10-Q 1 file001.htm FORM 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X]    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2005

OR

[  ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                  to                 .

Commission File Number: 001-32307

Primus Guaranty, Ltd.

(Exact name of registrant as specified in its charter)


Bermuda Not Required
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer Identification No.)

Clarendon House
2 Church Street
Hamilton HM 11, Bermuda
(Address of principal executive offices, including zip code)

441-296-0519
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes   [X]    No   [ ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes   [ ]    No   [X]

As of November 5, 2005, the number of shares outstanding of the issuer's common stock, $0.08 par value, was 43,140,288.




Primus Guaranty, Ltd.
Form 10-Q
For the quarter ended September 30, 2005


Part I. Financial Information      
Item 1. Financial Statements      
  Consolidated Statements of Financial Condition
September 30, 2005 (Unaudited) and December 31, 2004
  3  
  Consolidated Statements of Operations (Unaudited)
Three and nine months ended September 30, 2005 and 2004
  4  
  Consolidated Statements of Cash Flows (Unaudited)
Nine months ended September 30, 2005 and 2004
  5  
  Notes to Consolidated Financial Statements   6  
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations
  19  
  Cautionary Note Regarding Forward-Looking Statements   33  
Item 3. Quantitative and Qualitative Disclosures about Market Risk   34  
Item 4. Controls and Procedures   35  
Part II. Other Information      
Item 1. Legal Proceedings   35  
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds   35  
Item 3. Defaults upon Senior Securities   36  
Item 4. Submission of Matters to a Vote of Security Holders   36  
Item 5. Other Information   36  
Item 6. Exhibits   36  
Signatures   37  

2




Part I.    Financial Information

Item 1.    Financial Statements

Primus Guaranty, Ltd.
Consolidated Statements of Financial Condition
(dollars in 000s except per share amounts)


  September 30,
2005
December 31,
2004
  (unaudited)  
Assets            
Cash and cash equivalents $ 80,951   $ 320,989  
Available-for-sale investments   416,597     161,101  
Accrued interest receivable   4,135     1,381  
Accrued premiums on credit swaps   3,198     3,349  
Premiums receivable on credit swaps   160     197  
Premiums receivable on financial guarantees   400     800  
Asset management fee receivable   3     15  
Prepaid expenses   524     868  
Unrealized gain on credit swaps, at fair value   29,157     46,517  
Fixed assets, less accumulated depreciation of $693 in 2005 and
$493 in 2004
  1,627     1,800  
Internal use software costs, less accumulated amortization of $7,267
in 2005 and $5,893 in 2004
  3,415     4,297  
Income tax receivable   279     279  
Debt issuance costs   1,124     1,125  
Total assets $ 541,570   $ 542,718  
             
Liabilities, preferred securities of subsidiary and shareholders' equity            
Accounts payable and accrued expenses $ 1,798   $ 904  
Compensation accrual   3,916     5,317  
Brokerage fees payable   6     14  
Taxes payable   220     12  
Interest payable   95     364  
Long-term debt   75,000     75,000  
Unrealized loss on credit swaps, at fair value   1,737     259  
Deferred rent payable   435     455  
Deferred financial guarantee premiums   506     806  
Deferred credit swap premiums   51     69  
Total liabilities   83,764     83,200  
Preferred securities of subsidiary   98,521     98,521  
Shareholders' equity:            
Common stock, $0.08 par value, 62,500,000 shares authorized, 43,120,989 and 42,780,033 shares issued and outstanding at September 30, 2005 and December 31, 2004, respectively   3,682     3,535  
Additional paid-in-capital   264,698     264,860  
Warrants   612     612  
Accumulated other comprehensive loss   (2,670    
Retained earnings   92,963     91,990  
Total shareholders' equity   359,285     360,997  
             
Total liabilities, preferred securities of subsidiary and shareholders' equity $ 541,570   $ 542,718  

See accompanying notes.

