10-Q 1 file1.htm FORM 10-Q

 
 

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 March 31, 2008

or

o 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 o

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 o                         Accelerated filer x                      Non-accelerated filer o

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

As of May 1, 2008, the number of shares outstanding of the issuer’s common shares, $0.08 par value, was 45,224,889.

 
 

 



Primus Guaranty, Ltd.

Form 10-Q

For the three months ended March 31, 2008

INDEX

 

Part I. Financial Information

 

 

 

Item 1.   Financial Statements

 

 

 

Condensed Consolidated Statements of Financial Condition as of March 31, 2008 (Unaudited) and December 31, 2007

 

3

 

Condensed Consolidated Statements of Operations (Unaudited) for the three months ended March 31, 2008 and 2007

 

4

 

Condensed Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2008 and 2007

 

5

 

Notes to Condensed Consolidated Financial Statements

 

6

 

Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

26

 

Cautionary Statement Regarding Forward Looking Information

 

45

 

Item 3.   Quantitative and Qualitative Disclosures about Market Risk

 

46

 

Item 4.   Controls and Procedures

 

47

 

Part II. Other Information

 

 

 

Item 1. Legal Proceedings

 

48

 

Item 1A. Risk Factors

 

48

 

Item 6. Exhibits

 

48

 

Signatures

 

49

 

 

 

2

 

 



Part I. Financial Information

Item 1. Financial Statements

Primus Guaranty, Ltd.

Condensed Consolidated Statements of Financial Condition

(in thousands except per share amounts)

 

 

 

March 31,
2008

 

December 31,
2007

 

Assets

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

453,822

 

$

242,665

 

Available-for-sale investments

 

 

417,194

 

 

617,631

 

Accrued interest receivable

 

 

7,700

 

 

7,684

 

Accrued premiums and receivables on credit and other swaps

 

 

4,033

 

 

4,187

 

Unrealized gain on credit and other swaps, at fair value

 

 

24

 

 

606

 

Fixed assets and software costs, net

 

 

4,960

 

 

5,036

 

Debt issuance costs, net

 

 

6,887

 

 

6,965

 

Other assets

 

 

5,973

 

 

3,872

 

Total assets

 

$

900,593

 

$

888,646

 

               

Liabilities and shareholders’ equity

 

 

 

 

 

 

 

Accounts payable and accrued expenses

 

$

1,927

 

$

2,182

 

Accrued compensation

 

 

2,500

 

 

5,957

 

Interest payable

 

 

523

 

 

831

 

Unrealized loss on credit and other swaps, at fair value

 

 

1,230,826

 

 

544,731

 

Accrued premiums and payables on credit and other swaps

 

 

457

 

 

1,770

 

Long-term debt

 

 

329,032

 

 

325,904

 

Restructuring liabilities

 

 

 

 

1,709

 

Other liabilities

 

 

523

 

 

503

 

Total liabilities

 

 

1,565,788

 

 

883,587

 

               

Preferred securities of subsidiary

 

 

98,521

 

 

98,521

 

               

Commitments and contingencies

 

 

 

 

 

 

 

Shareholders’ equity (deficit)

 

 

 

 

 

 

 

Common shares, $0.08 par value, 62,500,000 shares authorized, 45,220,938 and
45,035,593 shares issued and outstanding at March 31, 2008 and December 31, 2007, respectively

 

 

3,618

 

 

3,603

 

Additional paid-in-capital

 

 

281,354

 

 

280,224

 

Accumulated other comprehensive loss

 

 

(6,033

)

 

(4,712

)

Retained earnings (deficit)

 

 

(1,042,655

)

 

(372,577

)

Total shareholders’ equity (deficit)

 

 

(763,716

)

 

(93,462

)

Total liabilities, preferred securities of subsidiary and shareholders’ equity (deficit)

 

$

900,593

 

$

888,646

 

See accompanying notes.

 

 

3

 

 



Primus Guaranty, Ltd.

Condensed Consolidated Statements of Operations

(in thousands except per share amounts)

 

 

 

 

Three months ended
March 31,

 

 

 

 

2008

 

 

2007

 

 

 

 

(unaudited)

 

Revenues

 

 

 

 

 

 

 

Net credit swap revenue (loss)

 

$

(663,615

)

$

(4,877

)

Asset management and advisory fees

 

 

1,090

 

 

661

 

Interest income

 

 

9,194

 

 

9,977

 

Other trading revenue

 

 

 

 

1,259

 

Foreign currency revaluation gain (loss)

 

 

(25

)

 

51

 

Total net revenues (losses)

 

 

(653,356

)

 

7,071

 

               

Expenses

 

 

 

 

 

 

 

Compensation and employee benefits

 

 

6,191

 

 

6,004

 

Professional and legal fees

 

 

1,023

 

 

976

 

Depreciation and amortization

 

 

329

 

 

577

 

