Primus Guaranty Ltd Q4 2009 Earnings Call Transcript

| About: Primus Guaranty, (PRSG)

Primus Guaranty Ltd (PRS) Q4 2009 Earnings Call February 3, 2010 11:00 AM ET


Nicole Stansell - IR

Tom Jasper - CEO

Richard Claiden - CFO


Good day, ladies and gentlemen, and welcome to the fourth quarter 2009 Primus Guaranty Limited earnings conference call. My name is Heather and I will be your operator for today. At this time, all participants are in a listen-only mode. (Operator Instructions). I'll now turn the call over to your host for today’s conference Ms. Nicole Stansell, Investor Relations Officer. Please proceed.

Nicole Stansell

Good morning, ladies and gentlemen, and welcome to our quarterly earnings call. I am Nicole Stansell, Investor Relations Officer of Primus Guaranty and with me are Tom Jasper, Chief Executive Officer and Richard Claiden, Chief Financial Officer. I will begin the call with the Safe Harbor statement and then I will turn the call to Richard for a review of our quarter and year end financial results.

Tom will follow Richard with a discussion of the structured credit marketing environment and provide an update on our business priorities and key initiatives. This call is being webcast and a complete record of the call will be available on our website. In addition to today's earning press release, we will be posting a brief PowerPoint presentation on our website that summarizes our strategy and goals for 2010.

I would like to point that the company's use of non-GAAP financial measures is explained in today's earning press release, and a full reconciliation between GAAP and non-GAAP measures is provided in the table accompanying the press release. You can also find the reconciliation on our website.

Before we begin, I should caution you that some of the statements we make on this call, particularly those anticipating future financial performance, business prospects, growth in operating strategies, transactions and similar matters, are forward-looking statements that involve a number of assumptions, risks, and uncertainties, which change over time. We assume no duty to update any forward-looking statements. Our actual result could differ materially from those anticipated in forward-looking statements and our future results could differ materially from historical performance.

For discussion of the factors that could affect our results please refer to the risk factors identified in our filings with the SEC.

And now I'll turn the call over to Richard.

Richard Claiden

Thank you, Nicole. Let me start with the highlights for the quarter and the year. GAAP net income was $295 million in the fourth quarter of 2009, or $7.21 per diluted share, for all of 2009 GAAP net income was $1.5 billion or $35.26 per diluted share

Our GAAP net income for the quarter and the year was primarily driven one by unrealized mark-to-market gains on Primus Financials credit swap portfolio. Declines in market credit swap premium levels coupled with a reduction in the average remaining [tenure] of the portfolio resulted in favorable movements in the mark-to-market value of Primus Financials credit swap portfolio, the $336.8 million in the quarter and $1.5 billion for the year.

Economic results for the quarter was a loss of $35.5 million or a loss of $0.87 per diluted share. This included premium income of $18.5 million asset management fees of $3 million which were offset by credit event and credit mitigation cost of $38.2 million of Primus Financials credit swap portfolio. A payment of $10 million associated with a portfolio of repositioning transaction and operating expenses of $12.3 million.

The year ended December 31, 2009 economic results was a loss of (inaudible) or $0.09 per diluted share. The loss for the year included credit swap premium income of $85.1 million, asset management fees of $5.1 million offset by credit event and credit mitigation cost of $63.2 million, payments of $31.5 million associated with portfolio repositioning transactions and operating expenses of $40.3 million.

During 2009 our economic results book value increased $0.41 to $8.48 at December of 31, 2009. Now, turning to the details of our economic results for the quarter and for the year. Credit swap premium income for the quarter was $18.5 million compared with $23.6 million in the fourth quarter of 2008. Credit swap premium income for all of 2009 was $85.1 million compared with $102.6 million in the previous year.

Decrease in premium is mostly attributable to the reduction and size of the portfolio. Primus Financials consolidating credit swap portfolio was $22.5 billion at the beginning of 2009 and $17.5 billion at the end of 2009.

Over the course of 2009, approximately $1.9 billion of notional matured and approximately $2.5 billion of notional was terminated in conjunction with the portfolio of repositioning transactions.