3




Primus Guaranty, Ltd.
Consolidated Statements of Operations
(amounts in 000s except per share amounts)


  Three Months Ended
September 30,
Nine Months Ended
September 30,
  2005 2004 2005 2004
  (unaudited)
Revenues                        
Net credit swap revenue $ 27,449   $ 23,331   $ 15,672   $ 26,166  
Premiums earned on financial guarantees   101     99     300     295  
Investment portfolio realized gains/(losses)   (3       20      
Interest income on investment portfolio   4,483     1,166     10,969     2,534  
Rental income               40  
Asset management fees   49     3     140     3  
Foreign currency revaluation   55     66     (1,464   (40
Total net revenues   32,134     24,665     25,637     28,998  
                         
Expenses                        
Employee compensation and benefits   3,537     3,858     12,139     11,142  
Professional and legal fees   981     382     2,731     1,160  
Fixed asset depreciation and amortization   533     494     1,574     1,453  
Technology and data   535     243     1,250     914  
Rent   191     193     567     550  
Bank and investment management fees   203     275     660     438  
Rating agency fees   61     151     216     289  
Brokerage expense   18     151     107     515  
Interest expense   649     375     1,640     375  
Other   332     136     873     579  
Total expenses   7,040     6,258     21,757     17,415  
Distributions on preferred securities of subsidiary   (1,022   (403   (2,797   (1,550
Income before provision for income taxes   24,072     18,004     1,083     10,033  
Benefit/(Provision) for income taxes   (63   22     (108   (95
Net income available to common shares $ 24,009   $ 18,026   $ 975   $ 9,938  
                         
Earnings per common share:                        
Basic $ 0.56   $ 4.23   $ 0.02   $ 2.57  
Diluted $ 0.54   $ 0.51   $ 0.02   $ 0.28  
Average common shares outstanding:                        
Basic   43,120     4,264     43,147     3,866  
Diluted   44,543     35,219     44,673     35,081  

See accompanying notes.

4




Primus Guaranty, Ltd.
Consolidated Statements of Cash Flows
(dollars in 000s)


  Nine months ended
September 30,
  2005 2004
  (unaudited)
Cash flows from operating activities            
Net income $ 975   $ 9,938  
Adjustments to reconcile net income to net cash provided by operating activities:            
Non-cash items included in net income:            
Depreciation of fixed assets   200     167  
Amortization of internal use software costs   1,374     1,286  
Stock compensation   2,149     2,095  
Net unrealized loss on credit swap portfolio   18,837     10,412  
Unrealized loss on sublease       (39
Deferred rent   (20   (13
Amortization of debt issuance costs   31      
Distributions on preferred securities of subsidiary   2,798     1,550  
Increase (decrease) in cash resulting from changes in:            
Premiums receivable on credit swaps   37     112  
Accrued premiums on credit swaps   151     174  
Deferred credit swap premiums   (17   (38
Deferred financial guarantee premiums   (299   (295
Brokerage fees payable   (8   (14
Accrued interest receivable   (2,754   (263
Premiums receivable on financial guarantees   400     401  
Prepaid expenses   344     (712
Other       527  
Asset management fee receivable   12      
Accounts payable and accrued expenses   889     188  
Compensation accrual   (1,400   (995
Interest payable   (269   375  
Taxes payable.   208     50  
Net cash provided by operating activities   23,638     24,906  
Cash flows from investing activities            
Fixed asset purchases.   (27   (125
Net sale (purchase) of investments.   (258,165   539  
Other asset purchases   (492   (440
Net cash used in investing activities   (258,684   (26
Cash flows from financing activities            
Retirement of common shares   (2,397    
Proceeds from long term subordinated debt issuance of subsidiary       75,000  
Proceeds from issuance of common shares   234      
Debt issuance costs   (31   (958
Initial public offering costs       (3,300
Exercise of warrants       5,500  
Net preferred distributions of subsidiary   (2,798   (1,550
Net cash (used in)/ provided by financing activities   (4,992   74,692  
Net (decrease)/ increase in cash   (240,038   99,572  
Cash and cash equivalents at beginning of period   320,989     257,967  
Cash and cash equivalents at end of period $ 80,951   $ 357,539  
Supplemental disclosures            
Cash paid for interest $ 1,879   $  
Cash paid for taxes $ 4   $ 44  

See accompanying notes.

5




Primus Guaranty, Ltd.
Notes to Consolidated Financial Statements
September 30, 2005

1.    Organization and Basis of Presentation

Primus Guaranty, Ltd. ("Primus Guaranty" or the "Company"), is a Bermuda holding company and the 100% owner of Primus (Bermuda), Ltd. ("Primus Bermuda"), also a Bermuda holding company. The Company considers its legal domicile to be where it is incorporated, Bermuda. Primus Bermuda is the 100% owner of Primus Group Holdings, LLC ("Primus Group Holdings"), a Delaware limited liability company. Primus Group Holdings has two principal operating subsidiaries: Primus Financial Products, LLC ("Primus Financial"), and Primus Asset Management, Inc. ("Primus Asset Management"). Primus Financial is a Delaware limited liability company that maintains a long-term counterparty credit rating of AAA from Standard & Poor's Rating Services ("S&P") and Aaa from Moody's Investors Service, Inc. ("Moody's" and, together with S&P, the "Rating Agencies"). Primus Financial is primarily a provider of credit risk protection in the form of credit swaps, covering single name, corporate and sovereign financial obligations. Primus Financial also sells credit protection referencing portfolios containing obligations of multiple reference entities, or tranches. Primus Asset Management is a provider of administrative and technology support to Primus Financial and an asset manager for Primus Financial and third parties.

