Aug. 6 (Bloomberg) -- Knight Capital Group Inc.’s search for investors in the wake of a $440 million loss demonstrates why the biggest Wall Street banks shouldn’t be broken up, according to Brad Hintz, a Sanford C. Bernstein & Co. analyst.
Creditors and counterparties will abandon Knight unless it quickly finds a way to shore up capital, Hintz wrote in a weekend research note. As an independent broker-dealer instead of a bank, the Jersey City, New Jersey-based company can’t turn to the Federal Reserve as a lender of last resort, Hintz wrote.
JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc., the three-biggest U.S. lenders by assets, are among firms that some analysts and investors say would be more valuable if their securities units could be traded separately to avoid bank capital requirements and proprietary-trading restrictions. Knight’s predicament illustrates why securities firms need Fed protection, Hintz wrote.
“Perhaps the Knight story will put an end to the speculation that spinning off the trading units of the universal banks would increase shareholder value,” Hintz wrote. “Attempting to free a trading unit from these rules by returning to the independent broker-dealer model will sharply increase the wholesale funding and contingent liquidity risk of these firms.”
Knight plunged 75 percent in two days after a software failure in one of its trading systems on Aug. 1, leaving the company with positions that it later sold at a $440 million loss. The stock surged 57 percent on Aug. 3 after the Wall Street Journal reported that the firm had obtained short-term financing.
The company is selling $400 million of convertible securities to six investors to shore up its capital base, said two people with knowledge of the matter. The purchasers -- Getco LLC, the automated trading firm backed by General Atlantic LLC, private-equity firm Blackstone Group LLP, brokerages Stifel Nicolaus & Co. and TD Ameritrade Holding Co. and investment banks Jefferies Group Inc. and Stephens Inc. -- will own between 70 to 75 percent of the company, one of the people said.
Goldman Sachs Group Inc., which converted to a bank in 2008 a week after the collapse of competitor Lehman Brothers Holdings Inc., agreed Aug. 1 to buy Knight out of its errant positions, a person familiar with the matter said last week. That transaction is set to be completed at the end of trading today.
“Knight Capital should remind investors how the investment banks became bank holding companies four years ago; markets froze, confidence was lost, funding dried up and a reluctant central bank was forced to step in to save the U.S. capital markets,” Hintz wrote. “As investors learned in 2008-2009, the most significant risk to any major broker-dealer is a loss of confidence.”
Goldman Sachs and Morgan Stanley, the other securities firm that converted to a bank in 2008, are rated outperform by Hintz, meaning he expects the stocks to beat the broader market by more than 15 percentage points within a year. Goldman Sachs trades at about 80 percent of tangible book value, a measure of how much it could fetch if liquidated. Morgan Stanley trades at about 55 percent of tangible book. Both banks are based in New York.
“Hintz is reminding people of the massive, non-transparent and dangerous government subsidies that are available to securities firms that are connected to banks,” said Simon Johnson, a former chief economist for the International Monetary Fund who is now a professor at the Massachusetts Institute of Technology’s Sloan School of Management. “Why is this a good deal for taxpayers?”
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