10-Q 1 file1.htm

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

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2006

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of ‘‘accelerated filer and large accelerated filer’’ in Rule 12b-2 of the Exchange Act). (Check one):

Large accelerated filer [ ]                Accelerated filer [X]                Non-accelerated filer [ ]

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

As of November 1, 2006, the number of shares outstanding of the issuer's common stock, $0.08 par value, was 43,356,274.




Primus Guaranty, Ltd.
Form 10-Q
For the three months ended September 30, 2006

INDEX


Part I. Financial Information    
Item 1. Financial Statements    
  Condensed Consolidated Statements of Financial Condition as of
September 30, 2006 (Unaudited) and December 31, 2005
3  
  Condensed Consolidated Statements of Operations (Unaudited) for the
Three and nine months ended September 30, 2006 and 2005
4  
  Condensed Consolidated Statements of Cash Flows (Unaudited) for the
Nine months ended September 30, 2006 and 2005
5  
  Notes to Condensed Consolidated Financial Statements 6  
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 19  
  Cautionary Statement Regarding Forward Looking Information 38  
Item 3. Quantitative and Qualitative Disclosures about Market Risk 40  
Item 4. Controls and Procedures 40  
Part II. Other Information    
Item 1. Legal Proceedings 41  
Item 1A. Risk Factors 41  
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 41  
Item 3. Defaults upon Senior Securities 41  
Item 4. Submission of Matters to a Vote of Security Holders 41  
Item 5. Other Information 41  
Item 6. Exhibits 41  
Signatures 42  

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Part I.    Financial Information

Item 1.  Financial Statements

Primus Guaranty, Ltd.
Condensed Consolidated Statements of Financial Condition
(in thousands except per share amounts)


  September 30,
2006
December 31,
2005
  (unaudited)  
Assets        
Cash and cash equivalents $ 58,701   $ 69,355  
Available-for-sale investments 599,932   560,147  
Trading investments 1,257    
Accrued interest receivable 5,900   5,127  
Accrued premiums and interest receivable on credit and other swaps 3,813   3,461  
Premiums receivable on financial guarantees 100   300  
Unrealized gain on credit and other swaps, at fair value 59,930   25,342  
Deposit and warehouse loan agreements 4,116    
Fixed assets and software costs, net 5,753   4,993  
Debt issuance costs, net 3,032   3,147  
Other assets 1,597   1,210  
Total assets $ 744,131   $ 673,082  
Liabilities and stockholders’ equity        
Accounts payable and accrued expenses $ 2,236   $ 3,035  
Accrued compensation 5,974   4,833  
Interest payable 339   404  
Accrued premiums on credit and other swaps 42    
Taxes payable 19   54  
Unrealized loss on credit and other swaps, at fair value 1,350   3,521  
Deferred credit swap premiums 29   46  
Deferred financial guarantee premiums 100   401  
Deferred rent payable 586   416  
Long-term debt 200,000   200,000  
Total liabilities 210,675   212,710  
Preferred securities of subsidiary 98,521   98,521  
Stockholders’ equity:        
Common stock, $0.08 par value, 62,500,000 shares authorized, 43,341,973 and 43,176,511 shares issued and outstanding at September 30, 2006 and December 31, 2005 3,572   3,572  
Additional paid-in-capital 268,365   265,848  
Warrants 612   612  
Accumulated other comprehensive loss (3,182 )  (4,254 ) 
Retained earnings 165,568   96,073  
Total stockholders’ equity 434,935   361,851  
Total liabilities, preferred securities of subsidiary and stockholders’ equity $ 744,131   $ 673,082  

See accompanying notes.

