||||||
| Customer Equity (in billions)(1) | $ | 124.8 | $ | 85.5 | 46 | % | ||||
| Cleared DARTs | 681 | 591 | 15 | % | ||||||
| Total Customer DARTs | 730 | 640 | 14 | % | ||||||
| Cleared Customers (in $'s, except DART per account) | ||||||||||
| Commission per DART | $ | 3.92 | $ | 4.01 | (2 | )% | ||||
| DART per Avg. Account (Annualized) | 363 | 394 | (8 | )% | ||||||
| Net Revenue per Avg. Account (Annualized) | $ | 3,318 | $ | 3,205 | 4 | % |
(1)
Excludes non-customers.
Business Segments
The following sections discuss the results of our operations by business segment, excluding a discussion of corporate segment income and expense. In the following tables, revenues and expenses directly associated with each business segment are included in determining income before income taxes. Due to the integrated nature of the business segments, estimates and judgments have been made in allocating certain revenue and expense items. Transactions between business segments generally result from one subsidiary facilitating the business of another subsidiary through the use of its existing trading memberships and clearing arrangements. In such cases, certain revenue and expense items are eliminated to accurately reflect the external business conducted in each business segment. Rates on transactions between business segments are designed to approximate full costs. In addition to execution and clearing expenses, which are the main cost driver for both the market making and the electronic brokerage segments, each business segment's operating expenses include: (i) employee compensation and benefits expenses that are incurred directly in support of each business segment, (ii) general and administrative expenses, which include directly incurred expenses for property leases, professional fees, travel and entertainment, communications and information services, equipment, and (iii) indirect support costs (including compensation and other related operating expenses) for administrative services provided by corporate segment subsidiaries. Such administrative services include, but are not limited to, computer software development and support, accounting, tax, legal and facilities management.
Electronic Brokerage
The following table sets forth the results of our electronic brokerage operations for the indicated periods:
| Year Ended December 31, | ||||||||||
| 2017 | 2016 | 2015 | ||||||||
| (in millions) | ||||||||||
| Revenues | ||||||||||
| Commissions | $ | 648 | $ | 613 | $ | 618 | ||||
| Interest income | 829 | 537 | 431 | |||||||
| Other income | 108 | 128 | 79 | |||||||
| | | | | | | | | | | |
| Total revenues | 1,585 | 1,278 | 1,128 | |||||||
| Interest expense | 180 | 39 | 31 | |||||||
| | | | | | | | | | | |
| Total net revenues | 1,405 | 1,239 | 1,097 | |||||||
| | | | | | | | | | | |
| Non-interest expenses | ||||||||||
| Execution and clearing | 210 | 181 | 160 | |||||||
| Employee compensation and benefits | 122 | 113 | 97 | |||||||
| Occupancy, depreciation and amortization | 18 | 21 | 16 | |||||||
| Communications | 15 | 14 | 12 | |||||||
| General and administrative | 178 | 148 | 130 | |||||||
| Customer bad debt | 2 | 6 | 146 | |||||||
| | | | | | | | | | | |
| Total non-interest expenses | 545 | 483 | 561 | |||||||
| | | | | | | | | | | |
| Income before income taxes | $ | 860 | $ | 756 | $ | 536 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Year Ended December 31, 2017 ("current year") compared to the Year Ended December 31, 2016 ("prior year")
Electronic brokerage total net revenues, for the current year, increased $166 million, or 13%, compared to the prior year, to $1,405 million, primarily due to higher net interest income and commissions, partially offset by lower other income.
Commissions, for the current year, increased $35 million, or 6%, compared to the prior year, to $648 million, driven by higher customer trading volumes in options and stocks, continued customer account growth, and higher average commission per customer order. Cleared customer options contract and stock share volumes increased 11% and 51%, respectively, while futures contract volume decreased 9%, compared to the prior year. Total DARTs for cleared and execution-only customers, for the current year, increased 4% to 688 thousand, compared to 660 thousand for the prior year. DARTs for cleared customers, i.e., customers for whom we execute trades, as well as, clear and carry positions, for the current year, increased 5% to 639 thousand, compared to 609 thousand for the prior year. Average commission per DART for cleared customers, for the current year, increased 1% to $3.97, compared to $3.92 for the prior year, reflecting larger average order sizes in stocks.
Net interest income, for the current year, increased $151 million, or 30%, compared to the prior year, to $649 million driven by a $5.5 billion increase in average customer credit balances, a portion of which were invested in interest-bearing U.S. government securities, a $6.8 billion increase in average customer margin loans, and a 61 basis point increase in the average Federal Funds effective rate to 1.00%. As a result of increases in the Federal Funds effective rate since December 2016, interest expense on customer credit balances increased from the prior year, in part, as certain customer credit balances that were not eligible to earn interest in the prior year became eligible to earn interest in the current year. The increase in benchmark rates also drove higher interest income earned on investment of customer segregated cash and on margin lending to customers.