Technology and data

 

 

1,111

 

 

877

 

Interest expense

 

 

4,891

 

 

4,862

 

Other

 

 

1,323

 

 

1,535

 

Total expenses

 

 

14,868

 

 

14,831

 

Distributions on preferred securities of subsidiary

 

 

1,805

 

 

1,902

 

Loss before provision for income taxes

 

 

(670,029

)

 

(9,662

)

Provision for income taxes

 

 

49

 

 

56

 

Net loss available to common shares

 

$

(670,078

)

$

(9,718

)

               

Loss per common share:

 

 

 

 

 

 

 

Basic

 

$

(14.85

)

$

(0.22

)

Diluted

 

$

(14.85

)

$

(0.22

)

Average common shares outstanding:

 

 

 

 

 

 

 

Basic

 

 

45,108

 

 

44,164

 

Diluted

 

 

45,108

 

 

44,164

 

See accompanying notes.

 

 

4

 



Primus Guaranty, Ltd.

Condensed Consolidated Statements of Cash Flows

(in thousands except per share amounts)

 

 

 

 

Three months ended
March 31,

 

 

 

 

2008

 

 

2007

 

 

 

 

(unaudited)

 

Cash flows from operating activities

 

 

 

 

 

 

 

Net loss

 

$

(670,078

)

$

(9,718

)

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

 

 

 

 

 

 

 

Non-cash items included in net loss:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

329

 

 

577

 

Share compensation

 

 

1,310

 

 

1,007

 

Net unrealized losses on credit and other swaps

 

 

686,677

 

 

22,848

 

Net amortization of premium and discount on securities

 

 

(765

)

 

(2,223

)

Amortization of debt issuance costs

 

 

78

 

 

78

 

Distributions on preferred securities of subsidiary

 

 

1,805

 

 

1,902

 

Increase (decrease) in cash resulting from changes in:

 

 

 

 

 

 

 

Accrued interest receivable

 

 

(16

)

 

254

 

Accrued premiums and interest receivable on credit and other swaps

 

 

154

 

 

(387

)

Deposit and warehouse loan agreement

 

 

 

 

(5,089

)

Warehouse loans held for securitization.

 

 

 

 

(59,369

)

Other assets

 

 

1,027

 

 

(2,433

)

Trading account assets

 

 

 

 

1,585

 

Accounts payable and accrued expenses

 

 

(255

)

 

1,581

 

Accrued compensation

 

 

(3,457

)

 

(6,769

)

Trading account liabilities

 

 

 

 

8

 

Interest payable

 

 

(308

)

 

181

 

Accrued premiums and payables on credit and other swaps

 

 

(1,313

)

 

 

Restructuring liabilities

 

 

(1,709

)

 

 

Other liabilities

 

 

20

 

 

37

 

Net cash provided by (used in) operating activities

 

 

13,499

 

 

(55,930

)

               

Cash flows from investing activities

 

 

 

 

 

 

 

Fixed asset purchases and capitalized software costs

 

 

(253

)

 

(427

)

Cash receipts on CLO investments

 

 

871

 

 

 

Purchases of available-for-sale investments

 

 

(568,884

)

 

(267,249

)

Maturities and sales of available-for-sale investments

 

 

767,940

 

 

210,714

 

Net cash provided by (used in) investing activities

 

 

199,674

 

 

(56,962

)

               

Cash flows from financing activities

 

 

 

 

 

 

 

Repurchase and retirement of common shares

 

 

(165

)

 

(1,131

)

Proceeds from exercise of warrants

 

 

 

 

7,335

 

Warehouse loan payable

 

 

 

 

59,369

 

Net preferred distributions of subsidiary

 

 

(1,805

)

 

(1,902

)

Net cash provided by (used in) financing activities

 

 

(1,970

)

 

63,671

 

Net effect of exchange rate changes on cash

 

 

(46

)

 

5

 

Net increase (decrease) in cash

 

 

211,157

 

 

(49,216

)

Cash and cash equivalents at beginning of period

 

 

242,665

 

 

204,428

 

Cash and cash equivalents at end of period

 

$

453,822

 

$

155,212

 

               

Supplemental disclosures

 

 

 

 

 

 

 

Cash paid for interest

 

$

5,122

 

$

4,603

 

Cash paid for taxes

 

$

13

 

$

11

 

See accompanying notes.

 

 

5

 



 

1. Organization and Basis of Presentation

Primus Guaranty, Ltd., together with its consolidated subsidiaries (“Primus Guaranty” or “the Company”), is a Bermuda holding company that conducts business through its two principal operating subsidiaries, Primus Financial Products, LLC (“Primus Financial”) and Primus Asset Management, Inc. (“Primus Asset Management”).