During the fourth quarter of 2009, Primus Financial experienced two corporate credit events at a single name portfolio. On CIT and financial guarantee insurance company or FGIC. The net charge to economic results for these events is approximately $37 million. In addition, there was a provision of $1 million related to credit swaps that Primus Financial had written on asset backed securities.

During the quarter, Primus Financial completed a portfolio of repositioning transaction with the major counterparty, in this transaction; Primus Financial paid $10 million to the counterparty to terminate single name swaps and to restructure tranche transactions with their counterparty. The restructuring significantly reaches the risk associated with these tranche transactions.

Asset management fees which we own primarily for managing CLOs and CSOs were $3 million in the fourth quarter of 2009 compared with $776,000 in the fourth quarter of 2008. The increase in fee income was attributable to two factors. The acquisition of Cypress Tree in July 2009, which contributed about $950,000 in asset management fees for the fourth quarter of 2009. In addition CLO subordinated fee income rose by $1.4 million in the fourth quarter of 2009 compared with the fourth quarter of 2008.

As you may know, subordinated fees on certain of the company's CLOs are deferred until specified tests within those CLOs are satisfied. For the full year 2009 asset management fees grows from $4.1 million to $5.1 million. Third party assets under management which are primarily CLOs and CSOs increased from $1.4 billion at the beginning of 2009 to $3.7 billion at the end of the year.

Net interest income in the fourth quarter 2009 was $2 million compared with $4.9 million in the fourth quarter of 2008 interest income for 2009 as a whole was $6.7 compared with $26.6 million for 2008. The change was due to decline in short term interest rates on our investment portfolio and lower investment balances.

The average yield on our investment portfolio was 94 basis points in 2009 compared with 3.11% in 2008 average investment balances was $718.1 in 2009 compared with an average of $855.4 million in 2008.

Financing cost in the fourth quarter of 2009 were $2.7 million compared with $5.7 million in the fourth quarter of 2008, financing cost for 2009 as a whole was $12.5 million compared with $23.7 million for 2008. The interest cost on our differed or on our debt to preferred securities declined in 2009 due to lower rates of interest and declining debt and preferred balances due to repurchases by the company.

Operating expenses for the fourth quarter were $12.3 million compared with $7.1 million in the same quarter 2008. The increases was to due principally to three factors the first is an additional provision of $2.6 million associated with the acquisition of CypressTree.

Primus has agreed to the pay the owners of CypressTree a proportion of future subordinated fees as and when these fees are received. We provide for these potential earn up payments based on the likelihood of receiving subordinated fees in the future.

During the latter part of 2009, the structured loan market improved and the likelihood of receiving future subordinated fees on our CLOS increased significantly. As a result we increased the provision we make for potential earn out payments. I would stress that we do not share the subordinated fees until they are actually received in the future but we do make provision for potential payments on a current basis.

Furthermore the provision may increase or decline overtime depending on the likelihood of collecting future subordinated fees. Other factors affecting the operating expenses were an increase in expense for variable compensation which was approximately $1.7 million higher in the fourth quarter of 2009 compared with the same quarter of 2008 and legal and professional fees associated with the portfolio repositioning transactions. Operating expenses for the full year 2009 were $40.3 million, compared with $31.1 million for 2008. The increase in 2009 included increased variable compensation expense of approximately $3 million, a provision of $2.8 million against the earn out of subordinated fees under the CypressTree acquisition.

Turning to our balance sheet, we have $701.1 million of cash and cash equivalents and investments on a consolidated basis at December 31, 2009. This compares with $767.8 million at December 31, 2008. During the fourth quarter of 2009 the company repurchased and retired approximately 1.5 million shares of its common equity at a cost of approximately $4.9 million. From the inception of the share buyback program in 2008 through the end of 2009, the company has purchased 7.9 million shares of its common equity at a cost of approximately $13.2 million. The company did not purchase any of its 7% senior notes in the fourth quarter of 2009. However, since the inception of the debt purchase program in 2008 through the end of 2009 the company has paid $11.5 million to retire $30.4 million in face value of a 7% senior notes.