Primus Financial and Primus Asset Management function as separate entities from Primus Group Holdings. Additionally, the obligations of Primus Financial are not the obligations of Primus Bermuda, Primus Group Holdings, or any other of its affiliates, and vice versa. Primus Asset Management wholly owns Primus Re, Ltd. ("Primus Re"), a Bermuda company that operates as a financial guarantee insurance company and is licensed as a Class 3 Insurer under the Insurance Act of 1978 of Bermuda.

The accompanying unaudited consolidated financial statements of Primus Guaranty, Ltd. have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the periods presented are not necessarily indicative of the results that may be expected for any other interim period or for the year ended December 31, 2005. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances have been eliminated.

The consolidated financial statements represent a single reportable segment, as defined in Statement of Financial Accounting Standards ("SFAS") No. 131, Disclosures about Segments of an Enterprise and Related Information.

The consolidated financial statements are presented in U.S. dollar equivalents. At September 30, 2005 and December 31, 2004, Primus Financial's credit swap activities were conducted in U.S. dollars and Euros.

Certain 2004 amounts have been reclassified to be consistent with the 2005 presentation.

2.    Summary of Significant Accounting Policies

Credit swaps

Credit swaps are over-the-counter ("OTC") derivative financial instruments and are recorded at fair value in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. Obtaining the fair value (as such term is defined in SFAS No. 133) for such instruments requires the use of management judgment. These instruments are valued using pricing models based on the net present value of expected future cash flows and observed prices for other OTC transactions

6




Primus Guaranty, Ltd.
Notes to Consolidated Financial Statements
September 30, 2005

bearing similar risk characteristics. The fair value of these instruments appears on the consolidated statement of financial condition as unrealized gains or losses on credit swaps. The Company does not believe that its credit swaps fall outside the scope of the guidance of SFAS No. 133 paragraph 10d, as amended by SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, because there is no contractual requirement that the protection purchaser be exposed to the underlying risk.

Net credit swap revenue includes realized and unrealized gains and losses on credit swaps and net premiums earned.

Premiums are taken into income as they are earned over a specified time period. Accrued premiums on credit swaps represent premiums earned but not yet payable by Primus Financial's counterparty. Premiums receivable on credit swaps represents premiums that are both earned by and payable to Primus Financial.

Financial Guarantee-Insurance Contracts

The Company has undertaken a limited amount of financial guarantee business through its subsidiary, Primus Re. Financial guarantees are insurance contracts that contingently require the guarantor to make payments to the guaranteed party. The Company designs its guarantee contracts to qualify as non-derivatives in accordance with the scope exception under paragraph 10d of SFAS 133 as amended by SFAS No. 149. This scope exception requires that the guaranteed party be exposed to loss both at inception and over the life of the contract, incurrence of loss must be a precondition for payment under the contract, and these losses are based on payments to be made solely to reimburse the guaranteed party for failure of the debtor to satisfy its required payment obligations under a nonderivative contract, either at pre-specified payment dates or accelerated payment dates as a result of the occurrence of an event of default (as defined in the financial obligation covered by the guarantee contract) or notice of acceleration being made to the debtor by the creditor. Thus, the Company accounts for its financial guarantee contracts in accordance with SFAS No. 60, Accounting and Reporting by Insurance Enterprises. This requires that premiums are deferred and recognized over the life of the contract and that losses are recorded in the period that they occur based on an estimate of the ultimate cost of losses incurred.

The Company does not actively offer financial guarantee insurance. Rather, it is an alternative the Company has available when a counterparty requests an insurance contract instead of a credit swap. Generally, a counterparty's choice of a financial guarantee insurance contract versus a credit swap is determined by economic terms available in the marketplace as well as regulatory and accounting considerations. Also, the purchaser of an insurance contract cannot submit a claim for payment unless it has an insurable loss, whereas the purchaser of a credit swap need not have actual exposure to the underlying risk.

