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Executives

Richard Claiden - CFO

Tom Jasper - CEO

Chris Gerosa - Corporate Treasurer

Nicole Fatica - IR

Analyst

Ken Zerbe - Morgan Stanley

Darrin Peller - Lehman Brothers

Geoffrey Dunn - KBW

Mark Lane - William Blair

Gregory DiMarzio - Century Capital

Greg Eisen - ICM Asset Management

Primus Guaranty Ltd. (PRS) Q3 2007 Earnings Call November 6, 2007 ET

Operator

Good day ladies and gentlemen, and welcome to the Third Quarter 2007 Primus Guaranty Earnings Call. My name is Coressa and I will be your coordinator for today. At this time, all participants are in a listen-only mode, we will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions).

I'd now like to turn the presentation over to your host for today's conference Mr. Richard Claiden, Chief Financial Officer. Please proceed sir.

Richard Claiden

Thank you, Coressa. Good morning ladies and gentlemen, welcome to our quarterly earnings call. I am Richard Claiden, Chief Financial Officer for Primus Guaranty, and with me is Tom Jasper, Chief Executive Officer, Chris Gerosa, our Corporate Treasurer and Nicole Fatica, our Investor Relations Officer.

I'll begin the call, discussing the Company's overall financial results for the quarter and current portfolio size, later focusing on our financial results for the quarter in greater detail. Tom will then give his perspective on the third quarter, the market and business developments since July and provide discussion of our business outlook. I will follow Tom by discussing the company's overall financial results for the quarter.

Some of the statements included in our discussion, particularly those anticipating future financial performance, business prospects, growth and operating strategies and similar matters are forward-looking statements that involve a number of risks and uncertainties. For those statements, we claim the protection of the Safe Harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. For a discussion of the factors that could affect our actual results, please refer to the risk factors identified in our 10-Q.

We expect to take about 30 minutes to complete our sections, and then plan to open the call for your questions. In discussing the results, I'll refer to both, the earnings release and supplementary information package, which were both published earlier today and contain the reconciliation from GAAP to economic results. I will focus on our economic results while I also refer to our GAAP results.

As many of you know, we derive our economic results by excluding from our GAAP income, the unrealized gains or losses on our portfolio and credit swaps sold in private by Primus financial products at any realized gains on the early termination of credits swaps sold, although those gains are amortized into economic results of the original lives of the terminated contracts.

Our economic results for the third quarter of 2007 were $12.6 million or $0.28 per diluted share, compared with $12.7 million or $0.29 per diluted share in the same quarter of 2006. During the quarter we generated higher credit swap premium income, higher CLO, CDO asset management fees and net interest income compared with the year earlier period. In credit, this was partially offset by loss at our credit, Harrier Credit Strategies Fund. Harrier's results reflected trading loss of $6.5 million in the funds investment portfolio, resulting from volatility and de-liquidity in the credit markets. The company's operating expenses for the quarter were practically flat from the year and a year period.

Turning to our credit protection business, as of September 30th 2007, Primus Financial's portfolio and credit swaps sold including single name credit swaps, tranches and credit swaps on asset-backed securities was $24.4 billion in total with a weighted average premium of 44 basis points and A/A3 rating and the remaining tenor of 3.7 years.

We sold $2.8 billion of new credit swaps in the quarter. This represents the highest level of new transactions since becoming a public company in 2004. These new transactions would generate over $65 million in future premiums, assuming the contracts are held to term.

Breaking the new transaction volume in two components, we sold $2.2 billion in single name credit swaps with a weighted average premium of 41 basis points, a weighted average rating of A+, A/A2 and an average tenor of 5.1 years.

New tranches transactions in the quarter total $600 million, with the weighted average premium of 60 basis points, weighted average rating of AAA and an average tenor of 7.1 years.

New transactions volume for credit swaps on asset-backed securities in the quarter was $5 million with the weighted average rating of AA-, A2 and weighted average premium of 280 basis points.

Our GAAP net loss for the third quarter of 2007 was $128.4 million compared with net GAAP income of $23.7million in the third quarter of 2006. The major contributor to the GAAP results in this last quarter was an unrealized mark-to-market loss of $140 million in Primus Financial Products credit protection business. This loss was primarily attributable to the general increase in market premium levels during the quarter.

As many of you know, when market credit spreads widen, the likely result is an unrealized losses in our credit swap portfolio, resulting in diminished or a negative GAAP net income. However, quarterly fluctuations in the value of a credit swap contract will net out to zero if the contract is held to maturity. In addition, as credit spreads widen, Primus Financials' new business activity will be written at higher premium levels.

At quarter end, the fair value of Primus' credit swaps portfolio was a negative $128 million, broken down as follows: single name credit swaps and unrealized losses, $13 million; tranches and unrealized loss of $86 million and CDS on ABS credit swaps on asset-backed securities and unrealized loss of $29 million.