Other income, for the current year, decreased $20 million, or 16%, compared to the prior year, to $108 million, mainly driven by a $12 million net mark-to-market loss on our U.S. government securities portfolio in the current year, compared to a $26 million net mark-to-market gain in the prior year, partially offset by higher exposure fee and market data fee income. Despite an increase in average medium term interest rates during the current year the net mark-to-market loss on our U.S. Government securities portfolio was only $12 million, reflecting a reduction in the size and average duration of the portfolio. In general, mark-to-market gains and losses on U.S. government securities are expected to reverse when, as intended, these securities are held to maturity.
Non-interest expenses, for the current year, increased $62 million, or 13%, compared to the prior year, to $545 million. Within non-interest expenses, execution and clearing expenses increased $29 million, or 16% driven by higher trading volumes in options and stocks and a reduction in liquidity rebates from exchanges operating a make-or-take pricing model, in which we are paid for adding liquidity and charged for removing liquidity, as the options trading volume shifted away from orders that added liquidity to orders that removed liquidity in the current year. A 10% increase in the number of employees providing services to the electronic brokerage segment led to increased employee compensation and benefits expenses of $9 million, or 8% and increased general and administrative expenses of $30 million, where the latter includes software development provided by the corporate segment on a consulting basis, which accounted for $18 million of this increase. In addition, general and administrative expenses for the current year include higher advertising expenditures and professional services fees, compared to the prior year. As a percentage of total net revenues, non-interest expenses were 39% for both the current year and the prior year.
Income before income taxes, for the current year, increased $104 million, or 14%, compared to the prior year, to $860 million. As a percentage of total net revenues for the electronic brokerage segment, income before income taxes was 61% for both the current year and the prior year.
Electronic brokerage operating results, for the current year, excluding the net mark-to-market gains and losses from our U.S. government securities portfolio, compared to the prior year were as follows: net revenues were $1,417 million, up 17%; income before income taxes was $872 million, up 19%; and pre-tax profit margin increased to 62% for the current year from 60% for the prior year.
Year Ended December 31, 2016 compared to the Year Ended December 31, 2015
Electronic brokerage total net revenues, in 2016, increased $142 million, or 13%, compared to 2015, to $1,239 million, primarily due to higher net interest income and other income.
Commissions, in 2016, decreased $5 million, or 1%, compared to 2015, to $613 million, driven by mixed customer trading volumes and lower average commission per customer order, but moderated by continued customer account growth. Cleared customer options contract and stock share volumes decreased 7% and 10%, respectively, while futures contract volume increased 3% compared to 2015. Total DARTs for cleared and execution-only customers, in 2016, increased 2% to 660 thousand, compared to 647 thousand during 2015. DARTs for cleared customers, i.e., customers for whom we execute trades, as well as, clear and carry positions, in 2016, increased 3% to 609 thousand, compared to 589 thousand in 2015. Average commission per DART for cleared customers, in 2016, decreased 4% to $3.92, compared to $4.07 in 2015, reflecting smaller average order sizes across product types.
Net interest income, in 2016, increased $98 million, or 25% compared to 2015, to $498 million. The increase in net interest income was attributable to higher net customer interest of $100 million, driven by a $5.3 billion increase in average customer cash balances, the majority of which were invested in interest-bearing U.S. government securities, while average customer margin borrowings decreased by $1.5 billion. In addition, the average Fed Funds effective rate increased by approximately 26 basis points to 0.39% in 2016, compared to 2015.
Other income, in 2016, increased $49 million, or 62%, compared to 2015, to $128 million, mainly driven by $26 million net mark-to-market gains on our U.S. government securities portfolio compared to $33 million net mark-to-market losses in 2015 due to a decline in average medium-term interest rates, partially offset by the non-recurrence of an $18 million gain from hedging activities related to the Swiss franc event in 2015. In general, mark-to-market gains and losses on U.S. government securities are expected to reverse when, as intended, these securities are held to maturity.
Non-interest expenses, in 2016, decreased $78 million, or 14%, compared to 2015, to $483 million, mainly due to a decrease in bad debt expense of $140 million, or 96%, compared to 2015, to $6 million, on the non-recurrence of $137 million in customer bad debt expense related to the Swiss franc event in 2015. Within non-interest expenses, execution and clearing expenses increased $21 million, or 13%, driven by higher trading volume in futures and a reduction in liquidity rebates from exchanges operating a make-or-take pricing model, in which we are paid for adding liquidity and charged for removing liquidity, as the options trading volume shifted away from orders that added liquidity to orders that removed liquidity in 2016 compared to 2015. A 16% increase in the number of employees providing services to the electronic brokerage segment led to increased employee compensation and benefits expenses of $16 million, or 16%, and in general and administrative expenses of $18 million, where the latter includes software development provided by the corporate segment on a consulting basis. In addition, general and administrative expenses in 2016 include higher professional fees and expenses related to legal and regulatory matters, compared to 2015. As a percentage of total net revenues, non-interest expenses were 39% in 2016 and 51% in 2015.