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


  Three Months Ended
September 30,
Nine Months Ended
September 30,
  2006 2005 2006 2005
  (unaudited) (unaudited)
Revenues                
Net credit swap revenue $ 28,905   $ 27,449   $ 85,865   $ 15,672  
Net total return swap revenue 313     437    
Net warehouse loan revenue 76     76    
Premiums earned on financial guarantees 100   101   300   300  
Asset management and advisory fees 542   49   709   140  
Interest income 7,143   4,483   20,530   10,969  
Investment portfolio realized gains (losses)   (3 )    20  
Foreign currency revaluation gain (loss) (32 )  55   (56 )  (1,464 ) 
Total net revenues 37,047   32,134   107,861   25,637  
Expenses                
Compensation and employee benefits 5,023   3,537   15,517   12,139  
Professional and legal fees 1,361   981   3,645   2,731  
Depreciation and amortization 649   533   1,846   1,574  
Technology and data 726   535   1,546   1,250  
Interest expense 2,831   649   7,933   1,640  
Other 1,302   805   3,632   2,423  
Total expenses 11,892   7,040   34,119   21,757  
Distributions on preferred securities of subsidiary (1,437 )  (1,022 )  (4,206 )  (2,797 ) 
Income before provision for income taxes 23,718   24,072   69,536   1,083  
(Provision) benefit for income taxes 14   (63 )  (41 )  (108 ) 
Net income available to common shares $ 23,732   $ 24,009   $ 69,495   $ 975  
Income per common share:                
Basic $ 0.55   $ 0.56   $ 1.61   $ 0.02  
Diluted $ 0.54   $ 0.54   $ 1.56   $ 0.02  
Average common shares outstanding:                
Basic 43,314   43,120   43,285   43,147  
Diluted 44,341   44,543   44,410   44,673  

See accompanying notes.

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Primus Guaranty, Ltd.
Condensed Consolidated Statements of Cash Flows
(in thousands except per share amounts)


  Nine months ended
September 30,
  2006 2005
  (unaudited)
Cash flows from operating activities        
Net income $ 69,495   $ 975  
Adjustments to reconcile net income to net cash provided by operating activities:        
Non-cash items included in net income:        
Depreciation and amortization 1,846   1,574  
Stock compensation 2,747   2,149  
Net unrealized (gain) loss on swap portfolio (36,759 )  18,837  
Net amortization of premium and discount on securities (2,669 )   
Deferred rent 170   (20 ) 
Loss on disposal of assets 25    
Amortization of debt issuance costs 128   31  
Distributions on preferred securities of subsidiary 4,206   2,798  
Increase (decrease) in cash resulting from changes in:        
Accrued interest receivable (773 )  (2,754 ) 
Accrued premiums and interest receivable on credit and other swaps (352 )  188  
Premiums receivable on financial guarantees 200   400  
Deposit and warehouse loan agreement (4,116 )   
Other assets (387 )  356  
Purchase of trading investments (1,257 )   
Accounts payable and accrued expenses (799 )  881  
Accrued compensation 1,141   (1,400 ) 
Interest payable (65 )  (269 ) 
Accrued premiums payable on credit swaps 42    
Taxes payable (35 )  208  
Deferred credit swap premiums (17 )  (17 ) 
Deferred financial guarantee premiums (301 )  (299 ) 
Net cash provided by operating activities 32,470   23,638  
Cash flows from investing activities        
Fixed asset purchases and capitalized software costs (2,631 )  (519 ) 
Purchases of available-for-sale investments (103,129 )  (258,165 ) 
Maturities of available-for-sale investments 67,000    
Net cash used in investing activities (38,760 )  (258,684 ) 
Cash flows from financing activities        
Repurchase and retirement of common stock (684 )  (2,397 ) 
Proceeds from employee exercise of stock options and issuance of common stock 454   234  
Debt issuance costs (13 )  (31 ) 
Net preferred distributions of subsidiary (4,206 )  (2,798 ) 
Net cash used in financing activities (4,449 )  (4,992 ) 
Net effect of exchange rate changes on cash 85    
Net decrease in cash (10,654 )  (240,038 ) 
Cash and cash equivalents at beginning of period 69,355   320,989  
Cash and cash equivalents at end of period $ 58,701   $ 80,951  
Supplemental disclosures        
Cash paid for interest $ 7,870   $ 1,879  
Cash paid for taxes $ 76   $ 4  

See accompanying notes.

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1.  Organization and Basis of Presentation

Primus Guaranty, Ltd., together with its consolidated subsidiaries (‘‘Primus Guaranty’’ or ‘‘the Company’’), is a Bermuda holding company, and the 100% owner of Primus Bermuda, Ltd. (‘‘Primus Bermuda’’), a Bermuda holding company and PRS Trading Strategies, LLC. 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 financial products limited liability company that maintains a long-term counterparty credit rating of AAA from Standard & Poor’s (‘‘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 seller of credit swaps against investment grade credit obligations of corporate and sovereign reference entities. Primus Financial also sells credit swaps referencing portfolios containing obligations of multiple reference entities. Primus Asset Management, a Delaware services company, is an asset manager for Primus Financial and unrelated third parties.

