Are Wachovia Bank and Ambac next to fail?

| September 26, 2008 | 0 Comments
Are Wachovia Bank and Ambac next to fail?

Wachovia Corporation (WB)

When Harvard economist, Professor Kenneth Rogoff - formerly head of the IMF - predicted at the end of August that at least one major US bank would collapse along with hundreds of smaller banks, trader speculation fell on three names:

- Lehman Brothers
- Washington Mutual
- Wachovia Corporation

Since his warning on August 28th, we saw Lehman Brothers file bankruptcy on September 15th, and Washington Mutual was taken over by the OTS last night and sold to JP Morgan.

It now remains to be seen how the Wachovia bank will hold up.

What all three had in common was extensive exposure to subprime mortgage assets, specifically ALT-A, interest only mortgages, which were a particularly toxic mix of short-term discount and self certification - and which have seen defaults in the region of up to 20% in some US metropolitan areas.

While Washington Mutual had exposure of $56 billion in ALT-A mortgages, Wachovia has exposure to over $160 billion in the same market.

The 20% foreclosure rate isn’t the only loss for banks holding these mortgage loans - there is another 20% potential loss through foreclosure and resale in the middle of the worst housing crisis in the US.

With a string of high profile collapses in the US, and a lack of confidence in US companies with significant mortgage exposure, all eyes will be on Wachovia to see whether it can survive long enough to see a Federal plan legislated.

Ambac (ABK)

Ambac is the second-largest bond insurer in the US, and between July 2007 to 2008, lost over 95% of its share price value.

The main reason, again, was massive exposure to subprime mortgages, as a number of bond insurers had expanded from insuring not just bonds, but also subprime mortgage assets.

The result was that bond insurers backing mortgages faced heavy write-downs.

We’ve not been the only ones to cheer the downtrodden bond insurers such as Ambac and MBIA, and both companies saw share prices leap to highs over August, before these slipped back.

While Ambac shares have since recovered from $1.9 a share on July 15th of this year, to $3.0 yesterday, the company is facing serious problems.

Moody’s has given notice that Ambac credit ratings are under review. If it does, Amabc could be next to go without a US government bail-out plan.

According to a report on Marketwatch:

Ambac Financial Group said late Friday that a downgrade by ratings agency Moody’s Investors Service would leave its guaranteed investment-contract business short of collateral to meet liabilities. The company also said plans to pump $850 million into a new municipal bond-insurance business called Connie Lee have been postponed. In addition, Ambac cancelled a $50 million share-buyback plan that was announced earlier this year.

In other words, the company’s recovery plans have been shelved, and if downgraded, Ambac has no cash to pay its obligations - setting the scene for either a bankruptcy or bail out.

Neither which is likely to instill confidence in the US financial system, which is already reeling from a strong of collapses and outright lack of investor confidence.

Of course, if the Paulson Plan comes to fruition first, then there is hope yet for Ambac - but it’s hardly comforting that the future of the company’s survival could be entirely dependent on massive government aid.

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