Primus Financial, incorporated in Delaware, is a Credit Derivative Product Company (“CDPC”), which has AAA/Aaa counterparty ratings by Standard & Poor’s Rating Group (“S&P”), and Moody’s Investors Service, Inc. (“Moody’s”), respectively. Primus Financial is a seller of credit swaps to banks and credit swap dealers, referred to as counterparties, against primarily investment grade credit obligations of corporate and sovereign issuers. In exchange for a fixed quarterly premium Primus Financial agrees, upon the occurrence of a defined credit event (e.g., bankruptcy, failure to pay or restructuring) affecting a designated issuer, referred to as a Reference Entity, to pay its counterparty an agreed upon notional amount against delivery to Primus Financial of the Reference Entity’s debt obligation in the same notional amount. Credit swaps related to a single specified Reference Entity are referred to as “single name credit swaps.” Primus Financial seeks to minimize the risk inherent in its credit swap portfolio by maintaining a high quality, diversified credit swap portfolio across Reference Entities, industries, countries and rating grades. Primus Financial also sells credit swaps referencing portfolios containing obligations of multiple Reference Entities, which are referred to as “tranches” and sells credit swaps referencing residential mortgage-backed securities, which are referred to as ABS. Defined credit events related to ABS may include any or all of the following: failure to pay principal, write-down in the reference obligation and downgrades to CCC/Caa2 (S&P/Moody’s) or below of the reference obligation.

Primus Asset Management, a Delaware services company, acts as an investment manager to affiliated companies and third party entities. It currently manages the credit swap and cash investment portfolios of its affiliate, Primus Financial. Primus Asset Management also manages two CLOs. A CLO issues securities backed by a diversified pool of primarily below investment grade rated senior secured loans of corporations. Additionally, Primus Asset Management manages three investment grade Collateralized Swap Obligations or CSOs on behalf of third parties. A CSO issues securities backed by one or more credit swaps sold against a diversified pool of investment grade corporate or sovereign reference entities. Primus Asset Management receives fees from third party entities for its investment management services on the five transactions totaling $1.6 billion of assets currently under management. Primus Asset Management has entered into a Services Agreement with its affiliates, whereby it provides services to its affiliates including management, consulting and information technology.

Primus Re, Ltd. (“Primus Re”), another subsidiary, is a Bermuda company that operates as a financial guaranty insurance company and is licensed as a Class 3 Insurer under the Bermuda Insurance Act of 1978. Primus Re’s business is to act as a conduit, or transformer, between parties interested in buying or selling protection in insurance form and other parties interested in assuming the opposite risk position in the form of credit swaps. Primus Re was inactive during the three months ended March 31, 2008.

At March 31, 2008, Harrier Credit Strategies Master Fund, LP (“Harrier”) ceased trading activities and closed all of its trading positions. As of December 31, 2007, PRS Trading Strategies, LLC (“PRS Trading Strategies”) was inactive.

 

 

6

 



The accompanying unaudited condensed consolidated financial statements of Primus Guaranty, Ltd. have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) 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 GAAP 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. The results of operations for any interim period are not necessarily indicative of the results for a full year. 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. During the periods presented, 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. There was no effect on net income (loss) as a result of these reclassifications.

2. Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS No. 157). SFAS No.157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Effective January 1, 2008, the Company adopted the provisions of SFAS No. 157. For additional information and discussion, see note 5 of notes to the condensed consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Liabilities (“SFAS No. 159”). SFAS No. 159 provides a fair value option election that allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities, with changes in fair value recognized in earnings as they occur. SFAS No. 159 permits the fair value option election on an instrument by instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Effective January 1, 2008, the Company adopted the provisions of SFAS No. 159. The adoption of SFAS No. 159 did not have a material impact on the Company’s condensed consolidated financial statements. For additional information and discussion, see note 5 of notes to the condensed consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133 (“SFAS No. 161”). SFAS No. 161 is intended to improve transparency in financial reporting by requiring enhanced disclosures of an entity’s derivative instruments and hedging activities and their effects on the entity’s financial position, financial performance, and cash flows. SFAS No.161 applies to all derivative instruments within the scope of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”). It also applies to non-derivative hedging instruments and all hedged items designated and qualifying as hedges under SFAS No. 133. SFAS No. 161 is effective prospectively for financial statements issued for fiscal years beginning after November 15, 2008. The Company will adopt SFAS No. 161 in the first quarter of 2009. The Company is

 

 

7

 



currently evaluating the disclosure requirements that adoption SFAS No. 161 will have on its consolidated financial statements. However, since SFAS No. 161 requires only additional disclosures concerning derivatives and hedging activities, adoption of SFAS No. 161 will not affect the Company’s financial condition, results of operations or cash flows.