Primus Financial and Primus Asset Management function as separate entities from Primus Group Holdings. Additionally, the obligations of Primus Guaranty are not the obligations of Primus Bermuda, Primus Group Holdings, or any other of its affiliates, and vice versa. Primus Asset Management is the 100% owner of Primus Re, Ltd. (‘‘Primus Re’’), a Bermuda company that operates as a financial guaranty insurance company and is licensed as a Class 3 Insurer under the Insurance Act of 1978 of Bermuda.

In July 2005, PRS Trading Strategies, LLC (PRS Trading), a Delaware limited liability company, was formed. PRS Trading engages in relative value trading and other strategies involving buying and selling of credit swaps and other financial instruments in pursuit of financial returns. These trading strategies generally have a short-term investment horizon and are subject to tight risk controls and liquidity management. PRS Trading commenced operations in January 2006. PRS Trading does not engage in trading activity with Primus Financial. PRS Trading has no rating from the rating agencies and, accordingly generally provides its swap counterparties with collateral to support its contractual obligations. More recently, PRS Trading has entered into total return swaps and a loan warehouse financing arrangement.

In November 2005, Primus Guaranty (UK), Ltd. (PGUK) was incorporated in England to expand the Company’s presence and further develop its business and relationships across Europe. Primus Bermuda is the 100% owner of PGUK.

The accompanying unaudited condensed consolidated financial statements of Primus Guaranty 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, 2006. The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances have been eliminated.

The condensed 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 condensed consolidated financial statements are presented in U.S. dollar equivalents. At September 30, 2006 and December 31, 2005, the Company’s credit swap activities were conducted in U.S. dollars and euros.

Certain prior year amounts have been reclassified to conform to current year presentation.

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2.  Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (‘‘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 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) until the first fiscal year beginning after June 15, 2005 to provide additional time for companies to comply with the reporting requirements. Effective January 1, 2006, the Company adopted SFAS No. 123(R). See note 9 of notes to condensed consolidated financial statements for further detail.

In March 2005, the SEC staff issued Staff Accounting Bulletin No. 107 (‘‘SAB No. 107’’) to provide supplemental implementation guidance on SFAS No. 123(R). The Company applied the relevant provisions of SAB No. 107 in its adoption of SFAS No. 123(R).

In May 2005, the 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 Company will apply SFAS 154 in future periods, if applicable.

In November 2005, the FASB issued FASB Staff Position FSP 115-1, The Meaning of Other-Than Temporary Impairment and Its Application to Certain Investments (FSP 115-1), which addresses the determination as to when an investment is considered impaired, whether that impairment is other-than-temporary, and the measurement of an impairment loss. FSP 115-1 also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance in FSP 115-1 is required to be applied to reporting periods beginning after December 15, 2005. The adoption did not have any effect on the condensed consolidated financial statements.

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 prescribes a recognition threshold and measurement attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact that adoption of FIN 48 will have on its consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS No. 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact that adoption of SFAS No. 157 will have on its consolidated financial statements.

3.  Available-for-Sale Investments

Available-for-sale investments included U.S. government agency obligations (including government-sponsored enterprises) rated AAA and Aaa by the respective rating agencies and commercial paper rated A-1 and P-1 by the respective rating agencies. Available-for-sale investments have original maturities or maturities at time of purchase greater than 90 days.

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The following table summarizes the composition of the Company’s available-for-sale investments at September 30, 2006 and December 31, 2005 (in thousands):


  September 30, 2006
  Amortized
Cost
Unrealized
Gains
Unrealized
Losses
Estimated
Fair Value
U.S government agency obligations $ 572,411   $   $ (3,279 )  $ 569,132  
Commercial paper 30,788   12     30,800  
Total 603,199   12   (3,279 )  599,932  

  December 31, 2005
  Amortized
Cost
Unrealized
Gains
Unrealized
Losses
Estimated
Fair Value
U.S government agency obligations $ 544,824   $   $ (4,259 )  $ 540,565  
Commercial paper 19,577   5     19,582  
Total $ 564,401   $ 5   $ (4,259 )  $ 560,147  

The unrealized losses on the Company’s investments in U.S. government agency obligations were the result of an increase in interest rates during the first nine months of 2006 and during 2005. These securities have primarily been in a loss position for more than 12 months. Because the decline in market value is attributable to changes in interest rates and not credit quality, and the Company has the ability and intent to hold these investments until maturity, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2006 and December 31, 2005. These securities have maturities of less than 3 years.