It’s important to bear in mind that GAAP results have no impact on Primus' AAA ratings. Our rating agency capital models, our cash flow models and unrealized gains on losses in the portfolio do not impact the capital base supporting them. Also, in our credit protection business, we do not post collateral, and Primus Financial does not face margin calls or provide ratings triggers.

I hope this information is helpful in understanding Primus' third quarter performance.

Now, Tom will discuss our business strategy and performance in greater detail.

Tom Jasper

Thanks, Richard. Good morning, everyone. During the third quarter, our business performance and financial results were mixed, reflecting a very challenging credit market environment. Out credit protection business had a very solid quarter with strong growth in new transaction volume and portfolio size. Our Harrier Credit Strategies Fund, however, had a difficult quarter and did not perform according to plan.

As announced in our earnings release, given the challenges of toady's credit markets and the difficulties of raising third-party capital for the fund, we have decided to discontinue its operations, which will free up capital to invest in the growth of our credit protection business.

Now, prior to commenting in detail on our business line performance and our strategic priorities, I would like to discuss the current market environment, given its impact on our business.

Anyone following the financial markets over the last four months is more than aware of the impact that recent credit dislocations has had on financial institutions. The level of anxiety in illiquidity, which began early in the quarter, led to a re-pricing of credit risk across a number of sectors in the credit markets.

One indicator of this re-pricing of risk was performance of the Dow Jones investment grade index. It practically doubled at its peak from 41 basis points at the end of June to 81 basis points at August 3rd and then subsequently settled back to levels in the mid 50's by the end of the quarter. Many of the largest participants in the credit markets, the dealers and banks, took large charges across their portfolios of structured credit assets.

There were periods where there was a complete lack of trading activity and liquidity in various sectors of the markets. The Federal Reserve cut rates twice since the end of the second quarter. Stock markets were very volatile. I can go on and on, but it's fair to say that navigating through the series of market events has been a challenge for us, but it has also offered us opportunities.

I believe we demonstrated during the quarter that we are well positioned to capitalize on a widening in credit spreads as we saw a significant acceleration in new transaction volume in our credit protection business at much more attractive levels.

Much of our activity during the quarter was focused on those sectors that were impacted by the credit crisis, particularly financial institutions and dealers. We did not see a broad widening across global corporates, although that has started to change recently as announcements of disappointing third quarter earnings have become more pronounced.

There were no new announced LBOs during the quarter, and the risk to us associated with the leveraging of the corporate balance sheet has become less of a factor in managing our portfolio. Yet, the recent completion of last debt transactions for some LBOs indicates that the capital can be raised to support these transactions. So we continue to be mindful of the risk.

Our credit mitigation charges were quite limited in the quarter and certainly below the historical two basis points or total notional we had taken in the past. As you know, we managed the business for the long term, and we continue to use the range of five to seven basis points for credit mitigation charges for our business planning purposes.

We continue to be very disciplined in the quarter in responding to what we believe is a riskier market environment and our view that credit fundamentals are likely to deteriorate in 2008.

As in the second quarter, we focus most of our activity on higher-quality corporate reference entities rated A+ and better, which offered very attractive risk returns. This is also the reason why the weighted average premiums on our new transaction volume did not show the same sort of increase that you might have expected using index levels as a point of reference. Over the past two quarters, I am very pleased that we have been able to significantly improve overall portfolio quality to a solid A/A3.

Much of our new transaction volume in the quarter was in single name credit swaps versus tranches. Essentially, this was the reverse of what we saw in the second quarter during which we had relatively more tranche activity than single name activity.

Part of the reason for the change in tranche versus single name volumes was due to illiquidity and volatility in the tranche markets during the period which made price transparency and the ability to execute at market levels very difficult.

Tranche activity volume was more than offset by increased demand from a broad universe of credit protection buyers on single name credit swaps. I believe this continues to show the results of steps we have taken over the past of couple of years to enhance our talent pool and operating flexibility so that we can offer a broad range of credit protection products to our customers.

I believe it is very important for us strategically, in our credit protection business, to have the ability to move between tranches and single name credit swaps depending upon the market opportunity and demand.

I have spoken to you on a number of occasions about the risk to our growth strategy including access to capital and counterpart the capacity. Our ability to manage these two issues becomes paramount in a period like the third quarter, as we want to have the ability to grow our credit protection business when the risk returns are most attractive.

Let me start with our capital position. Primus Financial currently has in excess of $675 million in capital, which under our 35 to 1 leverage ratio, means that it could support our portfolio well above its current level. I want to note here that at the 35 to 1 leverage, we would still be maintaining a significant capital cushion that is substantially beyond the level require by the rating agencies for our AAA ratings. Based on our current forecast, our current capital base plus the additional capital injection from December premium payment, will certainly allow us to grow the portfolio through the first quarter of '08, and perhaps longer depending, of course, upon the market opportunities.