Insurance Premiums Earned and Receivable and Related Expenses

In exchange for providing financial guarantee protection to counterparties, Primus Re receives premiums over the life of the contract. The amount expected over the life of the policy is reflected in the statement of financial condition and will be reduced as payments are received quarterly in advance.

Although Primus Re provides insurance and purchases off-setting credit swaps through "separate accounts" under a private act, those accounts of Primus Re are not deemed to be separate accounts under SOP 03-01, Accounting & Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts for Separate Accounts, since investment performance is not passed through to the contract holder.

7




Primus Guaranty, Ltd.
Notes to Consolidated Financial Statements
September 30, 2005

Policy acquisition costs include only those expenses that relate primarily to, and vary with, premium production. Such costs generally include compensation of employees involved in underwriting and policy issuance functions, certain rating agency fees, state premium taxes and certain other underwriting expenses. No costs have been deferred by the Company as of September 30, 2005, as any such amounts have been immaterial.

Deferred Financial Guarantee Premiums

Unearned premiums related to the financial guarantee protection provided are used to establish the liability at inception. This liability is reflected in income on a straight-line basis over the period the risk protection is provided.

Unpaid Losses and Loss Expenses on Financial Guarantees

Liabilities for unpaid losses and loss expenses include the accumulation of individual case estimates for claims reported as well as estimates of incurred but not reported claims and estimates of loss settlement expenses on the obligations it has insured. Estimates will be based upon historical industry loss experience modified for current trends as well as prevailing economic, legal and social conditions. Any changes in estimates are reflected in operating results in the period in which the estimates changed. At September 30, 2005 and at December 31, 2004, the Company had no loss reserves recorded.

Income Taxes

Income tax expense is computed in accordance with the requirements of SFAS No. 109, Accounting for Income Taxes, which prescribes the asset and liability approach to accounting for income taxes. The asset and liability approach requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities.

Employee Compensation Plans

In 2003, the Company adopted the fair value approach on a prospective basis for recording stock-based employee compensation in accordance with the fair value method prescribed by SFAS No. 123, Accounting for Stock-based Compensation, as amended by SFAS No. 148, Accounting for Stock Based Compensation—Transition and Disclosure. Compensation expense is recognized based on the fair value of stock options, performance shares, restricted shares and restricted share units ("RSU") granted over the related vesting period. The fair value of the stock options granted is determined through the use of a market accepted option-pricing model.

Recently Issued Accounting Standards

In May 2005, the Financial Accounting Standards Board ("FASB") issued SFAS 154, Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3. This statement requires retrospective application to prior periods' financial statements of changes in accounting principle. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS 154 is not expected to have a significant impact on the Company's financial statements.

In December 2004, the FASB issued SFAS No. 123 (R), Share-Based Payment. SFAS No. 123 (R) is a revision of SFAS No. 123 and supersedes Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95 Statement of Cash Flows. SFAS No. 123 (R) eliminates the ability to account for share-based compensation transactions using APB

8




Primus Guaranty, Ltd.
Notes to Consolidated Financial Statements
September 30, 2005

Opinion No. 25 and requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements using a fair value-based method. In April 2005, the Securities and Exchange Commission ("SEC") amended the effective date of SFAS No. 123 (R) to provide additional time for companies to comply with the reporting requirements. The Company will adopt SFAS No. 123 (R) on January 1, 2006, and does not expect a material impact on the consolidated financial statements.

In March 2005, the SEC staff issued Staff Accounting Bulletin No. 107 ("SAB No. 107") to provide guidance on SFAS No. 123 (R). SAB No. 107 provides the staff's view regarding the valuation of share-based payment arrangements for public companies. In particular, this SAB provides guidance related to share-based payment transactions with non-employees, the transition from non public to public entity status, valuation methods (including assumptions such as expected volatility and expected term), the accounting for certain redeemable financial instruments issued under share-based payment arrangements, the classification of compensation expense, non-GAAP financial measures, first time adoption of SFAS No. 123 (R), the modification of employee share options prior to the adoption of SFAS No. 123 (R) and disclosure in Management's Discussion and Analysis subsequent to adoption of SFAS No. 123 (R). SAB No. 107 was effective March 29, 2005. The Company does not expect the adoption of this guidance to have a material impact on the consolidated financial statements.