Today the company announced that its board of directors have authorized an additional expenditure up to $15 million of available cash for the purchase of the company’s common shares and or its 7% senior notes. The purchases will be made at management’s discretion. Now I will hand you over to Tom for his perspective on 2009 and to outline our 2010 strategic plan.

Tom Jasper

Thanks, Richard and good morning to all. During our call at this time last year, I outlined our plan for navigating through the dislocation in the credit markets and I discussed our strategic business objectives for 2009. Looking back over the past twelve months, I believe we’ve made good progress on what we set out to do. I am proud of our employees for what we’ve enabled to accomplish. But it's also fair to say that we continue to have a significant amount of work ahead and that’s what management plans to focus on in 2010.

We also recognized however, that the environment in which we are operating has changed. A year ago we were in the midst of a credit crisis whose outcome was still largely uncertain. While there continue to be pockets of dislocation, and the financial markets regulatory environment remains highly uncertain the economy, the capital markets and the credit markets have show significant improvement during 2009. Credit spreads during the year had narrowed significantly as indicated by 49% increase in the CDX IG index which is a measure of investment grade credit. The value of many structured finances instruments also has improved as indicated by a 52% gain in the S&P, LSTA and X which is a measure of corporate loan pricing.

Capital is returning to work as evidence by the volume of new credit capital markets issuance during the year. This improving environment requires Primus to change. Our board and our management team have been fine tuning our strategies and priorities within the new landscape.

Most importantly, we are shifting to an offensive build value approach. As you recall a year ago, Primus along with many participants in the credit markets was focused primarily on preserving value, since then there has been an overall shift in settlement and provides us the framework for building growth opportunities for Primus. I would like to discuss with you today, how we planned a build shareholder value in 2010 based on our current market view and our strategic business priorities.

It all starts with our current market position. Today our subsidiary Primus Asset Management or PAM ranks as one of the larger structure credit managers in the credit markets. We have a team of top caliber professionals overseeing and managing over $20 billion in cash and synthetic instruments across the variety of structured finance vehicle, this includes the Primus Finance credit swap portfolio which at December 31 2009 at $17.5 billion in credit default swaps outstanding and also includes the structured finance vehicles we managed with $3.7 billion in third party assets.

Premium income from Primus Financials credit swap portfolio will continue to be a significant component of our web news during 2010. Over the remaining life of the CDS business, we have written premium income is expected to be a $165 million. As you can appreciate, potential revenues from premium income could be impacted by any additional credit losses.

While the revenues from premium income associated with Primus Financials credit swap portfolio comprised most of our earnings in 2009, we also saw a good growth in fee income from our asset management business.

We should see further growth in 2010, as we currently expect asset management fee income to more than double based on just our existing portfolio. To give your sense of revenue potential over the life of the CLOs and COOs that are managed by PAM, fee income could be as much as $63 million. Just to remind you, management fee income on CLOs PAM manages is comprised of two elements.

First the senior fees for managing the portfolios and second subordinated fees that we can receive depending upon the performance of the vehicles we manage. This fee structure generally provides this potential for a significant upside as subordinated fees are generally in the range of 65% of total fees. For most of 2009, PAM was receiving only senior fees.

Late in the fourth quarter we began to see this upside, as we earned an additional $1.8 million of revenue as the subordinated fees began to pay out on one of the CLOs that PAM manages. So we have begun to build our more diverse revenue in earnings model for the company, but we understand that all of our manage credit vehicles including Primus Financial have a shelf life. This means that as they wind down to mature, we need to find ways at the very least to replace the stream of revenues that they generate.

This will be our major focus in 2010. Developing new streams of asset management revenues is one of our top priorities and there are number of ways we're looking to scale this business.

First, we're continuing to look for acquisition opportunities. At the beginning of 2009, we anticipated there would be a significant level of consolidation amongst credit asset managers as size and scale became more and more important. This played out larger as expected. We've seen a number of transactions over the course of the year and we've explored a number of opportunities in the U.S. and in Europe.