Income before income taxes, in 2016, increased $220 million, or 41%, compared to 2015, to $756 million. As a percentage of total net revenues for the electronic brokerage segment, income before income taxes was 61% in 2016 and 49% in 2015.
Electronic brokerage operating results, for 2016, excluding the net mark-to-market gains and losses from our U.S. government securities portfolio and the Swiss franc related customer losses in 2015 were as follows: net revenues were $1,213 million, up 9%; non-interest expenses were $483 million up 14%; income before income taxes was $730 million, up 6%; and pre-tax profit margin decreased to 60% in 2016 from 62% in 2015.
Market Making
The following table sets forth the results of our market making operations for the indicated periods:
| Year Ended December 31, | ||||||||||
| 2017 | 2016 | 2015 | ||||||||
| (in millions) | ||||||||||
| Revenues | ||||||||||
| Trading gains | $ | 40 | $ | 163 | $ | 269 | ||||
| Interest income | 89 | 71 | 62 | |||||||
| Other income | 16 | 4 | 10 | |||||||
| | | | | | | | | | | |
| Total revenues | 145 | 238 | 341 | |||||||
| Interest expense | 59 | 48 | 43 | |||||||
| | | | | | | | | | | |
| Total net revenues | 86 | 190 | 298 | |||||||
| | | | | | | | | | | |
| Non-interest expenses | ||||||||||
| Execution and clearing | 32 | 63 | 72 | |||||||
| Employee compensation and benefits | 25 | 31 | 38 | |||||||
| Occupancy, depreciation and amortization | 3 | 4 | 4 | |||||||
| Communications | 7 | 10 | 10 | |||||||
| General and administrative | 46 | 38 | 44 | |||||||
| | | | | | | | | | | |
| Total non-interest expenses | 113 | 146 | 168 | |||||||
| | | | | | | | | | | |
| Income (loss) before income taxes | $ | (27 | ) | $ | 44 | $ | 130 | |||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Year Ended December 31, 2017 ("current year") compared to the Year Ended December 31, 2016 ("prior year")
As previously described, in early 2017 we started the process of winding down our options market making operations and the market making results described below were mainly impacted by such pull-back.
Market making total net revenues, for the current year, decreased $104 million, or 55%, compared to the prior year, to $86 million, primarily due to lower trading gains.
Trading gains, for the current year, decreased $123 million, or 75% compared to the prior year, to $40 million, unfavorably impacted by lower trading volumes, as we began to wind down our market making activities in March 2017, and, to a lesser extent, by decreases in volatility and in the actual-to-implied volatility ratio, compared to the prior year. The VIX®, which measures perceived U.S. equity market volatility, decreased 30% to an average of 11.1 for the current year, compared to an average of 15.9 for the prior year. The ratio of actual to implied volatility decreased to an average of 60% for the current year, compared to an average of 83% for the prior year. Options and futures contract and stock share volumes decreased 67%, 60%, and 45%, respectively, compared to the prior year.
Net interest income, for the current year, increased $7 million, or 30%, compared to the prior year, to $30 million. As described above, our trading gains and our net interest income are interchangeable and depend on the mix of market making positions in our portfolio and on relative interest rates in the stock and options markets.
Other income, for the current year, increased $12 million, compared to the prior year, to $16 million due to an $11 million one-time recovery of costs related to the sale of our U.S. options market making operations to Two Sigma Securities, LLC and $2 million in consulting fees related to the reimbursement of costs incurred during the transition of these operations to Two Sigma Securities, LLC.
Non-interest expenses, for the current year, decreased $33 million, or 23%, compared to the prior year, to $113 million. Within non-interest expenses, execution and clearing fees decreased $31 million, or 49%, on lower trading volumes across product types. Employee compensation and benefits expenses decreased $6 million, or 19%, driven by continued reductions in staff. General and administrative expenses increased $8 million, or 21%, due to a $21 million write-down of the value of exchange trading rights related to the wind-down of our U.S. options market making operations, partially offset by lower consulting expenses, primarily for internal software development. As a percentage of total net revenues, non-interest expenses were 131% for the current year and 77% for the prior year.
Income before income taxes, for the current year, decreased $71 million, compared to the prior year, to a loss of $27 million.