3.    Cash and Cash Equivalents

The Company and its subsidiaries invest only in obligations of the United States of America or direct debt obligations of U.S. Agencies (including government-sponsored enterprises) rated AAA and Aaa by the respective Rating Agencies, commercial paper rated A-1 and P-1 by the respective Rating Agencies and money market funds.

All outstanding obligations in this category mature within 90 days.

4.    Available-for-Sale Investments

Available-for-sale investments included obligations of the United States of America or direct debt obligations of U.S. Agencies (including government-sponsored enterprises) rated AAA and Aaa by the respective Rating Agencies. Available-for-sale investments have original maturities or maturities at time of purchase greater than 90 days. At September 30, 2005, no investment has an original maturity or maturity at time of purchase of greater than 3 years.

Available-for-sale investments are reported in the balance sheet at their fair value. Changes in fair value are reported in other comprehensive income/(loss) in shareholders' equity, net of taxes.

5.     Credit Swap Revenues and Portfolio

Net credit swap revenue, as presented in the consolidated statement of operations, is comprised of changes in the fair value of credit swaps, realized gains or losses on the termination of credit swaps and premium income or expense. The realized gains and losses on credit swaps represent realized gains and losses on terminated or assigned credit swaps. The realization of gains or losses on credit swaps will generally result in a reduction in unrealized gains or losses and accrued premium at the point in time realization occurs.

In exchange for providing credit protection to its counterparties, Primus Financial receives premium payments as a series of fixed cash flows. Premiums are taken into income as they are earned over a specified time period. Accrued premiums on credit swaps represent premiums earned but not yet payable by Primus Financial's counterparty. Premiums receivable on credit swaps represents premiums that are both earned by and payable to Primus Financial. When Primus Financial purchases credit protection from its counterparties, Primus Financial pays premiums as a series of fixed cash flows. The premium expense is recognized ratably over the life of the transaction as a component of net credit swap revenue.

9




Primus Guaranty, Ltd.
Notes to Consolidated Financial Statements
September 30, 2005

In accordance with accounting principles generally accepted in the United States, the Company carries its credit swaps on its balance sheet at their fair value. Changes in the fair value of the Company's credit swap portfolio are recorded as unrealized gains or losses in the Company's consolidated statement of operations. If a credit swap has an increase in fair value during a period, the increase will add to the Company's net credit swap revenues for that period. Conversely, if a credit swap has a decline in fair value during the period, the decline will subtract from the Company's net credit swap revenues for that period. Changes in the fair value of the Company's credit swap portfolio are a function of the notional amount and composition of the portfolio and prevailing market credit swap premiums for comparable credit swaps. The Company generally holds the credit swaps it sells to maturity, at which point, assuming no credit event has occurred, the cumulative unrealized gains and losses on each credit swap would equal zero. In general, the Company aggregates fair values of individual credit swaps by counterparty for presentation on the Company's statement of condition. If the aggregate total of fair values for a counterparty is a net gain, the total is recorded as a component of unrealized gains on credit swaps, at fair value in the statement of financial condition. If the aggregate total of fair values for a counterparty is a net loss, the total is recorded as a component of unrealized losses on credit swaps, at fair value in the statement of financial condition. Aggregation by counterparty is applied where a valid International Swaps and Derivatives Association ("ISDA") master agreement is in place with the counterparty. In instances where the Company does not yet have a valid ISDA master agreement with the counterparty, the fair values of individual swap transactions are recorded as components of unrealized gains or losses on credit swaps, at fair value, dependent upon whether the individual contract was in a gain or a loss position.

As a general rule, when the Company sells credit protection, it intends to hold the transaction until maturity. However, there are two sets of circumstances in which the Company could elect to terminate transactions prior to maturity, and the Company monitors its portfolio on a continuing basis to assess whether those circumstances are present.

First, whenever the Company receives new information suggesting that the credit quality of the underlying risk has deteriorated to a material degree, the Company considers the possibility of terminating the transaction, usually at a loss, to avoid the larger loss that could result if the credit swap were to remain in place until a credit event occurs. The principal factor that governs the Company's decision regarding termination in these circumstances is whether the Company believes that the underlying risk has become substantially greater than the level of risk the Company would choose to assume in entering into a new sale of credit default protection.

Second, the Company may also elect to terminate a transaction for which it has an unrealized gain based on one or more of the following considerations: the likelihood of further gains arising from the position, its view as to whether the capital dedicated to the position would be profitably reallocated, its total exposure to a particular Reference Entity, the total size of its portfolio in relation to its capital and the total size of its swap positions and exposures with a particular counterparty which might be reduced so that the counterparty may enter into additional swaps with the Company.

