On Primus Credit Mitigations

Primus Guaranty (PRS) announced the other day that it entered into a significant credit mitigation deal with one of its counterparties, reworking $1.2 billion in notional value of credit default swaps. According to the press release, $40 million in notional exposure written on a monoline insurer was terminated for $15 million, or 37.5 cents on the dollar. The other billion-plus is being moved to a subsidiary of Primus Financial capitalized with $36 million, which is the maximum exposure (plus future premiums on those swaps) that can be lost.

Working backwards, ring-fencing certain swaps clips the tail risk existing in the portfolio at about 3.1% – a fairly high level that’s about 50% above what I’ve modeled previously. From the press release, my assumption is that the counterparty is willing to do this to minimize credit/counterparty risk related to Primus; it’s not collateral per se, but it functions in the same way.

As for the monoline settlement, well, it speaks volumes about what happens if you aren’t a systemic risk – privately negotiated solutions actually come about, and it means that companies that took risks take losses (or at least agree to accept more uncertainty/variability). One possibly safe extrapolation: if counterparties to a company that doesn’t warrant liquidity concerns like Primus are willing to take substantial haircuts on their CDS transactions, you better believe that Santa Claus came down the chimney for everyone with claims against AIG that were repaid in full. It’s simply a perverse trait of the financial system, and our government, that smaller players are left to deal amongst themselves, whereas larger players are assisted and handed a different set of rules to play by.

More to come after earnings next week…

Lastly, a non-related note. I’ve learned a lot from David Merkel, and he asked those who read him to link to this about the SEC. It’s the least I can do, and I encourage you to read it.

click to enlarge

Disclosure: I own both Primus stock (PRS) and debt (PRD).

Comments

[David Merkel:]

Thanks, James.

Aug 03 12:27 PM

[Gtarras:]

So, what is the future for Primus? do you believe they return to writing new business/generating revenue?

if they do, how profitable do you think it will be? they will have to post CSAs, how much of capital will this be tying up? will they need a high rating?

TIA. i'm actually interested in this stock and this platform. given the upcoming demand for risk management products, and wiped out competition (such as monolines, AIG etc), i 'm curious if there is bright future for Primus.

Aug 03 02:30 PM

[James Cullen:]

There's the possibility for a collateralized CDS seller, which could possibly be economic if spreads remain elevated, since it would operate with lower leverage than the CDPC. But if that's in the works, it's going to involve outside investors, since the stated operating plan is to run off PFP and return that capital. So there, you're relying not only on the ratings agencies to bless the endeavor, but whatever capital allocated to the structured credit markets that still exists to want to fund the venture.

Devoting time and resources to building out a collateralized entity would also detract from the mission of building out Primus' asset management capabilities. There's plenty of institutional skepticism about how successful those efforts will be, so I don't know if management wants to tackle a second growth avenue at this point.

You're right about the reduced competition finally making new business attractive (a theme applicable to a number of areas). I'd like to see them raise new capital and seed a collateralized DPC to extend the credit platform. But it'll take nine figures worth of fresh capital, so I don't know how realistic it is.


On Aug 03 02:30 PM Gtarras wrote:

> So, what is the future for Primus? do you believe they return to
> writing new business/generating revenue?
>
> if they do, how profitable do you think it will be? they will have
> to post CSAs, how much of capital will this be tying up? will they
> need a high rating?
>
> TIA. i'm actually interested in this stock and this platform. given
> the upcoming demand for risk management products, and wiped out competition
> (such as monolines, AIG etc), i 'm curious if there is bright future
> for Primus.

Aug 04 03:48 PM

[Gtarras:]

thanks. just listened to their call, Jasper said they have experimented with the idea of a collaterized CDPC entity, and had promising results. he even said they were in talks with potential investors, as well as their current clients, as the talks were encouraging. I am especially interested in what their clients said, because the way I see it, the old business models such as AIGs are gone, while the demand to this sort of risk management service is spiking.


On Aug 04 03:48 PM James Cullen wrote:

> There's the possibility for a collateralized CDS seller, which could
> possibly be economic if spreads remain elevated, since it would operate
> with lower leverage than the CDPC. But if that's in the works, it's
> going to involve outside investors, since the stated operating plan
> is to run off PFP and return that capital. So there, you're relying
> not only on the ratings agencies to bless the endeavor, but whatever
> capital allocated to the structured credit markets that still exists
> to want to fund the venture.
>
> Devoting time and resources to building out a collateralized entity
> would also detract from the mission of building out Primus' asset
> management capabilities. There's plenty of institutional skepticism
> about how successful those efforts will be, so I don't know if management
> wants to tackle a second growth avenue at this point.
>
> You're right about the reduced competition finally making new business
> attractive (a theme applicable to a number of areas). I'd like to
> see them raise new capital and seed a collateralized DPC to extend
> the credit platform. But it'll take nine figures worth of fresh capital,
> so I don't know how realistic it is.

Aug 05 12:50 PM