Year Ended December 31, 2016 compared to the Year Ended December 31, 2015
Market making total net revenues, in 2016, decreased $108 million, or 36%, compared to 2015, to $190 million, primarily due to lower trading gains, partially offset by higher net interest income.
Trading gains, in 2016, decreased $106 million, or 39%, compared to 2015, to $163 million, unfavorably impacted by lower trading volumes, a divergence in price behavior among a significant number of individual stocks during the first quarter of 2016 and decreases in volatility and in the actual-to-implied volatility ratio as compared to 2015. The VIX®, which measures perceived U.S. equity market volatility, decreased 5% to an average of 15.9 in 2016, compared to an average of 16.7 in 2015. The ratio of actual to implied volatility decreased to an average of 83% in 2016, compared to an average of 88% in 2015. Options and futures contract and stock share volumes decreased 8%, 5%, and 15%, respectively, compared to 2015.
Net interest income, in 2016, increased $4 million, or 21%, compared to 2015, to $23 million. As described above, our trading gains and our net interest income are interchangeable and depend on the mix of market making positions in our portfolio and on relative interest rates in the stock and options markets. In 2016, these factors produced more net interest income than in 2015.
Non-interest expenses, in 2016, decreased $22 million, or 13%, compared to 2015, to $146 million. Within non-interest expenses, execution and clearing fees decreased $9 million, or 13%, on lower trading volumes across product types. Employee compensation and benefits expenses decreased $7 million, or 18%, driven by continued reductions in staff. General and administrative expenses decreased $6 million, or 14%, due to lower consulting expenses, primarily for internal software development. As a percentage of total net revenues, non-interest expenses were 77% in 2016 and 56% in 2015.
Income before income taxes, in 2016, decreased $86 million, or 66%, compared to 2015, to $44 million. As a percentage of total net revenues for the market making segment, income before income taxes was 23% in 2016 and 44% in 2015.
Liquidity and Capital Resources
We maintain a highly liquid balance sheet. The majority of our assets consist of investments of customer funds, collateralized receivables arising from customer-related and proprietary securities transactions, and exchange-listed marketable securities, which are marked-to-market daily. Collateralized receivables consist primarily of customer margin loans, securities borrowed, and, to a lesser extent, receivables from clearing houses for settlement of securities transactions, and securities purchased under agreements to resell. As of December 31, 2017, total assets were $61.2 billion of which approximately $60.8 billion, or 99.3%, were considered liquid.
Daily monitoring of liquidity needs and available collateral levels is undertaken to help ensure that an appropriate liquidity cushion, in the form of unpledged collateral, is maintained at all times. Our ability to quickly reduce funding needs by balance sheet contraction without adversely affecting our core businesses and to pledge additional collateral in support of secured borrowings is continuously evaluated to ascertain the adequacy of our capital base.
We actively manage our excess liquidity and we maintain significant borrowing facilities through the securities lending markets and with banks. As a general practice, we maintain sufficient levels of cash on hand to provide us with a buffer should we need immediately available funds for any reason. Based on our current level of operations, we believe our cash flows from operations, available cash and available borrowings will be adequate to meet our future liquidity needs for more than the next twelve months.
Liability balances, as of December 31, 2017, in connection with our payables to customers and securities loaned were higher than their respective average monthly balances during the current year and short-term borrowings were lower than the average monthly balance during the current year.
Cash and cash equivalents held by our non-U.S. operating companies as of December 31, 2017 were $590 million ($448 million as of December 31, 2016). These funds are primarily intended to finance each individual operating company's local operations, and thus would not be available to fund U.S. domestic operations unless repatriated through payment of dividends to IBG LLC. In June 2016, December 2016, and September 2017 dividends of $40 million, $22 million, and $32 million, respectively, were paid to IBG LLC from two of our non-U.S. subsidiaries. As of December 31, 2017, we had no intention to repatriate further amounts from non-U.S. operating companies. With the enactment of the Tax Act, we recognized a $62 million liability for the one-time transition tax on deemed repatriation of earnings of some of our foreign subsidiaries. As a result, in the event dividends were to be paid to the Company in the future by a non-U.S. operating company, the Company would not be required to accrue and pay income taxes on such dividends, except for foreign taxes in the form of dividend withholding tax, if any, imposed on the recipient of the distribution or dividend distribution tax imposed on the payor of the distribution.
Historically, our consolidated equity has consisted primarily of accumulated retained earnings, which to date have been sufficient to fund our operations and growth. Our consolidated equity increased 10% to $6.4 billion as of December 31, 2017 from $5.8 billion as of December 31, 2016. This increase is attributable to total comprehensive income, partially offset by distributions and dividends paid during 2017.
Cash Flows
The following table sets forth our cash flows from operating activities, investing activities and financing activities for the periods indicated:
| Year-Ended December 31, | ||||||||||
| 2017 | 2016 | 2015 | ||||||||
| (in millions) | ||||||||||
| Net cash provided by operating activities | $ | 142 | $ | 544 | $ | 725 | ||||
| Net cash used in investing activities | (26 | ) | (6 | ) | (35 | ) | ||||
| Net cash used in financing activities | (374 | ) | (189 | ) | (295 | ) | ||||
| Effect of exchange rate changes on cash and cash equivalents | 65 | (25 | ) | (63 | ) | |||||
| | | | | | | | | | | |
| (Decrease) increase in cash and cash equivalents | $ | (193 | ) | $ | 324 | $ | 332 | |||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Our cash flows from operating activities are largely a reflection of the changes in customer credit and margin loan balances in our electronic brokerage business, and of the size and composition of trading positions held by our market making subsidiaries. Our cash flows from investing activities are primarily related to other investments, capitalized internal software development, purchases and sales of memberships at exchanges where we trade, and strategic investments where such investments may enable us to offer better execution alternatives to our current and prospective customers, or where we can influence exchanges to provide competing products at better prices using sophisticated technology. Our cash flows from financing activities are comprised of short-term borrowings and capital transactions. Short-term borrowings from banks are part of our daily cash management in support of operating activities. Capital transactions consist primarily of quarterly dividends paid to common stockholders and related distributions paid to Holdings.
Year Ended December 31, 2017: Our cash and cash equivalents decreased by $193 million to $1.7 billion for the year ended December 31, 2017. We raised $142 million in net cash from operating activities. We used net cash of $400 million in our investing and financing activities, primarily for distributions to noncontrolling interests, dividends paid to our common stockholders and payments made under the Tax Receivable Agreement. Investing activities mainly consisted of distributions received from investments and purchases of property, equipment and intangible assets.
Year Ended December 31, 2016: Our cash and cash equivalents increased by $324 million to $1.9 billion for the year ended December 31, 2016. We raised $544 million in net cash from operating activities. We used net cash of $195 million in our investing and financing activities, primarily for distributions to noncontrolling interests, dividends paid to our common stockholders and payments made under the Tax Receivable Agreement. Under investing activities, purchases and sales of other investments mainly consisted of transactions in marketable securities held for investment purposes and distributions received from investments.
Year Ended December 31, 2015: Our cash and cash equivalents increased by $332 million to $1,601 million for the year ended December 31, 2015. We raised $725 million in net cash from operating activities. We used net cash of $330 million in our investing and financing activities, primarily for distributions to noncontrolling interests, dividends paid to our common stockholders, and payments made to Holdings under the Tax Receivable Agreement. Under investing activities, purchases and sales of other investments mainly consisted of transactions in marketable securities held for investment purposes.
Regulatory Capital Requirements
Our principal operating companies are subject to separate regulation and capital requirements in the U.S. and other jurisdictions. IB LLC and TH LLC are registered U.S. broker-dealers and their primary regulators include the SEC, the Chicago Board Options Exchange, and FINRA. Additionally, IB LLC is regulated by the CFTC and the Chicago Mercantile Exchange. IB LLC is also a registered U.S. futures commission merchant, as such it is regulated by the NFA. THE is registered to do business in Switzerland as a securities dealer and is regulated by the Swiss Financial Market Supervisory Authority. Our various other operating companies are similarly regulated. See the notes to the audited consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K for further information regarding our regulated operating companies.
As of December 31, 2017, aggregate excess regulatory capital for all of the operating companies was $4.5 billion, and all of the operating companies were in compliance with their respective regulatory capital requirements.
| Net Capital/ Eligible Equity | Requirement | Excess | ||||||||
| (in millions) | ||||||||||
| IB LLC | $ | 3,548 | $ | 495 | $ | 3,053 | ||||
| TH LLC | 279 | 1 | 278 | |||||||
| THE | 614 | 92 | 522 | |||||||
| Other regulated operating companies | 773 | 121 | 652 | |||||||
| | | | | | | | | | | |
| $ | 5,214 | $ | 709 | $ | 4,505 | |||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Capital Expenditures
Our capital expenditures are comprised of compensation costs of our software engineering staff for development of software for internal use and expenditures for computer, networking and communications hardware. These expenditure items are reported as property, equipment, and intangible assets. Capital expenditures for property, equipment, and intangible assets were approximately $28 million, $27 million, and $30 million for the three years ended December 31, 2017, 2016, and 2015, respectively. In the future, we plan to meet capital expenditure needs as we continue our focus on technology infrastructure initiatives to further enhance our competitive position. We anticipate that we will fund capital expenditures with cash from operations and cash on hand. In response to changing economic conditions, we believe we have the flexibility to modify our capital expenditures by adjusting them (either upward or downward) to match our actual performance. If we pursue any strategic acquisitions, we may incur additional capital expenditures.