3. Available-for-sale Investments

Available-for-sale investments include U.S. government agency obligations (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 the Company’s collateralized loan obligations or CLO investments. The Company accounts for its CLO investments as debt securities and fixed maturity securities in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities (“SFAS 115”) and Emerging Issues Task Force (“EITF”) Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets (“EITF 99-20”). Accordingly, the CLO investments are classified as available-for-sale investments. Available-for-sale investments are carried at fair value with the unrealized gains or losses reported in accumulated other comprehensive loss as a separate component of shareholders’ equity. Available-for-sale investments have maturities at time of purchase greater than 90 days.

The following table summarizes the composition of the Company’s available-for-sale investments at March 31, 2008 and December 31, 2007 (in thousands):

 

 

 

 

March 31, 2008

 

 

 

 

Amortized
Cost

 

 

Unrealized
Gains

 

 

Unrealized
Losses

 

 

Estimated
Fair Value

 

U.S government agency obligations

 

$

408,938

 

$

1,256

 

$

(21

)

$

410,173

 

Collateralized loan obligations

 

 

14,379

 

 

 

 

(7,458

)

 

6,921

 

ABS bond

 

 

125

 

 

 

 

(25

)

 

100

 

Total

 

$

423,442

 

$

1,256

 

$

(7,504

)

$

417,194

 

 

 

 

 

December 31, 2007

 

 

 

 

Amortized
Cost

 

 

Unrealized
Gains

 

 

Unrealized
Losses

 

 

Estimated
Fair Value

 

U.S government agency obligations

 

$

607,663

 

$

480

 

$

(169

)

$

607,974

 

Collateralized loan obligations

 

 

14,880

 

 

 

 

(5,223

)

 

9,657

 

Total

 

$

622,543

 

$

480

 

$

(5,392

)

$

617,631

 

 

 

8

 



The following table summarizes the fair value of investments that have been in a continuous unrealized loss position for less than 12 months and for 12 months or more at March 31, 2008 and December 31, 2007 (in thousands):

 

 

 

 

March 31, 2008
Securities with Unrealized Losses

 

 

 

 

Less than 12 months

 

 

12 months or more

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

Fair
Value

 

 

Gross
Unrealized
Losses

 

 

Fair
Value

 

 

Gross
Unrealized
Losses

 

 

Fair
Value

 

 

Gross
Unrealized
Losses

 

U.S. government agency obligations

 

$

28,771

 

$

(21

)

$

 

$

 

$

28,771

 

$

(21

)

Collateralized loan obligations

 

 

3,736

 

 

(4,568

)

 

3,185

 

 

(2,890

)

 

6,921

 

 

(7,458

)

ABS bond

 

 

100

 

 

(25

)

 

 

 

 

 

100

 

 

(25

)

Total

 

$

32,607

 

$

(4,614

)

$

3,185

 

$

(2,890

)

$

35,792

 

$

(7,504

)

 

 

 

 

December 31, 2007
Securities with Unrealized Losses

 

 

 

 

Less than 12 months

 

 

12 months or more

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

Fair
Value

 

 

Gross
Unrealized
Losses

 

 

Fair
Value

 

 

Gross
Unrealized
Losses

 

 

Fair
Value

 

 

Gross
Unrealized
Losses

 

U.S. government agency obligations

 

$

127,139

 

$

(59

)

$

104,600

 

$

(110

)

$

231,739

 

$

(169

)

Collateralized loan obligations

 

 

5,302

 

 

(3,065

)

 

4,355

 

 

(2,158

)

 

9,657

 

 

(5,223

)

Total

 

$

132,441

 

$

(3,124

)

$

108,955

 

$

(2,268

)

$

241,396

 

$

(5,392

)

 

The Company makes an assessment to determine whether unrealized losses reflect declines in value of securities that are other-than-temporarily impaired. The Company considers many factors including the length of time and significance of the decline in fair value; the Company’s intent and ability to hold the investment for a sufficient period of time for a recovery in fair value; recent events specific to the issuer or industry; credit ratings and asset quality of collateral structure; and any significant changes in estimated cash flows. If the Company, based on its evaluation of the above factors, determines that the impairment is other-than-temporary, the carrying value of the security is written down to fair value and the unrealized loss is recognized through a charge to earnings in the consolidated statements of operations. Based on the Company’s evaluation, it does not consider these investments to be other-than-temporarily impaired at March 31, 2008 and December 31, 2007.

The U.S. government agency obligations mature before November 2008. The two CLO investments are scheduled to mature in 2019 and 2021, respectively, although the actual maturity of each may be sooner.

4. Net Credit Swap Revenues and Portfolio

Overview

Net credit swap revenue (loss) as presented in the 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.

 

 

9

 



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 (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 defined 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 (loss). 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 (loss).

