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Is It Time To Buy Ambac?

08/27/08 11:56:18 AM
by Koos van der Merwe

Has the time come to start nibbling at financials, or is it a case of "Fools rush in..."?

Security:   ABK
Position:   Accumulate

If your answer is yes, consider Ambac Financial (ABK).
Ambac Financial Group is a holding company that has two main subsidiaries: financial guarantee and financial services. Its primary business, the guarantee side, is known as Ambac Assurance Group, insuring securitized debt. This means that if a bond/security fails, the company will cover the interest and the principal. Over the years, Ambac built its reputation on low-risk investments with predictable returns such as municipal bonds and investment grade corporate debt. The company earned a top AAA rating from all major rating agencies because of its strong balance sheet.
Unfortunately, as with other insurers, Ambac insured large numbers of collateralized debt obligations (CDOs) such as mortgage-backed securities. These insurance policies were very lucrative and allowed Ambac to double its revenues in the four years between 2002 and 2006. As shown recently, Ambac underestimated the probability of defaults. With the onset of the subprime lending crisis, the company was obligated to cover huge numbers of failed mortgage-backed securities. This led to the company losing its AAA credit rating, resulting in a dramatic fall in the stock price, as the company found that assets could not cover its obligations.

FIGURE 1: ABK, MONTHLY. Ambac shows how the stock price collapsed from May 2007 to July 2008.
Graphic provided by: AdvancedGET.
Figure 1 is a monthly chart showing how the stock price collapsed from a high of $96.59 in May 2007 to a low of $1.04 by July 2008. So is it time to start buying? The US government has bailed out companies caught with their pants down by the subprime lending crisis. Have these companies learned their lesson and become more risk averse, or will they wait for the government to control them by regulating the amount of risk they may take? Daily charts suggests the former.

FIGURE 2: ABK, DAILY. The cup & handle formation developing indicates that if the price breaks above $6.31, we could see a rise to the target of $11.02.
Graphic provided by: AdvancedGET.
Figure 2 shows a cup & handle formation developing. This means that should the price break above $6.31, we could see a rise to the target of $11.02. The relative strength index (RSI) is, however, suggesting further weakness ahead.

The subprime lending crisis throughout the world has hurt all financial institutions that became reckless with assets in their pursuit of profits. However, many of these companies are fundamentally sound and should come out of their depths of despair much stronger.

When to buy them is the question. Ambac is one of these companies that should be placed on your watchlist, with a buy signal given when the price moves above $6.31.

Koos van der Merwe

Has been a technical analyst since 1969, and has worked as a futures and options trader with First Financial Futures in Johannesburg, South Africa.

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