4.  Trading Investments

During the end of the third quarter of 2006, PRS Trading purchased corporate bonds for trading purposes. Trading investments are carried at fair value, with unrealized gains or losses recorded in the condensed consolidated statements of operations. At September 30, 2006, the fair value of these trading investments was approximately $1.3 million.

5.  Net Credit Swap Revenue and Credit Swap Portfolio

Overview

Net credit swap revenue as presented in the condensed consolidated statements of operations comprises 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 the termination of 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.

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 an unrelated third party or portfolio of third parties (the ‘‘Reference Entity’’) specified in the contract be subject to one of a specified group of events (‘‘Credit Events’’). 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 taking the risk of the contract, 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. Premium income is recognized ratably over the life of the transaction as a component of net credit swap revenue. When the Company purchases credit swaps from its counterparties, the Company pays fixed premiums over the term of the contract. Premium expense is recognized ratably over the life of the transaction as a component of net credit swap revenue.

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All credit swap transactions entered into between the Buyer and the Seller, or will shortly be, are subject to an International Swaps and Derivatives Association, Inc. Master Agreement or (‘‘ISDA Master Agreement’’) executed by both parties. The Master Agreement allows for the consolidation of the market exposures and termination of all transactions between the Buyer and Seller in the event a Default (as defined by the Master Agreement) occurs in respect of either party.

The primary risks inherent in the Company’s activities are (a) where the Company is a Seller that Reference Entities specified in its credit swap transactions will experience Credit Events that will require the Company to make payments to the Buyers of the transactions. Credit Events may include any or all of the following: bankruptcy, failure to pay, repudiation or moratorium, and modified or original restructuring, (b) where the Company 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 the Company will default on their required premium payments. During the three and nine months ended September 30, 2006 and 2005, none of these events have occurred.

The Company terminates a credit swap in one of two ways. The Company may negotiate an agreed termination with 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, in order to reduce its exposure, the Company may enter into an equal and opposite transaction with a third party under which the Company purchases credit swaps 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 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.

In accordance with accounting principles generally accepted in the United States, the Company carries its credit swaps on its condensed consolidated statements of financial condition at their fair value. Changes in the fair value of the Company’s credit swap portfolio are recorded as unrealized gains or losses as a component of net credit swap revenue in the Company’s consolidated statements 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 revenue 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 revenue 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 condensed consolidated statements of financial condition. If the aggregate total of fair values with a counterparty is a net gain, the total is recorded as a component of unrealized gains on credit swaps, at fair value in the condensed consolidated statements of financial condition. If the aggregate total of fair values with a counterparty is a net loss, the total is recorded as a component of unrealized losses on credit swaps, at fair value in the condensed consolidated statements of financial condition. Aggregation by counterparty is applied where a valid 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 at a gain or a loss.

The Company’s portfolio of credit swaps is generally held by Primus Financial and PRS Trading.

Primus Financial

Under the terms of Primus Financial’s operating guidelines, derivatives transactions can only include credit swaps.

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Primus Financial is primarily a Seller of credit swaps, although it may also buy credit swaps to off-set the risks it has incurred as a Seller. Credit swaps purchased to off-set risks do not qualify as hedges in accordance with SFAS No. 133. As a general rule, when Primus Financial sells credit swaps, it intends to maintain 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 Primus Financial 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.

Second, Primus Financial may elect to terminate a transaction for which it has an unrealized gain or loss based on one or more of the following considerations: the likelihood of further gains or losses 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 Primus Financial.

Primus Financial distinguishes among credit swaps sold-single name and credit swaps sold-tranche. Credit swaps sold-single name refers to credit swaps referencing a single entity. Credit swaps sold-tranche refers to credit swaps referencing portfolios containing obligations of multiple reference entities, which Primus Financial began selling during the second quarter of 2005.