All credit swap transactions entered into between the Buyer and the Seller are subject to an International Swaps and Derivatives Association, Inc. Master Agreement or (“ISDA Master Agreement”) executed by both parties. The ISDA Master Agreement allows for the aggregation of the market exposures and termination of all transactions between the Buyer and Seller in the event a default (as defined by the ISDA 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. Defined 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 defined 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. Defined credit events related to the Company’s credit swaps against ABS may include any or all of the following: failure to pay principal, write-down in the reference obligation and downgrades to CCC/Caa2 (S&P/Moody’s) or below of the reference obligation. See note 6 of notes to condensed consolidated financial statements for further discussion.

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). 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 U.S. GAAP, the Company carries its credit swaps on its 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 (loss) in the Company’s consolidated statements of operations. If a credit swap has an increase or decline in fair value during a period, the increase will add to the Company’s net credit swap revenue and the decline will subtract from the Company’s net credit swap revenue for that period, respectively. 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 defined credit event has occurred, the cumulative unrealized gains and losses on each credit swap would equal zero.

 

 

10

 



Primus Financial enters into ISDA Master Agreements with its counterparties and aggregates its respective transactions on a counterparty basis 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 and other swaps, at fair value in the condensed consolidated statements of financial condition.

Primus Financial

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

Primus Financial is primarily a Seller of credit swaps. As a general rule, when Primus Financial sells credit swaps, 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 Primus Financial receives new information suggesting that the credit quality of the underlying reference entity 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 defined 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: its view as to whether the capital dedicated to the position could 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.

Harrier/PRS Trading Strategies

At December 31, 2007, PRS Trading Strategies was inactive. At March 31, 2008, Harrier had closed its remaining credit swap positions.

 

 

11

 



Consolidated Net Credit Swap Revenue (Loss) and Credit Swap Portfolio Information

The table below presents the components of consolidated net credit swap revenue (loss) for the three months ended March 31, 2008 and 2007 (in thousands).

 

 

 

 

Three months ended
March 31,

 

 

 

 

2008

 

 

2007

 

Net premium income

 

$

27,312

 

$

18,524

 

Realized gains

 

 

1,032

 

 

2,796

 

Realized losses

 

 

(5,186

)

 

(3,169

)

Net change in unrealized losses

 

 

(686,773

)

 

(23,028

)

Net credit swap revenue (loss)

 

$

(663,615

)

$

(4,877

)

The table below, represents the Company’s consolidated notional amount, fair value and average fair value of open credit swap transactions entered into with third parties at March 31, 2008 and December 31, 2007 are as follows (in thousands):  

 

 

 

 

March 31,
2008

 

 

December 31,
2007

 

Gross Notional Amounts:

 

 

 

 

 

 

 

Credit swaps sold-single name

 

$

19,535,817

 

$

18,260,653

 

Credit swaps sold-tranche

 

 

4,700,000

 

 

4,700,000

 

Credit swaps sold-ABS

 

 

75,000

 

 

80,000

 

Credit swaps purchased-single name

 

 

(16,610

)

 

(25,410

)

Fair value:

 

 

 

 

 

 

 

Asset

 

 

24

 

 

606

 

Liability

 

 

1,230,826

 

 

544,731

 

Average fair value:

 

 

 

 

 

 

 

Asset

 

 

34

 

 

33,217

 

Liability

 

 

1,232,741

 

 

165,087

 

“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 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.

 

 

12

 



 

The tables that follow summarize in thousands, by credit rating of Reference Entities and of counterparties, the notional amounts and fair values of credit swap transactions outstanding for the Company as of March 31, 2008 and December 31, 2007:

 

 

 

March 31, 2008

 

December 31, 2007

 

Moody’s Rating Category

 

Notional
Amount

 

Fair
Value

 

Notional
Amount

 

Fair
Value

 

By Single Name Reference Entity/Tranche

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit Swaps Sold-Single Name:

 

 

 

 

 

 

 

 

 

 

 

 

 

Aaa

 

$

800,502

 

$

(17,352

)

$

828,504

 

$

(3,953

)

Aa

 

 

3,647,482

 

 

(130,108

)

 

3,832,904

 

 

(91,863

)

A

 

 

6,779,056

 

 

(149,319

)

 

6,047,762

 

 

(36,544

)

Baa

 

 

7,411,002

 

 

(138,629

)

 

6,882,813

 

 

(22,162

)

Ba

 

 

632,225

 

 

(33,106

)

 

570,090

 

 

(17,235

)

B

 

 

238,050

 

 

(47,338

)

 

71,080

 

 

(2,390

)

Caa

 

 

27,500

 

 

(3,908

)

 

27,500

 

 

(2,791

)

Total

 

$

19,535,817

 

$

(519,760

)

$

18,260,653

 

$

(176,938

)

                           

Credit Swaps Sold-Tranche:

 

 

 

 

 

 

 

 

 

 

 

 

 

Aaa

 

$

3,450,000

 

$

(405,259

)

$

3,450,000

 

$

(172,175

)

Aa

 

 

950,000

 

 

(173,262

)

 

950,000

 

 

(94,312

)

A

 

 

200,000

 

 