The Company terminates (or offsets) a credit swap in any one of three ways. The Company may negotiate an agreed termination through the original counterparty (an unwind). The Company may negotiate an assignment and novation of its rights and obligations under the credit swap to a third party (an assignment). As an alternative to terminating a transaction, the Company may enter into an equal and opposite transaction with a third party under which the Company purchases credit default protection on terms that match the terms of the original transaction (an offset). In this last case, both sides of the position may subsequently be unwound or assigned.

In the event of an unwind or assignment, the Company pays or receives a cash settlement negotiated with the counterparty or assignee, based on the fair value of the credit swap contract and the accrued premium on the swap contract at the time of negotiation. The amounts the Company pays

10




Primus Guaranty, Ltd.
Notes to Consolidated Financial Statements
September 30, 2005

or receives are recorded as a realization of fair value and as a realization of accrued premiums in the period in which the termination occurs.

The Company distinguishes among credit swaps sold – single name, credit swaps sold – tranche, credit swaps purchased as short-term investments and credit swaps purchased to offset the credit risk on credit swaps previously sold. Credit swaps sold – single name refers to credit swap protection relating to a single reference entity. Credit swaps sold – tranche refers to credit swap protection referencing portfolios containing obligations of multiple reference entities, which we began selling during the second quarter of 2005. We have only purchased credit swap protection against single name reference entities. The tables below present the components of credit swap revenues for the three and nine months ended September 30, 2005 and 2004, in thousands.

Net credit swap revenues/ (losses) for the three months ended September 30, 2005


  Premium
income/
(expense)
Realized
gains
Realized
(losses)
Change in
unrealized
gains/(losses)
Total
Credit swaps sold – single name $ 14,177   $ 201   $ (1,264 $ 15,214   $ 28,328  
Credit swaps sold – tranche   114             (167   (53
Credit swaps purchased as short-term investments   (308   15     (26   (455   (774
Credit swaps purchased to offset credit risk on certain swaps sold   (21       (174   143     (52
Total $ 13,962   $ 216   $ (1,464 $ 14,735   $ 27,449  

Net credit swap revenues/ (losses) for the nine months ended September 30, 2005


  Premium
income/
(expense)
Realized
gains
Realized
(losses)
Change in
unrealized
gains/(losses)
Total
Credit swaps sold – single name $ 38,458   $ 790   $ (4,283 $ (19,514 $ 15,451  
Credit swaps sold – tranche   210             300     510  
Credit swaps purchased as short-term investments   (1,040   671     (56   171     (254
Credit swaps purchased to offset credit risk on certain swaps sold   (67       (174   206     (35
Total $ 37,561   $ 1,461   $ (4,513 $ (18,837 $ 15,672  

Net credit swap revenues/ (losses) for the three months ended September 30, 2004


  Premium
income/
(expense)
Realized
gains
Realized
(losses)
Change in
unrealized
gains/(losses)
Total
Credit swaps sold – single name $ 11,192   $ 3,251   $ (778 $ 10,998   $ 24,663  
Credit swaps purchased as short-term investments   (279   346     (34   (1,335   (1,302
Credit swaps purchased to offset credit risk on certain swaps sold   (23           (7   (30
Total $ 10,890   $ 3,597   $ (812 $ 9,656   $ 23,331  

11




Primus Guaranty, Ltd.
Notes to Consolidated Financial Statements
September 30, 2005

Net credit swap revenues/ (losses) for the nine months ended September 30, 2004


  Premium
income/
(expense)
Realized
gains
Realized
(losses)
Change in
unrealized
gains/(losses)
Total
Credit swaps sold – single name $ 31,600   $ 5,360   $ (791 $ (9,254 $ 26,915  
Credit swaps purchased as short-term investments   (527   1,086     (81   (1,198   (720
Credit swaps purchased to offset credit risk on certain swaps sold   (69           40     (29
Total $ 31,004   $ 6,446   $ (872 $ (10,412 $ 26,166  

The notional amount, fair value and average fair value of open credit swap transactions entered into with third parties at September 30, 2005 and December 31, 2004 are as follows (in thousands and US dollar equivalent):


  September 30,
2005
December 31,
2004
Gross Notional Amounts:            
Credit swaps sold – single name $ 13,028,562   $ 10,544,728  
Credit swaps sold – tranche   50,000      
Credit swaps purchased   358,364     468,175  
Fair value:            
Asset   29,157     46,517  
Liability   1,737     259  
Average fair value:            
Asset   29,483     33,778  
Liability   3,475     392  

"Asset" in the above table represents unrealized gains on credit swaps while "Liability" represents unrealized losses on credit swaps. All credit swaps that have been contractually established with each counterparty under an ISDA master agreement are subject to netting arrangements. The notional amounts of the credit swap contracts in the preceding table are presented on a gross basis and the fair values of such contracts are presented net by counterparty, where a master agreement is in place. "Average fair value" in the table above represents the averages over the nine months ended September 30, 2005 and the year ended December 31, 2004.