PRS Trading

PRS Trading engages in relative value trading and other strategies involving buying and selling of credit swaps and other financial instruments in pursuit of financial returns. These trading strategies generally have a short-term investment horizon and are subject to tight risk controls and liquidity management. PRS Trading commenced operations in January 2006. PRS Trading does not engage in trading activity with Primus Financial. PRS Trading has no rating from the rating agencies and, accordingly generally provides its swap counterparties with collateral to support its contractual obligations. Credit swaps purchased to off-set risks do not qualify as hedges in accordance with SFAS No. 133. PRS Trading also transacts in credit default swap indices (CDS index), which are over-the-counter transactions based on the risk of credit defaults against a pool of sub-investment grade corporate reference entities.

Consolidated Net Credit Swap Revenue and Credit Swap Portfolio Information

The tables below present the components of consolidated net credit swap revenue for the three and nine months ended September 30, 2006 and 2005 (in thousands):


  Three Months Ended
September 30,
Nine Months Ended
September 30,
  2006 2005 2006 2005
Net premium income $ 18,034   $ 13,962   $ 51,081   $ 37,561  
Realized gains 101   216   1,043   1,461  
Realized losses (1,927 )  (1,464 )  (3,141 )  (4,513 ) 
Change in unrealized gains (losses) 12,697   14,735   36,882   (18,837 ) 
Total net credit swap revenue $ 28,905   $ 27,449   $ 85,865   $ 15,672  

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The Company’s consolidated notional amount, fair value and average fair value of open credit swap transactions (excluding the CDS index) entered into with third parties at September 30, 2006 and December 31, 2005 are as follows (in thousands):


  September 30,
2006
December 31,
2005
Gross Notional Amounts:        
Credit swaps sold-single name $ 15,377,221   $ 13,374,031  
Credit swaps sold-tranche 350,000   50,000  
Credit swaps purchased-single name (192,156 )   
Fair value:        
Asset 59,930   25,342  
Liability 1,110   3,521  
Average fair value:        
Asset 51,575   28,140  
Liability 2,064   3,545  

‘‘Asset’’ in the table above represents unrealized gains on credit swaps while ‘‘Liability’’ represents unrealized losses on credit swaps. All credit swaps are subject to netting arrangements that have been contractually established independently by Primus Financial and PRS Trading with each counterparty under an ISDA Master Agreement. 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 netted by counterparty.

At September 30, 2006 and December 31, 2005, Primus Financial had three derivative transactions with its affiliate, Primus Re, totaling $87 million in notional principal which are eliminated in consolidation.

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The tables that follow summarize, by credit rating of Reference Entities and of Counterparties, the consolidated notional amounts and fair values of credit swap transactions outstanding (excluding transactions with affiliates and a negative $240 thousand net fair value associated with the CDS index and total return swaps, as discussed in note 6) for the Company as of September 30, 2006 and December 31, 2005 (in thousands):

(in thousands)


  September 30, 2006 December 31, 2005
Moody’s Rating Category Notional
Amount
Fair
Value
Notional
Amount
Fair
Value
Reference Entity/Tranche                
Credit Swaps Sold – Single Name:                
Aaa $ 784,352   $ 1,492   $ 561,472   $ 1,118  
Aa 2,601,928   9,520   2,268,090   8,006  
A 5,851,422   24,711   5,270,706   15,008  
Baa 5,612,040   28,316   5,041,442   4,328  
Ba 467,807   (895 )  199,321   (5,785 ) 
B 59,672   (2,634 )  33,000   (1,539 ) 
Total $ 15,377,221   $ 60,510   $ 13,374,031   $ 21,136  
Credit Swaps Sold – Tranche:                
Aa $ 150,000   $ 938   $ 50,000   $ 685  
A 200,000   (2,076 )     
Total $ 350,000   $ (1,138 )  $ 50,000   $ 685  
Credit Swaps Purchased                
A $ (65,344 )  $ (131 )  $   $  
Baa (111,812 )  (361 )     
Ba (15,000 )  (60 )     
Total $ (192,156 )  $ (552 )  $   $  
Counterparty Buyer                
Credit Swaps Sold – Single Name:                
Aaa $ 5,000   $ 16   $ 5,000   $ 37  
Aa 12,841,615   50,246   11,228,563   13,341  
A 2,530,606   10,248   2,140,468   7,758  
Total $ 15,377,221   $ 60,510   $ 13,374,031   $ 21,136  
Credit Swaps Sold – Tranche:                
Aa $ 350,000   $ (1,138 )  $ 50,000   $ 685  
Total $ 350,000   $ (1,138 )  $ 50,000   $ 685  
Counterparty Seller                
Credit Swaps Purchased:                
Aa $ (192,156 )  $ (552 )  $   $  
Total $ (192,156 )  $ (552 )  $   $  

