Thursday, August 02, 2012

(BN) $440 Million Bug


Knight Capital Group Inc. (KCG) has "all hands on deck" and is in close contact with clients and counterparties as it tries to weather trading errors that cost it $440 million, Chief Executive Officer Thomas Joyce said.

Joyce said it's "hard to comment" on discussions with creditors as Knight stock extended a two-day plunge to 70 percent and the firm explored strategic and financial alternatives following a loss almost four times its annual profit. The problems were triggered by what Joyce called "a bug, but a large bug" in software as the company, one of the largest U.S. market makers, prepared to trade with a New York Stock Exchange program catering to individual investors.

"Technology breaks," Joyce said in an interview on Bloomberg Television's "Market Makers" program with Erik Schatzker and Stephanie Ruhle today. "It ain't good. We don't look forward to it."

Knight was fighting to preserve its business as concern grew about its solvency. Analysts at CLSA Credit Agricole Securities said bankruptcy was a possibility if it failed to get financing. The trading error caused dozens of stocks to swing as much as 151 percent, leaving the firm with what Joyce called a "large error position."

The company is in contact with clients, counterparties and creditors as it works to recover.

'Capable People'

"That's what our goal is," he told Bloomberg TV. "We understand what the issues are. We're talking to a lot of capable people, people who are in touch with situations like this," he said. "You might imagine during the day-to-day activity, it's kind of hard to comment" on discussions about credit lines.

Knight said that while the bug occurred as the firm prepared to trade with the NYSE's new so-called retail liquidity program, it had "nothing to do" with the NYSE.

"The software had a fairly major bug in it," he said. "It sent into the market a ton of orders, all erroneous. So we ended up with a very large error position which we had to sort through during the balance of the day."

The bad software code is gone now, he said, and clients of the market-making business were executing with the firm by the end of the day after Knight told them initially to go elsewhere.

NYSE Review

The New York Stock Exchange reviewed trading in 140 stocks from Molycorp Inc. to AT&T Inc. yesterday as the market's open was disrupted. Trades that occurred during the height of the volatility were canceled in six securities, where prices swung at least 30 percent in the first 45 minutes.

Knight's market-making unit executed a daily average of $19.5 billion worth of equities in June with volume of 3.1 billion shares, according to its website. The $440 million loss compares with net income of $115.2 million in 2011 on revenue of $1.4 billion, data compiled by Bloomberg show.

"Although the company's capital base has been severely impacted, the company's broker/dealer subsidiaries are in full compliance with their net capital requirements," Knight said today. "The company is actively pursuing its strategic and financing alternatives to strengthen its capital base."

The loss represents about 40 percent of Knight's book value and would "exhaust" the firm's cash, according to CLSA Credit Agricole Securities, which said Knight should consider selling itself.

Sell Rating

"We believe Knight Capital is at risk of bankruptcy following the loss and so we are lowering our rating to sell," Robert Rutschow, a New York-based analyst with CLSA who had an outperform rating on the stock, wrote in a note today. He also cut the price estimate to $3 from $9. "The company's best option at this point is a sale."

While Knight reported July 18 that second-quarter earnings exceeded analyst projections, sales fell short by 1.7 percent. Cash and equivalents fell 22 percent to $364.8 million in the last quarter, data compiled by Bloomberg show. The company's debt amounted to 46.4 times total assets, compared with 64 a year ago, data compiled by Bloomberg show.

"This loss is larger than we expected," Rich Repetto, a New York-based analyst with Sandler O'Neill & Partners LP, wrote in an e-mail. "More monitoring and safeguards need to be built into these trading algorithms of both market makers and exchanges."

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