Under the terms of Primus Financial's operating guidelines, derivatives transactions can only include credit swaps. Credit swaps are derivative transactions that obligate one party to the transaction (the "Seller") to pay an amount to the other party to the transaction (the "Buyer") should one of a specified group of events ("Credit Events") be incurred by an unrelated third party (the "Reference Entity") specified in the contract. The amount to be paid by the Seller will either be (a) the notional amount of the transaction, in exchange for which the Seller must be delivered a defined obligation of the Reference Entity (called physical settlement), or (b) the difference between the current market value of a defined obligation of the Reference Entity and the notional amount of the transaction (called cash settlement). In exchange for incurring the potential of a Credit Event-generated loss, the Seller will receive a fixed premium for the term of the contract (or until the occurrence of a Credit Event). The fixed premium is generally paid quarterly in arrears over the term of the transaction.

Nearly all transactions entered into between the Buyer and the Seller are subject to an ISDA master agreement executed by both parties. The master agreement allows for the consolidation of the

12




Primus Guaranty, Ltd.
Notes to Consolidated Financial Statements
September 30, 2005

market exposures and termination of all transactions between the Buyer and Seller in the event a Default (as defined by the master agreement) is incurred by either party.

Primus Financial is primarily a Seller of credit swaps, although it may also buy credit swaps. Credit swaps purchased to off-set risks do not qualify as hedges in accordance with SFAS No. 133. In addition, Primus Financial is permitted to purchase credit swaps in order to seek short-term market appreciation as a limited percentage of its overall portfolio (represented as Credit Swaps Purchased in the below tables). The company's operating guidelines and board authorization limits the notional amount of credit swaps purchased for this purpose to seven and a half percent of the notional amount of credit swaps sold.

The primary risks inherent in the Company's activities are (a) that Reference Entities specified in its credit swap transactions will incur Credit Events (Credit Events may include any or all of the following: bankruptcy, failure to pay, repudiation or moratorium, and modified or original restructuring) that will require Primus Financial to make payments to the Buyers of the transactions, (b) where Primus Financial is a Buyer of a credit swap and a Credit Event occurs, the Seller fails to make payment to the Company, and (c) that Buyers of the transactions from Primus Financial will default on their required premium payments at times when the fair value of the underlying transactions are positive to Primus Financial. Since inception, none of these events have occurred.

The tables below summarize the notional amounts and fair value at risk to performance by Reference Entities and Counterparties of credit swap transactions, which are recorded at fair value (summarized by credit rating) as of September 30, 2005 and December 31, 2004. Fair Value is the fair value of all transactions after consideration of offsetting exposures under Master Agreements with counterparties.

Risk off-set transactions are included in the table above and tables below as part of Credit Swaps Purchased. The total notional amounts of risk off-set transactions were zero and $5.0 million at September 30, 2005 and December 31, 2004, respectively. Fair value of the risk offset transactions equaled zero and $(206) thousand at September 30, 2005 and December 31, 2004, respectively.

13




Primus Guaranty, Ltd.
Notes to Consolidated Financial Statements
September 30, 2005

(in thousands and U.S. dollar equivalent)