Contractual Obligations Summary
Our contractual obligations principally include obligations associated with our outstanding indebtedness and interest payments as of December 31, 2017.
| Payments Due by Year | |||||||||||||
| Total | 2018 - 2019 | 2020 - 2021 | Thereafter | ||||||||||
| (in millions) | |||||||||||||
| Payable to Holdings under Tax Receivable Agreement(1) | $ | 187 | $ | 49 | $ | 34 | $ | 104 | |||||
| Operating leases | 154 | 25 | 20 | 109 | |||||||||
| Transition Tax liability(2) | 62 | 10 | 10 | 42 | |||||||||
| | | | | | | | | | | | | | |
| Total contractual cash obligations | $ | 403 | $ | 84 | $ | 64 | $ | 255 | |||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
(1)
As of December 31, 2017, contractual amounts owed under the Tax Receivable Agreement of $187 million have been recorded in payable to affiliate in the consolidated financial statements representing management's best estimate of the amounts currently expected to be owed under the Tax Receivable Agreement. Through December 31, 2017, approximately $131 million of cumulative cash payments have been made.
(2)
The Tax Act implemented a modified territorial tax system that includes a one-time transition tax on deemed repatriated earnings of foreign subsidiaries to be paid over an eight-year period. We believe this tax will not have a material impact on our liquidity.
Seasonality
Our businesses are subject to seasonal fluctuations, reflecting varying numbers of market participants at times during the year, varying numbers of trading days from quarter-to-quarter, and declines in trading activity due to holidays. Typical seasonal trends may be superseded by market or world events, which can have a significant impact on prices and trading volume.
Inflation
Although we cannot accurately anticipate the effects of inflation on our operations, we believe that, for the three most recent years, inflation has not had a material impact on our results of operations and will not likely have a material impact in the foreseeable future.
Investments in U.S. Government Securities
We invest in U.S. government securities for the purpose of satisfying U.S. regulatory requirements. As a broker-dealer, unlike banks, we are required to mark these investments to market even though we intend to hold them to maturity. Sudden increases in interest rates will cause mark-to-market losses on these securities, which are recovered if we hold them to maturity, as currently intended. The impact of changes in interest rates is further described in ITEM 7A of this Annual Report on Form 10-K entitled "Quantitative and Qualitative Disclosures about Market Risk."
Strategic Investments and Acquisitions
We regularly evaluate potential strategic investments and acquisitions. We hold strategic investments in electronic trading exchanges including: BOX Options Exchange, LLC and OneChicago LLC. In addition, on September 20, 2017, we announced our agreement to make a strategic investment in Tiger Brokers, an online stock brokerage established for global Chinese retail and institutional clients.
We intend to continue making acquisitions on an opportunistic basis, generally only when the acquisition candidate will, in our opinion, enable us to acquire either technology or customers faster than we could develop them on our own.
As of December 31, 2017, there were no other definitive agreements with respect to any material acquisition.
Certain Information Concerning Off-Balance-Sheet Arrangements
We may be exposed to a risk of loss not reflected in our consolidated financial statements for futures products, which represent our obligations to settle at contracted prices, and which may require us to repurchase or sell in the market at prevailing prices. Accordingly, these transactions result in off-balance sheet risk, as our cost to liquidate such futures contracts may exceed the amounts reported in our consolidated statements of financial condition.
Critical Accounting Policies
Principles of Consolidation, including Noncontrolling Interests
The consolidated financial statements include the accounts of IBG, Inc. and its majority and wholly owned subsidiaries. As sole managing member of IBG LLC, we exert control over the Group's operations. In accordance with Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") ASC Topic 810, "Consolidation," we consolidate the Group's consolidated financial statements and record as noncontrolling interest the interests in the Group that we do not own.
We are the sole managing member of IBG LLC and, as such, operate and control all of the business and affairs of IBG LLC and its subsidiaries and as such, consolidate IBG LLC's financial results into our financial statements. We hold approximately 17.4% ownership interest in IBG LLC. Holdings is owned by the original members of IBG LLC and holds approximately 82.6% ownership interest in IBG LLC. Our current share of IBG LLC's net income is approximately 17.4%.
Our policy is to consolidate all other entities in which we own more than 50% unless we do not have control. All inter-company balances and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements and accompanying notes. These estimates and assumptions are based on judgment and the best available information at the time. Therefore, actual results could differ materially from those estimates. Such estimates include the allowance for doubtful accounts, valuation of certain investments, compensation accruals, current and deferred income taxes, costs associated with exit or disposal activities, and contingency reserves.
