Knight Capital Reports Net Loss After Software Error

Knight Capital Reports Net Loss as Software Error Takes Toll
Traders from Knight Capital Group Inc. work on the floor of the New York Stock Exchange in New York. Photographer: Peter Foley/Bloomberg

Knight Capital Group Inc. reported a quarterly loss of $389.9 million on bigger-than-estimated costs from the software error that nearly pushed it into bankruptcy.

The third-quarter net loss was $6.30 a share, the widest since at least 2001, and compared with profit of 29 cents a year earlier, based on a statement today from Knight and data compiled by Bloomberg. The loss related to its Aug. 1 computer malfunction was $457.6 million, wider than the $440 million previously reported, Knight said.

A technology error Aug. 1 bombarded equity exchanges with erroneous orders, leading Knight, one of the largest traders of U.S. shares by volume, to the brink of insolvency as customers routed orders elsewhere and the shares plunged 75 percent in two days. The Jersey City, New Jersey-based company is now more than 70 percent owned by the companies that bailed it out with a $400 million cash infusion the following week. Almost all customers have come back to the firm, Chief Executive Officer Thomas Joyce said today on a conference call with analysts.

“In the aftermath of Knight Capital’s Aug. 1 trading glitch, a primary concern has been the potential for permanent loss of business for the firm’s U.S. equities market-making unit,” Patrick O’Shaughnessy, a Chicago-based analyst with Raymond James & Associates Inc., wrote in a note this month.

Client Relations

There are a “handful” of customers that have not resumed trading with Knight, Joyce said. Most of them cited credit department regulations and wanted to observe Knight’s operations before re-engaging, he said.

Knight’s trading loss caused it to report negative revenue of $189.8 million, compared with analyst projections for negative $216.5 million, data compiled by Bloomberg show. Knight posted revenue of $397.4 million a year ago, according to the report.

Knight slipped 0.4 percent to $2.57 at 11:30 a.m. New York time. The stock’s 2012 loss of 78 percent compares with a 3.2 percent gain in the NYSE Arca Broker/Dealer Index that tracks the company and 10 rivals.

Improperly installed software malfunctioned and increased trading, leading volume to surge and prices to swing in dozens of securities that day. The six firms that took over the company provided a $400 million cash infusion through the sale of convertible equity, leading the shares outstanding to nearly double after Jefferies Group Inc., one of the brokerages that arranged the bailout, converted almost all of its preferred stock last month.

‘Knucklehead’ Errors

Joyce said last month that the Aug. 1 event may spur regulatory changes to protect against future errors by “knuckleheads.” Regulators and market participants may examine whether trading curbs that focus on sudden price moves for individual stocks and exchange-traded funds should also consider volume, he said at a Barclays Plc conference in New York.

Knight formed a formal risk committee yesterday and has put in place controls that enable the firm to respond faster to trading errors, Joyce said today on the conference call. He said he has no plans to split apart the electronic business, the market-making unit and the institutional sales and trading segment, or reallocate resources between them.

Fees, Writedowns

“We are better off having them all than becoming a siloed kind of one-product firm,” Joyce said. “We came back as well as we came back because of the broadness of our organization.”

The company said today that it recorded $3.5 million in one-time fees related to the trading error and a $143 million writedown for goodwill and intangible assets. Legal fees will be above average in the future, though not as high as last quarter, according to Chief Financial Officer Steve Bisgay.

Expenses linked to payment for order flow, the practice of compensating retail brokerages for sending transaction requests, are expected to increase as the company vies to remain competitive, Joyce said.

The quarterly loss included a $3.08 per-share dividend related to the conversion feature for the preferred shares issued to the investor group, according to the release. The rest of the loss included $2.46 a share related to the trading error and 76 cents a share for asset impairment. Excluding the trading loss, related expenses and the asset impairment charge, Knight said earnings were 1 cent a share.

Trading Decline

Knight’s earnings suffered from lower volatility and trading activity last quarter. The VIX, or Chicago Board Options Exchange Volatility Index, averaged 16.19 during the third quarter, almost half what it was in the same three months of 2011. About 5.97 billion shares changed hands each day last quarter in the U.S., 32 percent lower than a year ago, according to data compiled by Bloomberg.

“The market making segment bore the near full financial impact of the trading loss incurred as a result of the technology issue,” Joyce said in the release. “Contributing to the poor results was a continued decline in retail trading activity and muted market volatility.”

For the third quarter, average daily trades for the company’s U.S equity market-making business fell 40 percent to 2.51 million from a year ago, the company said. From August to September, they rose 40 percent to 2.7 million as business started to recover from the trading loss, according to a separate release.

Knight said it had $420.8 million in cash and equivalents as of Sept. 30, compared with $467.6 million at the end of 2011. While the company’s share-repurchase program has $120.9 million remaining, “there are no assurances that any further repurchases may actually occur,” according to the statement.

“We will very likely have a higher than average cash balance for the foreseeable future” Joyce said. Knight’s priority is “a fortress balance sheet, to make sure all of our counterparties feel great about us.”


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