  September 30,
2005
December 31,
2004
Moody's Rating Category Notional
Amount
Fair
Value
Notional
Amount
Fair
Value
Reference Entity                        
Credit Swaps Sold – Single Name:                        
    Aaa $ 580,130   $ 966   $ 651,270   $ 866  
    Aa   2,353,109     6,281     1,917,131     5,609  
    A   5,270,203     17,561     4,310,452     22,511  
    Baa   4,682,055     9,103     3,642,330     19,295  
    Ba   110,065     (3,173   23,545     179  
    B   33,000     (1,586        
Total $ 13,028,562   $ 29,152   $ 10,544,728   $ 48,460  
Credit Swaps Sold – Tranche:                        
    Aa $ 50,000   $ 300   $   $  
Total $ 50,000   $ 300   $   $  
Credit Swaps Purchased:                        
Aaa $ 44,052   $ (231 $ 47,090   $ (158
Aa   12,026     (29   13,545     (44
A   185,195     (802   209,815     (803
Baa   81,013     (671   160,635     (969
NR   36,078     (298   37,090     (228
Total $ 358,364   $ (2,031 $ 468,175   $ (2,202
Counterparty Buyer                        
Credit Swaps Sold – Single Name:                        
Aaa $ 5,000   $ 42   $ 5,000   $ 49  
Aa   10,995,674     22,110     8,304,867     35,922  
A   2,027,888     7,000     2,234,861     12,489  
Total $ 13,028,562   $ 29,152   $ 10,544,728   $ 48,460  
Credit Swaps Sold – Tranche:                        
Aa $ 50,000   $ 300   $   $  
Total $ 50,000   $ 300   $   $  
Counterparty Seller                        
Credit Swaps Purchased:                        
Aa $ 280,325   $ (1,553 $ 387,858   $ (1,699
A   78,039     (478   80,317     (503
Total $ 358,364   $ (2,031 $ 468,175   $ (2,202

14




Primus Guaranty, Ltd.
Notes to Consolidated Financial Statements
September 30, 2005


  September 30,
2005
December 31,
2004
S&P Rating Category Notional
Amount
Fair
Value
Notional
Amount
Fair
Value
Reference Entity                        
Credit Swaps Sold − Single Name:                        
    AAA $ 630,130   $ 963   $ 627,725   $ 822  
    AA   1,963,109     4,747     1,826,628     4,462  
    A   6,029,816     21,103     4,863,204     25,569  
    BBB   4,265,494     8,529     3,217,171     17,536  
    BB   125,013     (4,712   10,000     71  
    B   15,000     (1,478        
Total $ 13,028,562   $ 29,152   $ 10,544,728   $ 48,460  
Credit Swaps Sold − Tranche:                        
    AA $ 50,000   $ 300   $   $  
Total $ 50,000   $ 300   $   $  
Credit Swaps Purchased:                        
    AAA $ 20,000   $ (67 $ 57,090   $ (198
    AA   24,052     (68   27,090     (109
    A   229,247     (1,164   216,270     (940
    BBB   73,039     (594   167,725     (955
    NR   12,026     (138        
Total $ 358,364   $ (2,031 $ 468,175   $ (2,202
Counterparty Buyer                        
Credit Swaps Sold − Single Name:                        
    AAA $ 35,065   $ (118 $ 5,000   $ 49  
    AA   8,959,205     16,599     6,643,559     27,941  
    A   4,034,292     12,671     3,896,169     20,470  
Total $ 13,028,562   $ 29,152   $ 10,544,728   $ 48,460  
Credit Swaps Sold − Tranche:                        
    AA $ 50,000   $ 300   $   $  
Total $ 50,000   $ 300   $   $  
Counterparty Seller                        
Credit Swaps Purchased:                        
    AA $ 236,273   $ (1,417 $ 290,768   $ (1,433
    A   122,091     (614   177,407     (769
Total $ 358,364   $ (2,031 $ 468,175   $ (2,202

Primus Financial's operating guidelines impose various limits on the geographical concentration of its business based on the country of domicile of each Reference Entity. Additionally, Primus Financial's counterparties are global financial institutions, and nearly all have entered into Master Agreements with Primus Financial that consolidate the counterparty risk to one office of that counterparty. For the nine months ended September 30, 2005, three counterparties each generated

15




Primus Guaranty, Ltd.
Notes to Consolidated Financial Statements
September 30, 2005

greater than ten percent of the Company's total premium revenue, and for the nine months ended September 30, 2004, three counterparties each generated greater than ten percent of the Company's total premium revenue.

The table below shows the geographical distribution of Primus Guaranty's credit swap portfolio by domicile of the Reference Entity and domicile of the counterparty (in thousands and U.S. dollar equivalent):


  September 30,
2005
December 31,
2004
Country of Domicile Notional
Amount
Fair
Value
Notional
Amount
Fair
Value
Credit Swaps Sold – Single Name                        
By Reference Entity:                        
    North America $ 7,828,565   $ 12,779   $ 5,798,363   $ 28,926  
    Europe   4,645,997     15,436     4,367,365     17,733  
    Pacific   425,000     976     305,000     1,421  
    Others   129,000     (39