Valuation of Financial Instruments
Due to the nature of our operations, substantially all of our financial instrument assets, comprised of financial instruments owned, securities purchased under agreements to resell, securities borrowed, receivable from customers, and receivables from brokers, dealers and clearing organizations are carried at fair value based on published market prices and are marked to market daily, or are assets which are short-term in nature and are reported at amounts that approximate fair value. Similarly, all of our financial instrument liabilities that arise from financial instruments sold but not yet purchased, securities sold under agreements to repurchase, securities loaned, payables to customers, and payables to brokers, dealers and clearing organizations are carried at fair value based on published market prices and are marked to market daily, or are liabilities which are short-term in nature and are reported at amounts that approximate fair value. Our long and short positions are mainly valued at the last consolidated trade price at the close of regular trading hours, in their respective markets. Given that we manage a globally integrated market making portfolio, we may have offsetting positions in securities and commodities that trade on different exchanges that close at different times of the trading day. As a result, there may be large and anomalous swings in the value of our positions daily and, accordingly, in our earnings in any period. This is especially true on the last business day of each calendar quarter or year, although such swings tend to come back into equilibrium on the first business day of the succeeding calendar quarter or year.
Earnings per Share
Earnings per share ("EPS") are computed in accordance with FASB ASC Topic 260, "Earnings per Share." Basic EPS is computed by dividing the net income available for common stockholders by the weighted average number of shares outstanding for that period. Diluted EPS is calculated by dividing the net income available for common stockholders by the diluted weighted average shares outstanding for that period. Diluted EPS includes the determinants of the basic EPS and, in addition, reflects the dilutive effect of shares of common stock estimated to be distributed in the future under our stock-based compensation plans, with no adjustments to net income available for common stockholders for dilutive potential common shares.
Stock-Based Compensation
We follow FASB ASC Topic 718, "Compensation—Stock Compensation" ("ASC Topic 718"), to account for our stock-based compensation plans. ASC Topic 718 requires all share-based payments to employees to be recognized in the consolidated financial statements using a fair value-based method. Grants, which are denominated in U.S. dollars, are communicated to employees in the year of grant, thereby establishing the fair value of each grant. The fair value of awards granted to employees are generally expensed as follows: 50% in the year of grant in recognition of the plans' post-employment provisions (as described below) and the remaining 50% over the related vesting period utilizing the "graded vesting" method permitted under ASC Topic 718. In the case of "retirement eligible" employees (those employees older than 59), 100% of awards are expensed when granted.
Awards granted under the stock-based compensation plans are subject to the plans' post-employment provisions in the event an employee ceases employment with us. The plans provide that employees who discontinue employment with us without cause and continue to meet the terms of the plans' post-employment provisions will be eligible to earn 50% of previously granted, but not yet earned awards, unless the employee is over the age of 59, in which case the employee would be eligible to receive 100% of previously granted, but not yet earned awards.
Contingencies
Our policy is to estimate and accrue for potential losses that may arise out of litigation and regulatory proceedings, to the extent that such losses are probable and can be estimated, in accordance with FASB ASC Topic 450, "Contingencies." Significant judgment is required in making these estimates and our final liabilities may ultimately be materially different. Our total liability accrued with respect to litigation and regulatory proceedings is determined on a case-by-case basis and represents an estimate of probable losses based on, among other factors, the progress of each case, our experience with and industry experience with similar cases and the opinions and views of internal and external legal counsel. Given the inherent difficulty of predicting the outcome of our litigation and regulatory matters, particularly in cases or proceedings in which substantial or indeterminate damages or fines are sought, or where cases or proceedings are in the early stages, we cannot estimate losses or ranges of losses for cases or proceedings where there is only a reasonable possibility that a loss may be incurred.
We have been from time to time subject to certain pending and legal actions which arise out of the normal course of business. Litigation is inherently unpredictable, particularly in proceedings where claimants seek substantial or indeterminate damages, or which are in their early stages. We cannot predict with certainty the actual loss or range of loss related to such legal proceedings, the manner in which they will be resolved, the timing of final resolution or the ultimate settlement. Consequently, we cannot estimate losses or ranges of losses related to such legal matters, even in instances where it is reasonably possible that a future loss will be incurred. As of December 31, 2017, we, along with certain of our subsidiaries, have been named parties to legal actions, which we and/or such subsidiaries intend to defend vigorously. Although the results of legal actions cannot be predicted with certainty, it is the opinion of management that the resolution of these actions is not expected to have a material adverse effect, if any, on our business or financial condition, but may have a material impact on the results of operations for a given period. As of December 31, 2017 and December 31, 2016, reserves provided for potential losses related to litigation matters were not material.
