Knight Lives! (At Least Until Monday): Financial Winner

NEW YORK (TheStreet) -- Knight Capital Group was the big winner on a strong Friday for financials, bouncing back from two days of brutal losses, with shares rising 57% to close at $4.05

After seeing its shares drop 33% on Wednesday after an early trading glitch, followed by a 63% plunge on Thursday, after announcing a pretax loss of $440 million from its efforts close-out its erroneous trades, Knight Capital's shares recovered some of the losses after the company told its clients early Friday that it had secured sufficient credit to allow it to operate for another day, as it continued to pursue a capital infusion or outright sale.

Knight Capital in June renewed a $200 million credit line with a group of banks led by U.S. Bancorp subsidiary U.S. Bank, NA, that also included bank subsidiaries of Bank of America , Bank of Montreal , and JPMorgan Chase .

Among the covenants of the credit agreement was a requirement that Knight maintain certain levels of capital for its broker-dealer subsidiaries, which the company might be unable to meet, following the three-day settlement of its erroneous trades, without securing additional capital from outside.

KBW analyst Niamh Alexander says that "it's possible that they could be in breach," of the $200 million credit facility's covenants, "but they may not have actually drawn down those facilities."

Alexander calls the new credit line reported by the Journal "very encouraging," but says the company still needs "to do something and do it very quickly. It will be difficult for customers to continue to route trades through Knight unless they are more comfortable about the capital situation."

"It is going to be day by day... something needs to happen for people to feel better about the capital," she says.

CRT Capital Group analyst Kevin Starke said on Friday that Knight Capital's trading loss is likely to be recognized on Monday, and that "solving the liquidity problem and capital shortfall that this will cause thus needs to be completed by Monday." Starke also said that "FINRA is on site and stated publicly Thursday that the Company was in compliance with capital requirements, but we wonder aloud whether that is simply because the bad trades have yet to settle."

Starke also said "it is possible though not likely that the capital shortfall can be remedied with internal resources. To solve the liquidity problem, Knight Execution & Clearing Services can draw on the $200 million line, though we are not entirely sure it can borrow the entire amount." The analyst added that "it will be recalled that MF Global too drew down on its lines in the days just prior to being put into administration."

So Monday looks to be another day for extreme volatility for Knight Capital and its shareholders.

Tim Smith, executive director of SunGard's Astec Analytics business discussed the short interest in Knight Capital's shares and a possible short squeeze, saying on Friday that "there is more borrowing of Knight's shares being undertaken today, and the cost to borrow those securities has quadrupled in the past day to about 22% per annum, reflecting the difficulty people are having getting the shares. One of the reasons for that is some institutional selling that has triggered a number of recalls of earlier borrowed positions and sent some scrambling to find replacement shares," he said, which "could explain why the share price has gone up today, as the only way to cover these recalls has been to buy."

The broad indexes on Friday were all very strong, with 2% gains, after the Labor Department reported that nonfarm payrolls rose by 163,000 in July, which was way ahead of the 100,000 new jobs expected by economists polled by Thomson Reuters. This was the largest monthly employment growth number since February, although the unemployment rate held at 8.3%.

The KBW Bank Index rose over 3% to close at 46.06, reversing four sessions of losses, so that the index was down only slightly from a week earlier. All 24 index components showed gains of over 1%, with Bank of America rising 3.5% to close at $7.43, while Citigroup was up 5%, closing at $27.40.

Among the largest U.S. bank holding companies, Morgan Stanley was winner, with shares rising 6% to close at $13.78. The shares have now declined 8% year-to-date, following a 44% decline during 2011.

MS data by YCharts

Morgan Stanley has been one of the most volatile financial names, especially when there is significant economic news, domestically or in Europe. The shares declined 4% on Thursday, after European Central Bank Mario Draghi at a press conference failed to back up his statement from the previous week that the ECB was "ready to do whatever it takes to preserve the euro," with any concrete action.

The company reported sovereign and non-sovereign net exposure to "Euro Peripherals," including Greece, Ireland, Italy, Spain, and Portugal, of $4.2 billion as of June 30, with another $1.4 billion in exposure to France.

Morgan Stanley's shares for a very low 0.4 times their reported June 30 tangible book value of $31.02, and for less than seven times the consensus 2013 EPS estimate of $1.96, among analysts polled by Thomson Reuters. The consensus 2012 EPS estimate is 90 cents.

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-- Written by Philip van Doorn in Jupiter, Fla.

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