(56,030

)

 

300,000

 

 

(53,569

)

Baa

 

 

100,000

 

 

(26,910

)

 

 

 

 

Total

 

$

4,700,000

 

$

(661,461

)

$

4,700,000

 

$

(320,056

)

                           

Credit Swaps Sold-ABS (1):

 

 

 

 

 

 

 

 

 

 

 

 

 

A

 

$

25,000

 

$

(14,798

)

$

25,000

 

$

(12,821

)

Baa

 

 

35,000

 

 

(25,504

)

 

35,000

 

 

(20,470

)

Ba

 

 

15,000

 

 

(11,851

)

 

15,000

 

 

(11,353

)

B

 

 

 

 

 

 

5,000

 

 

(4,038

)

Total

 

$

75,000

 

$

(52,153

)

$

80,000

 

$

(48,682

)

                           

Credit Swaps Purchased-Single Name:

 

 

 

 

 

 

 

 

 

 

 

 

 

Aa

 

$

(8,160

)

$

1,029

 

$

(8,160

)

$

403

 

A

 

 

(3,580

)

 

541

 

 

(12,380

)

 

335

 

Baa

 

 

(4,870

)

 

1,002

 

 

(4,870

)

 

813

 

Total

 

$

(16,610

)

$

2,572

 

$

(25,410

)

$

1,551

 

 

 

13

 



 

By Counterparty Buyer / (Seller)

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit Swaps Sold-Single Name:

 

 

 

 

 

 

 

 

 

 

 

 

 

Aaa

 

$

3,641,728

 

$

(87,223

)

$

3,625,845

 

$

(34,091

)

Aa

 

 

13,008,454

 

 

(361,254

)

 

12,153,764

 

 

(118,109

)

A

 

 

1,853,952

 

 

(46,660

)

 

2,481,044

 

 

(24,738

)

Baa

 

 

1,031,683

 

 

(24,623

)

 

 

 

 

Total

 

$

19,535,817

 

$

(519,760

)

$

18,260,653

 

$

(176,938

)

                           

Credit Swaps Sold-Tranche:

 

 

 

 

 

 

 

 

 

 

 

 

 

Aaa

 

$

400,000

 

$

(75,024

)

$

400,000

 

$

(33,706

)

Aa

 

 

3,850,000

 

 

(505,195

)

 

3,850,000

 

 

(246,490

)

A

 

 

450,000

 

 

(81,242

)

 

450,000

 

 

(39,860

)

Total

 

$

4,700,000

 

$

(661,461

)

$

4,700,000

 

$

(320,056

)

                           

Credit Swaps Sold-ABS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Aaa

 

$

10,000

 

$

(7,972

)

$

15,000

 

$

(10,241

)

Aa

 

 

40,000

 

 

(25,199

)

 

40,000

 

 

(21,969

)

A

 

 

25,000

 

 

(18,982

)

 

25,000

 

 

(16,472

)

Total

 

$

75,000

 

$

(52,153

)

$

80,000

 

$

(48,682

)

                           

Credit Swaps Purchased-Single Name:

 

 

 

 

 

 

 

 

 

 

 

 

 

Aaa

 

$

 

$

 

$

(5,000

)

$

383

 

Aa

 

 

(16,610

)

 

2,572

 

 

(20,410

)

 

1,168

 

Total

 

$

(16,610

)

$

2,572

 

$

(25,410

)

$

1,551

 


(1)

– See note 6 Credit Events – CDS on ABS for further discussion.

 

 

14

 



 

 

 

 

March 31, 2008

 

December 31, 2007

 

S&P Rating Category

 

Notional Amount

 

Fair Value

 

Notional Amount

 

Fair Value

 

By Single Name Reference Entity/Tranche

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit Swaps Sold-Single Name:

 

 

 

 

 

 

 

 

 

 

 

 

 

AAA

 

$

767,986

 

$

(13,813

)

$

1,071,504

 

$

(32,181

)

AA

 

 

4,027,956

 

 

(134,806

)

 

3,704,784

 

 

(56,437

)

A

 

 

7,164,329

 

 

(167,761

)

 

6,550,733

 

 

(42,398

)

BBB

 

 

6,788,037

 

 

(122,071

)

 

6,326,638

 

 

(20,200

)

BB

 

 

616,171

 

 

(60,581

)

 

478,820

 

 

(14,583

)

B

 

 

129,235

 

 

(18,051

)

 

128,174

 

 

(11,139

)

CCC

 

 

42,103

 

 

(2,677

)

 

 

 

 

Total

 

$

19,535,817

 

$

(519,760

)

$

18,260,653

 

$

(176,938

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit Swaps Sold-Tranche:

 

 

 

 

 

 

 

 

 

 

 

 

 

AAA

 

$

3,800,000

 

$

(469,443

)

$

3,800,000

 

$

(212,582

)

AA

 