Income Taxes
We account for income taxes in accordance with FASB ASC Topic 740, "Income Taxes" ("ASC Topic 740"). Our income tax expense, deferred tax assets and liabilities, and reserves for unrecognized tax benefits are based on enacted tax laws and reflect management's best assessment of estimated future taxes to be paid. We are subject to income taxes in both the U.S. and numerous foreign jurisdictions. Determining income tax expense requires significant judgments and estimates.
Deferred income tax assets and liabilities arise from temporary differences between the tax and financial statement recognition of the underlying assets and liabilities. In evaluating our ability to recover our deferred tax assets within the jurisdictions from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies, and results of recent operations. In projecting future taxable income, historical results are adjusted for changes in accounting policies and incorporate assumptions including the amount of future state, federal and foreign pre-tax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax-planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses. In evaluating the objective evidence that historical results provide, three years of cumulative operating income (loss) are considered. Deferred income taxes have not been provided for U.S. tax liabilities or for additional foreign taxes on the unremitted earnings of foreign subsidiaries that have been indefinitely reinvested.
The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations. Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities in the future. The enactment of the Tax Act on December 22, 2017 significantly revised the U.S corporate income tax law by, among other things, reducing the corporate income tax rate from 35% to 21% and implementing a modified territorial tax system that includes a one-time transition tax on deemed repatriated earnings of foreign subsidiaries. See Note 10 to the audited consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K. We record tax liabilities in accordance with ASC Topic 740 and adjust these liabilities when management's judgment changes as a result of the evaluation of new information not previously available. Because of the complexity of some of these uncertainties, the ultimate resolution may result in payments that are different from the current estimates of these tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which new information becomes available.
We recognize that a tax benefit from an uncertain tax position may be recognized only when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, on the basis of the technical merits. A tax position that meets this standard is measured at the largest amount of benefit that will more likely than not be realized on settlement.
We recognize interest related to income tax matters as interest income or interest expense and penalties related to income tax matters as income tax expense.
Recently Issued Accounting Pronouncements
Following is a summary of recently issued FASB Accounting Standards Updates ("ASUs") that have affected or may affect our consolidated financial statements:
| Affects | Status | ||||
| ASU 2016-01 | Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. | Effective for fiscal years beginning after December 15, 2017. | |||
| ASU 2016-02 | Leases (Topic 842): Requires the recognition of a right-of-use asset and a lease liability for leases previousely classified as operating leases in the statements of financial condition. | Effective for fiscal years beginning after December 15, 2018. | |||
| ASU 2016-08 | Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). | Effective for annual reporting periods beginning after December 15, 2017. | |||
| ASU 2016-10 | Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. | Effective for annual reporting periods beginning after December 15, 2017. | |||
| ASU 2016-13 | Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. | Effective for fiscal years beginning after December 15, 2019. | |||
| ASU 2016-15 | Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. | Effective for fiscal years beginning after December 15, 2017. | |||
| ASU 2016-16 | Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. | Effective for annual reporting periods beginning after December 15, 2017. | |||
| ASU 2017-01 | Business Combinations (Topic 805): Clarifying the Definition of a Business. | Effective for annual periods beginning after December 15, 2017. | |||
| ASU 2017-04 | Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. | Effective for fiscal years beginning after December 15, 2019. | |||
| ASU 2017-05 | Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets. | Effective for annual reporting periods beginning after December 15, 2017. | |||
| ASU 2017-08 | Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20): Amending the amortization period for certain purchased callable debt securities held at a premium. | Effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. |
| Affects | Status | ||||
| ASU 2017-09 | Compensation—Stock Compensation (Topic 718): Providing clarity and reduce both diversity in practice and cost and complexity when applying the guidance in Topic 718, Compensation—Stock Compensation, to a change to the terms or conditions of a share-based payment award. | Effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. | |||
| ASU 2017-11 | _Earnings Per Share (Topic 260) Distinguishing Liabilities from Equity (Topic 480) Derivatives and Hedging (Topic 815): C_hanging the classification analysis of certain equity-linked financial instruments (or embedded features) with down round features. | Effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. | |||
| ASU 2017-12 | Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. | Effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. | |||
| ASU 2018-02 | Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. | Effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. |
Adoption of those ASUs that became effective during 2017 and 2018 prior to the issuance of our consolidated financial statements, did not have a material effect on these financial statements.
We have reviewed the impact of FASB ASU Topic 606, "Revenue from Contracts with Customers" ("ASC Topic 606"), and identified similar performance obligations under ASC Topic 606 as compared with deliverables and separate units of account previously identified, as a result we expect the timing of our revenue to remain the same as compared to FASB ASC Topic 605, "Revenue Recognition." We expect to adopt ASC Topic 606 using the modified retrospective method, effective January 1, 2018.
Previous: Item 6. SELECTED FINANCIAL DATA · Next: Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK