Financial firms: The hunters and the hunted

NEW YORK (CNNMoney.com) -- When troubled bond insurer Ambac Inc. said Tuesday that it was mulling a sale in the wake of its recent financial downgrade, Wall Street went wild and shares of the company soared.

What investors may not realize is that finding a buyer won't be so easy to do.

The financial services sector is littered with distressed companies. But as cheap as these firms may be, analysts stress that it is unlikely the sector will undergo any major consolidation anytime soon because of the uncertainty in the market and the dearth of buyers.

"There are not a lot of hunters out there," said Frank Braden, a banking industry equity analyst with Standard & Poor's.

Granted, a few deals have cropped up lately.

Earlier this month, Bank of America (BAC, Fortune 500) announced plans to buy Countrywide Financial Corp. (CFC, Fortune 500), the embattled mortgage lender, in an all-stock deal worth $4 billion.

And just last week, Jamie Dimon, chairman and CEO of JPMorgan Chase (JPM, Fortune 500), said his company was "very open minded" to making acquisitions in the future.

But what worries companies with cash to spend, like JPMorgan or Wells Fargo (WFC, Fortune 500), is a fear they could find themselves in a capital crisis. Rivals like Citigroup (C, Fortune 500), for example, have not only had to sell a stake to foreign investors recently but have also needed to cut their dividend to raise capital.

Companies with the ability to acquire are also worried about taking on another company's problematic loan portfolio, especially at a time when there are few signs that the credit crisis is abating, said Thane Bublitz, senior equity analyst at the Minneapolis-based Thrivent Financial.

If the lending crunch takes a turn for the worse, particularly in consumer areas like credit cards, a buyer could be in for much more than they bargained for, according to Thane Bublitz, senior equity analyst at the Minneapolis-based Thrivent Financial.

"We haven't seen any slowing in deterioration," said Bublitz. "It's reasonable to expect they might wait and see what happens."

When analysts speculate about which companies in this vast sector could be snapped up, speculation seems to circle around a few names. One of them is First Horizon National Corp. (FHN)

The Memphis-based bank, hurt by rising delinquencies and defaults on both home and consumer loans, posted a steep fourth-quarter loss last week. The company also slashed its quarterly dividend by more than half.

Analysts also say that Cleveland, Ohio-based bank National City (NCC, Fortune 500) could soon find itself on the auction block. The company said it lost more than $300 million in the fourth quarter Tuesday, after announcing earlier this month it would cut its dividend and slash 900 jobs.

Ambac (ABK), even before saying it was looking at "strategic alternatives" Tuesday, was mentioned as a takeover target after rating agencies downgraded its credit ratings late last week - sparking worries Ambac would be unable to pay claims related to the credit crisis.

And, of course, there is Washington Mutual (WM, Fortune 500), which has long been speculated to be the takeover target of choice for JPMorgan.

In a bid to stay independent, Seattle-based WaMu raised $3.7 billion in capital last month by making job cuts, steeply reducing its dividend and offering preferred stock to investors.

Still WaMu, hurt by its troubled mortgage portfolio, swung to a $1.87 billion fourth-quarter loss last week.

Calls to First Horizon and Washington Mutual were not immediately returned. A spokesperson for National City said the company did not comment on market rumors, but said it was focused on its strategic objectives.

With so few mortgage lenders, bond insurers as well as regional and national banks are positioned to absorb their rivals, analysts speculate that other buyers, including private equity shops, could swoop in for the kill.

Buyout firms, fans of distressed companies, may have an additional incentive to buy languishing financial services companies if the Federal Reserve continues to lower interest rates after Tuesday's emergency cut.

"I could see them going through here like a combine through a cornfield," said Peter Sorrentino, a senior portfolio manager who helps oversee $13 billion at Huntington Asset Management in Cincinnati.

Another group of buyers even more likely to pounce are European and Canadian banks.

There has already been a big push to snap up U.S. regional banks. Last fall, the Royal Bank of Canada said it planned to acquire Alabama National (ALAB) for $1.6 billion, while rival Canada's Toronto-Dominion Bank followed with plans to buy the New Jersey-based Commerce Bancorp (CBH) for $7.6 billion in cash and stock.

Also last year, one of Spain's largest banks, Banco Bilbao Vizcaya Argentaria S.A., purchased the Texas-based Compass Bank, giving the company a key foothold in the Southwest.

Now with the dollar still suffering against both the euro and Canadian dollar, distressed U.S. financial firms might become even more attractive targets, said Jeff Davis, an analyst at FTN Midwest Research, a division of First Horizon National Corp.

"They are licking their chops on their ability to pick up attractive franchises and add to what they have already got," Davis said.