 

700,000

 

 

(133,177

)

 

700,000

 

 

(67,998

)

A

 

 

100,000

 

 

(31,931

)

 

100,000

 

 

(21,880

)

BBB

 

 

100,000

 

 

(26,910

)

 

100,000

 

 

(17,596

)

Total

 

$

4,700,000

 

$

(661,461

)

$

4,700,000

 

$

(320,056

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit Swaps Sold-ABS (1):

 

 

 

 

 

 

 

 

 

 

 

 

 

A

 

$

15,000

 

$

(6,318

)

$

50,000

 

$

(29,921

)

BBB

 

 

10,000

 

 

(6,091

)

 

15,000

 

 

(7,242

)

BB

 

 

10,000

 

 

(6,734

)

 

15,000

 

 

(11,519

)

CCC

 

 

40,000

 

 

(33,010

)

 

 

 

 

Total

 

$

75,000

 

$

(52,153

)

$

80,000

 

$

(48,682

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit Swaps Purchased-Single Name:

 

 

 

 

 

 

 

 

 

 

 

 

 

AA

 

$

(8,160

)

$

1,029

 

$

(8,160

)

$

403

 

A

 

 

(3,580

)

 

541

 

 

(12,250

)

 

765

 

BBB

 

 

(4,870

)

 

1,002

 

 

(5,000

)

 

383

 

Total

 

$

(16,610

)

$

2,572

 

$

(25,410

)

$

1,551

 

 

 

15

 

 



 

By Counterparty Buyer / (Seller)

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit Swaps Sold-Single Name:

 

 

 

 

 

 

 

 

 

 

 

 

 

AAA

 

$

5,000

 

$

(1

)

$

5,000

 

$

3

 

AA

 

 

15,850,262

 

 

(407,833

)

 

14,367,841

 

 

(131,277

)

A

 

 

3,680,555

 

 

(111,926

)

 

3,887,812

 

 

(45,664

)

Total

 

$

19,535,817

 

$

(519,760

)

$

18,260,653

 

$

(176,938

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit Swaps Sold-Tranche:

 

 

 

 

 

 

 

 

 

 

 

 

 

AA

 

$

4,250,000

 

$

(580,219

)

$

4,250,000

 

$

(280,196

)

A

 

 

450,000

 

 

(81,242

)

 

450,000

 

 

(39,860

)

Total

 

$

4,700,000

 

$

(661,461

)

$

4,700,000

 

$

(320,056

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit Swaps Sold-ABS:

 

 

 

 

 

 

 

 

 

 

 

 

 

AA

 

$

50,000

 

$

(33,171

)

$

55,000

 

$

(32,210

)

A

 

 

25,000

 

 

(18,982

)

 

25,000

 

 

(16,472

)

Total

 

$

75,000

 

$

(52,153

)

$

80,000

 

$

(48,682

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit Swaps Purchased-Single Name:

 

 

 

 

 

 

 

 

 

 

 

 

 

AA

 

$

(16,610

)

$

2,572

 

$

(25,410

)

$

1,551

 

Total

 

$

(16,610

)

$

2,572

 

$

(25,410

)

$

1,551

 

(1) – See note 6 Credit Events – CDS on ABS for further discussion.

Primus Financial’s counterparties are generally financial institutions with whom it has entered into ISDA Master Agreements. For the three months ended March 31, 2008, no individual counterparty generated greater than ten percent of the Company’s consolidated net premium revenue. For the three months ended March 31, 2007, one counterparty generated greater than ten percent of the Company’s consolidated net premium revenue.

The table below shows the geographical distribution of the Company’s credit swap portfolio by domicile of the Reference Entity and domicile of the counterparty as of March 31, 2008 and December 31, 2007 (in thousands):

 

 

 

March 31, 2008

 

December 31, 2007

 

Country of Domicile

 

Notional Amount

 

Fair Value

 

Notional Amount

 

Fair Value

 

Credit Swaps Sold-Single Name

 

 

 

 

 

 

 

 

 

 

 

 

 

By Reference Entity:

 

 

 

 

 

 

 

 

 

 

 

 

 

North America

 

$

9,790,092

 

$

(332,043

)

$

9,531,846

 

$

(149,169

)

Europe

 

 

8,849,725

 

 

(160,716

)

 

7,837,807

 

 

(21,719

)

Pacific

 

 

717,000

 

 

(20,884

)

 

712,000

 

 

(4,791

)

Others

 

 

179,000

 

 

(6,117

)

 

179,000

 

 

(1,259

)

Total

 

$

19,535,817

 

$

(519,760

)

$

18,260,653

 

$

(176,938

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

By Counterparty:

 

 

 

 

 

 

 

 

 

 

 

 

 

North America

 

$

9,828,919

 

$

(273,367

)

$

9,431,827

 

$

(100,747

)

Europe

 

 

9,564,898

 

 

(244,090

)

 

8,686,826

 

 

(75,709

)

Pacific

 

 

132,000

 

 

(2,314

)

 

132,000

 

 

(534

)

Others

 

 

10,000

 

 

11

 

 

10,000

 

 

52

 

Total

 

$

19,535,817

 

$

(519,760

)

$

18,260,653

 

$

(176,938

)

 

 

16

 

 



 

Credit Swaps Sold –Tranche

 

 

 

 

 

 

 

 

 

 

 

 

 

By Counterparty:

 

 

 

 

 

 

 

 

 

 

 

 

 

Europe

 

$

4,700,000

 

$

(661,461

)

$

4,700,000

 

$

(320,056

)

Total

 

$

4,700,000

 

$

(661,461

)

$

4,700,000

 

$

(320,056

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit Swaps Sold-ABS

 

 

 

 

 

 

 

 

 

 

 

 

 

By Reference Entity:

 

 

 

 

 

 

 

 

 

 

 

 

 

North America

 

$

75,000

 

$

(52,153

)

$

80,000

 

$

(48,682

)

Total

 

$

75,000

 

$

(52,153

)

$

80,000

 

$

(48,682

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

By Counterparty:

 

 

 

 

 

 

 

 

 

 

 

 

 

North America

 

$

45,000

 

$

(27,637

)

$

45,000

 

$

(24,418

)

Europe

 

 

30,000

 

 

(24,516

)

 

35,000

 

 

(24,264

)

Total

 

$

75,000

 

$

(52,153

)

$

80,000

 

$

(48,682

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit Swaps Purchased-Single Name

 

 

 

 

 

 

 

 

 

 

 

 

 

By Reference Entity:

 

 

 

 

 

 

 

 

 

 

 

 

 

North America

 

$

(16,610

)

$

2,572

 

$

(25,410

)

$

1,551

 

Total

 

$

(16,610

)

$

2,572

 

$

(25,410

)

$

1,551

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

By Counterparty:

 

 

 

 

 

 

 

 

 

 

 

 

 

Europe

 

$

(16,610

)

$

2,572

 

$

(25,410

)

$

1,551

 

Total

 

$

(16,610

)

$

2,572

 

$

(25,410

)

$

1,551

 

 

 

17

 


 


The table below shows the distribution of the Company’s credit swap portfolio by year of maturity as of March 31, 2008 and December 31, 2007 (in thousands). With respect to the credit swaps sold-ABS caption below, the actual maturity date for any contract will vary depending on the level of voluntary prepayments, defaults and interest rates with respect to the underlying mortgage loans. As a result, the actual maturity date for any contract may be earlier or later than the estimated maturity indicated.

 

 

 

March 31, 2008 

 

December 31, 2007 

 

 

 

Notional
Amount

 

Fair
Value

 

Notional
Amount

 

Fair
Value

 

Credit Swaps Sold-Single Name

 

 

 

 

 

 

 

 

 

 

 

 

 

Year of Maturity

 

 

 

 

 

 

 

 

 

 

 

 

 

2008

 

$

781,648

 

$

(2,464

)

$

1,180,401

 

$

(302

)

2009

 

 

2,803,603

 

 

(32,557

)

 

2,723,618

 

 

(6,449

)

2010

 

 

6,167,585

 

 

(145,926

)

 

6,052,998

 

 

(56,037

)

2011

 

 

3,051,222

 

 

(139,616

)

 

2,953,911

 

 

(53,905

)

2012

 

 

5,535,511

 

 

(183,329

)

 

5,309,725

 

 

(60,119

)

2013

 

 

1,196,248

 

 

(15,868

)

 

40,000

 

 

(126

)

Total

 

$

19,535,817

 

$

(519,760

)

$

18,260,653

 

$

(176,938

)

Credit Swaps Sold-Tranche

 

 

 

 

 

 

 

 

 

 

 

 

 

Year of Maturity

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

$

1,000,000

 

$

(43,495

)

$

1,000,000

 

$

(6,204

)

2013

 

 

350,000

 

 

(87,397

)

 

350,000

 

 

(58,715

)

2014

 

 

3,350,000

 

 

(530,569

)

 

3,350,000

 

 

(255,137

)

Total

 

$

4,700,000

 

$

(661,461

)

$

4,700,000

 

$

(320,056

)

Credit Swaps Sold-ABS (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

Year of Maturity

 

 

 

 

 

 

 

 

 

 

 

 

 

2010

 

$

10,000

 

$

(4,789

)

$

10,000

 

$

(4,632

)

2011

 

 

5,000

 

 

(3,654

)

 

10,000

 

 

(6,368

)

2012

 

 

15,000

 

 

(10,602

)

 

15,000

 

 

(9,322

)

2013

 

 

15,000

 

 

(10,341

)

 

15,000

 

 

(9,443

)

2014