As you know, during 2009, we closed on one particularly good opportunity, the acquisition of CypressTree, a highly regarded manager of CLOs. This acquisition has worked out extremely well and while currently maintaining a distinct identity in brand, CypressTree is now completely integrated into PAM. But we need to find additional acquisitions all the while making sure that any transactions are accretive and makes sense from a cultural perspective.

We have two investment banks working with us to locate roll up opportunities in the U.S. and Europe and quite frankly I would be disappointed if we did not make one or two additional acquisitions of structured credit asset managers during 2010. In addition, a major goal is to raise third capital during 2010 for the new funds that we're launching. As I mentioned on our last call, we've developed two new fund offerings, the Primus Absolute Return Credit fund or PARC, and the Primus credit strategy's fund.

Primus Financial has agreed to provide them with a modest level of seed capital, which will enable these funds to begin operation, establish a track record and to track outside investors. As the assets under management from outside investors grow in these funds they should generate attractive incremental fee income for PAM.

To help us attract third party capital we have begun to develop an internal distribution and investor marketing capability the large investment banks have significantly reduced their structured credit distribution capabilities during the recent financial crisis making an essential that we have the ability to market our own funds and vehicles directly to institutional investors.

These investor marketing capability will also be important as we developed and launch new CLO and/or CSO offerings. There have been signs recently that the structured credit markets for new transactions is beginning to come to life. In my view credit investors are now more willing to consider structured credit alternatives given the significant rally in credit spreads during 2009 and the low level of interest rates.

We are in discussions with the dealers about this changes and whether there are opportunities for PAM my goal during 2010 is to move forward with at least one new PAM managed CLO or CSO. So we have a lot of work ahead as we build our asset management business replacing revenues from businesses that are running of or maturing and transitioning back to a growth mode.

We also think we have lot of pieces in place to make this strategy work a leading market position a reputation for credit market expertise a broad portfolio vehicles and assets on the management and on a attractive platform for growth. We expect to see significant progress during 2010.

While so far I had discussed our shorter term goal there is one other longer term initiative that I want to touch on. As we have said we continue to see demand in the market place for a long term investor and credit risk that assumes this risk by selling credit protection we are moving forward restructuring a company, a rated, regulated financial guarantor that would provide this capacity to the market.

In particular, we are focused on those areas of the structured credit markets where the traditional non-dealer providers of credit risk protection such as the credit derivative product companies and insurance companies are no longer active. We want to aggressively take advantage of this GAAP and capacity and believe this new insurance company could offer investors attractive returns. Please keep in mind that this is a complex undertaking that will take at least the remainder of 2010 to complete.

Let me shift to our second priority, actively managing our credit swap portfolio and amortization. I am very pleased with the progress we made during 2009 in terms of de-risking Primus Financials credit swap portfolio.

A year ago I stated that we felt that this portfolio offered significant value to shareholders and that we plan to actively manage various concentrations and higher risk tranches to narrow the range of possible negative outcomes.

I felt at the time that giving up some of the upside to put a floor on the downside would be a good risk-reward tradeoff for shareholders. We believe we have made good progress on achieving this objective through the three substantial portfolio repositioning transactions that we completed during 2009.

We saw in later 2009 a clear example of how these portfolio repositioning transactions have benefitted shareholders. A case in point, in the first portfolio repositioning transaction we reduced our exposure to FGIC, which Richard mentioned earlier by $35 million at a cost of $15 million.

As you know FGIC late in the year suffered a credit event. After factoring in recovery values and that savings to Primus financial from this portfolio repositioning transaction was roughly $11 million. To date, Primus Financial has paid counter parties a total of $31.5 million to terminate or amend credit swaps under the three portfolio repositioning transactions we have completed. Primus Financial has also established two new subsidiaries and contributed a $126 million of capital to them in order to cap its exposure to $2.9 billion of transactions.

This is another important element of our strategy to derisk the portfolio. It's important to realize that this capital will be returned to Primus Financial at the final maturity of the credit swaps in these subsidiaries. And we continue to collect premiums on these credit swaps and interest income on Primus Financial’s capital invested in these subsidiaries.

During 2010 we intend to try and complete a small number of additional transactions to continue to derisk Primus Financial’s credit swap portfolio. These transactions will likely involve some additional incremental payments from Primus Financial and potentially the establishment of new subsidiaries. Some would say that given the improvements we are seeing in the economy and the credit markets, that the risk of default is decreasing and that Primus Financial doesn’t need to undertake these transactions. That sentiment is understandable.

Overall Primus Financial’s portfolio has performed very well during 2009. We’ve had only three credit events in our single named portfolio, IDR, CIT and FGIC in 2009 while there were 38 corporate credit events in total during the year according to a credit industry website. But it's important to consider the other side of the equation. The fact is we still have pockets of single named exposure concentrated on a high risk industries and Primus Financial’s credit swap portfolio. This includes over $300 million in exposure remaining to four financial guarantor companies, a large portion of which is set to mature over the course of 2010

We also have exposure to a small number of higher risk to (inaudible) comp transactions. This is why management believes we should continue to attempt the derisk components of Primus Financial's portfolio if we can achieve a reasonable cost benefit. I appreciate that it's difficult for shareholders to assess the significance for the three portfolio repositioning transactions completed to date, little own any future transactions on the value of Primus Financial.

Additionally, I recognize within the short-term of these transactions negatively impact our economic results. In many respects what we're trying to do is preserve the long-term value of Primus Financial for shareholders. We've made the decision as I said to give up some of the upside in order to establish the floor on the downside. At some point this year, we expect to be in the position to provide shareholders with a comprehensive report on the portfolio repositioning transactions, and how they have positively impacted the long-term value of Primus Financial.

This brings me to our third priority, capital allocation. During 2009, we effectively deployed capital through equity and debt repurchases to build tangible value for shareholders. We intended to continue down this path as evidenced by the board's approval that Richard mentioned to increase our repurchase authorization by $15 million. I recognize that shareholders have strong and often divergent views on how capital should be best allocated.

Some of our investors preferred to see a ramp up in the size and scope of the repurchase program; others prefer cash dividends because of the immediate return they provide. Please be assured that we have, and will continue to consider these options. At this point in time, and given the sharp discount that our shares trade at relative to economic book value, repurchases appear to make the most economic sense.

As I mentioned at the outset, the overall market environment has changed significantly over the past year and we have adapted our strategy to anticipate or respond to the impact of these changes. We are transitioning in 2010 to an approach where we are aggressively seeking new business opportunities. This approach requires that we allocate some of our capital during the year to support of growth initiatives.

It's been said that capital allocations is management's most important job and I could not agree more. We will continue to work hard to ensure that we optimize our use of capital. Before I close I want to spend the minute or two on the human capital will need to execute on our 2010 business priorities and the impact is we will have on our operating expenses.

To begin with our people and our operating platform have been critical to our successes of company. As I’ve mentioned we are selectively adding to our talent base to support our growth strategy. This includes hiring a senior portfolio manager to manage our new parts on building out our distribution capability and making a few other key hires during 2010.

While we are selectively adding talent to build our asset management business, we are also taking steps to ensure that we are optimizing the efficiency of our credit protection business as it amortizes. After factoring in all of these items, our operating expenses should decline in 2010 from 2009 by several million dollars. On a true run rate basis excluding the item we incurred in the fourth quarter that Richard discussed, operating expenses will be roughly flat year-over-year.

We will during 2010 to continue to keep a sharp eye on expenses particularly at the revenue growth from new initiatives lags. So that gives you a snapshot of our key business priorities for 2010, over the past two years we have worked very hard to preserve the value of this company during very difficult conditions. We have successfully stabilized the business, strengthened its foundations and are now and now we're looking again to regain our growth momentum. There is no question that we face important challenges, but the rewards that we will generate for shareholders will also be important.

Thank you again for your continued support and now let me turn the call over to Nicole to conclude it.

Nicole Stansell

Thank you all for joining us in today's earnings call. As a reminder a web cast of the call, and a copy of the press are available on our website You will also find a presentation outlined in our 2010 strategy and goals in the coming week. Please contact me with any questions you may have. Thank you.


Ladies and Gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.


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