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(in thousands)


  September 30, 2006 December 31, 2005
S&P Rating Category Notional
Amount
Fair
Value
Notional
Amount
Fair
Value
Reference Entity/Tranche                
Credit Swaps Sold – Single Name:                
AAA $ 898,040   $ 1,773   $ 636,472   $ 1,222  
AA 2,230,264   8,243   1,862,713   6,026  
A 6,597,765   27,708   6,143,717   17,753  
BBB 5,234,559   26,243   4,513,356   4,803  
BB 354,921   (760 )  197,773   (7,062 ) 
B 61,672   (2,697 )  20,000   (1,606 ) 
Total $ 15,377,221   $ 60,510   $ 13,374,031   $ 21,136  
Credit Swaps Sold – Tranche:                
AAA $ 150,000   $ (1,400 )  $   $  
AA 200,000   262   50,000   685  
Total $ 350,000   $ (1,138 )  $ 50,000   $ 685  
Credit Swaps Purchased:                
A $ (40,000 )  $ (80 )  $   $  
BBB (152,156 )  (472 )     
BB        
Total $ (192,156 )  $ (552 )  $   $  
Counterparty Buyer                
Credit Swaps Sold – Single Name:                
AAA $ 36,680   $ 70   $ 34,623   $ (57 ) 
AA 11,590,518   47,254   9,262,316   10,525  
A 3,750,023   13,186   4,077,092   10,668  
Total $ 15,377,221   $ 60,510   $ 13,374,031   $ 21,136  
Credit Swaps Sold – Tranche:                
AA $ 350,000   $ (1,138 )  $ 50,000   $ 685  
Total $ 350,000   $ (1,138 )  $ 50,000   $ 685  
Counterparty Seller                
Credit Swaps Purchased:                
AA $ (121,812 )  $ (517 )  $   $  
A (70,344 )  (35 )     
Total $ (192,156 )  $ (552 )  $   $  

Primus Financial’s and PRS Trading’s counterparties are generally financial institutions with whom it has entered into Master Agreements. For the nine months ended September 30, 2006 and 2005, respectively, two counterparties and three counterparties, respectively, each generated greater than ten percent of the Company’s total premium revenue. At September 30, 2006, the notional and fair value amount of credit swaps outstanding with respect to one non-rated counterparty was $5.0 million and $17 thousand, respectively. The premiums on these transactions were fully prepaid by the counterparty, and as such, they have been categorized as AAA/Aaa rating in our credit swap portfolio.

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The table below shows the geographical distribution of the Company’s credit swap portfolio (excluding transactions with affiliates) by domicile of the Reference Entity and domicile of the counterparty (in thousands):


  September 30, 2006 December 31, 2005
Country of Domicile Notional
Amount
Fair
Value
Notional
Amount
Fair
Value
Credit Swaps Sold – Single Name                
By Reference Entity:                
North America $ 9,247,368   $ 38,217   $ 8,243,123   $ 12,268  
Europe 5,380,853   20,088   4,561,908   7,412  
Pacific 565,000   1,362   445,000   992  
Others 184,000   843   124,000   464  
Total $ 15,377,221   $ 60,510   $ 13,374,031   $ 21,136  
By Counterparty:                
North America $ 7,971,447   $ 28,370   $ 6,878,892   $ 8,754  
Europe 7,310,774   31,924   6,388,139   12,359  
Pacific 75,000   127   65,000   (37 ) 
Others 20,000   89   42,000   60  
Total $ 15,377,221   $ 60,510   $ 13,374,031   $ 21,136  
Credit Swaps Sold – Tranche                
By Counterparty:                
North America $ 50,000   $ 805   $ 50,000   $ 685  
Europe 300,000   (1,943 )     
Total $ 350,000   $ (1,138 )  $ 50,000   $ 685  
Credit Swaps Purchased                
By Reference Entity:                
North America $ (138,000 )  $ (418 )  $   $  
Europe (39,156 )  (79 )     
Others (15,000 )  (55 )     
Total $ (192,156 )  $ (552 )  $   $  
By Counterparty: