From Knight To Schrödinger Cat: Brokerage Scrambles Half-Alive, Half-Dead

Tyler Durden's picture

Update via CNBC:

  • CITADEL, KRR SAID NO LONGER TO BE LOOKING AT KNIGHT
  • KNIGHT CAPITAL CLOSE TO FUNDING DEAL, CNBC'S KATE KELLY SAYS
  • KNIGHT MAY GENERATE ABOUT $400 MLN FROM INVESTORS, KELLY SAYS
  • GETCO, TD AMERITRADE LIKELY PART OF INVESTMENT GROUP: KELLY

Or not. We will know for sure in a few hours after TD and Getco know all they need to know about Knight's business and no longer need to give it false hope.

Knight Capital is scrambling: it has a few hours to convince any potential suitors that it is worth some $300 million more alive than having its carcass picked off at a cost of $0.01 over its debt (which itself will likely be materially impaired) in a Chapter 11 Stalking Horse sale. If the Sunday before the Lehman, and MF Global, bankruptcy filings is any indication, the third time will not be the charm for the company whose 1400 employees may have no place to call work at 9am tomorrow. Sadly, in a world in which entire countries and continents have taken on the patina of Schrödingerian felinism, constantly shifting between alive and dead states depending on who is looking, we would take the under on the probability that the firm's lawyers will not be visiting 1 Bowling Green at some point in the next 16 hours.

From the WSJ:

Knight Capital Group Inc. continued talks Sunday morning aimed at a deal that would allow the company to avert bankruptcy and open for business Monday morning, according to people familiar with the matter.

 

The discussions followed all-day meetings at Knight on Saturday as the hobbled brokerage sought to negotiate a transaction that would provide long-term funding, the people said. A software error at Knight last Wednesday caused millions of errant trades that the Jersey City, N.J.-based firm later said would cost it $440 million.

 

On Thursday, Knight arranged short-term funding that allowed it to operate on Friday. Knight needed the funding in place to be sure it could meet margin requirements, a necessary step in clearing trades at the heart of the firm's brokerage business.

 

Knight operates with two types of loans, short-term credit lines to fund daily trading and $300 million of syndicated loans for general corporate purposes, according to public filings. Several hedge funds have approached Knight about refinancing the syndicated loans if necessary, other people said.

 

It wasn't clear whether any such deal would happen, and the firm was also making bankruptcy preparations in case an agreement falls through.

The problem with Knight is that this is not a simple refinancing in a (Z/N)IRP environment: that could have been achieved in no time at all. In this case, it means providing additional capital to plug already incurred balance sheet losses, and shortfalls, that amount to more than the company's entire cash balance. That would mean not only cramming down everyone else on the balance sheet, but finding new unencumbered hard, money-good assets that can be pledged against new cash. Alas, very much like Europe, Knight just does not have these. Instead, anyone interested in the firm's existing assets will likely wait until fair value impairments wipe out its equity cap and impair its debt for a "fresh start", at which point any incremental debt will provide operation funding. Just like the Barclays take under of Lehman's North America brokerage even as the rest of the firm remained as a bad bank. In other words: a bankruptcy filing.

If this is the ritualistic sacrifice that has to be made in order to get someone within the regulatory staff to finally do something about the persistent threat that is HFT, so be it. All of this could have been avoided a long time ago ago if the SEC actually understood what it was doing and had any idea of how broken the market was, and if the SEC was not co-opted by the same HFT interests that have made amockery of stock trading.