As you know, we do manage our business for the longer term, so we are also looking out past this timeframe. We have initiated discussion with our investment bankers to help us analyze and address capital raising opportunities. Unfortunately, in the current market environment, there are no clear answers from our bankers on when we could raise the capital, in what size or what it would costs. This is clearly a risk to our growth strategy and is significantly factored into the very difficult decision we made regarding Harrier, which I will address in a moment.

As for the other risk to our long-terms growth strategy counterparty line capacity, I believe we have the capacity we need to continue to grow our credit protection business beyond its current levels. A small number of counterparties indicated to us during the quarter, that they had reached their limits for monolines and credit derivative products companies at least for the near future. We were assured this was not a Primus issue, but an overall industry concentration issues.

The counterparties do understand the distinction between our business model and business focus on those were monolines but nonetheless, Primus's group collectively under the same counterparty umbrella in these institutions.

Clearly, some counterparties are racked the overall market environment and generally speaking, will take some time before we can expect an increase in our lines from them. In the meantime, we do have the capacity to replace maturing swaps with some of these counterparties.

We have been moving our new transaction volume to others within our group of 47 counterparties. We did not see any constraints on our ability to grow the portfolio on the third quarter, so I am very pleased we were able to adapt to the changing market conditions. During October, for example, we transactioned with 13 different counterparties, it is also a validation of our long-term focus to grow our counterparty relationships beyond the most active dealers in the market. The good news is that we saw capacity in the quarter to grow the portfolio in a very attractive spread environment. But we are also clearly aware that our access to counterparty capacity can change quickly for reasons that have nothing to do with Primus.

Given the importance of the counterparty capacity issue, we are planning to include a more detailed discussion of how we manage our counterparty relationships at our upcoming Investor Day in early December. I want to bring you up to date on our current approach to credit default swaps on asset backed securities or CDS of ABS. As well as, some of the issues that have impacted, our $80 million portfolio during recent months. As Richard noted, we added one $5 million AA rated transaction to our portfolio during the third quarter.

Just a quick refresher, this activity involves selling protection on specific bonds that reference a pool of underlying residential mortgages. We always sell protection on a rated slice of bonds capital structure at BBB or better level. This means that there is significant capital underneath us to protect us against losses in the underlying mortgage pool.

We have 14 transactions in our ABS portfolio and it is well diversified across originators and loan pools. The largest position is $10 million. Our original forecast for this activity showed much higher growth than we have exhibited in the past quarters, past couple of quarters. But as the continuing flood of bad news has hit this market, we have been very cautious about adding risk to this portfolio. We expect this will continue to be the case for the foreseeable future, at least until we are comfortable with the performance data on the underlying mortgage pools.

During the past three to four months, the rating agencies have downgraded a number of residential mortgage securities. These actions lead to three of the bonds at our credit swaps reference being downgraded by Moody's to sub investment grade. On one $5 million CDS of ABS transaction in particular, the reference bond was downgraded to single B from its original rating of BBB. Unlike corporate credit swaps, a technical credit event on a CDS of ABS can be triggered, if the reference bond is downgraded to CCC. We are carefully monitoring this particular transaction, along with the rest of the portfolio and we'll keep you informed, should we incur a credit advance. We are planning to provide shareholders with a complete review of our credit swap of ABS portfolio at the upcoming Investor Day.

As we look forward to year end and into 2008, our challenge within our credit protection business will be managing portfolio growth and risk returns within an environment that is largely favorable, but that does contain some potential barriers to grow. As I have said, on a number of occasions, it is important for shareholders to assess our growth and our performance over a longer timeframe and not just on a quarter or shorter term basis. October is a good example of why. We saw it tightening in credit spreads early in the month, and we slowed portfolio growth as we believe this tightening would be temporary.

Our portfolio growth was $280 million, notional in October, which is quite slow in comparison in the months of July and August. More recently, credit spreads have widened out again and our growth has accelerated. It is hard to predict whether we will be able to produce the same level of growth and returns in the fourth quarter as in the third, but we expect on a year-over-year comparison, our growth and premium income and portfolio size in our credit protection business for 2007 will be very strong.

In summary, I am very pleased with the performance of our credit protection business in the quarter. It was a very good environment for us to recognize again, that there were challenges. We continue to believe that the current market dynamics are attractive, and then our financial strength and operating platform position us well to take advantage of these opportunities. Our strong credit culture and risk framework also help to ensure that we are appropriately analyzing and pricing the risk.

Let me now turn to our asset management business, starting with our relative value of credit strategy, Harrier. As we have discussed with shareholders on a number of occasions, our goal for Harrier has always been to incubate this strategy, create a marketable track record and then raise third-party capital to leverage our capital investment.

While it was difficult quarter for Harrier, the harsher reality is that the significant change in the credit market conditions were tough on most credit and fund [mix] strategies. And it will make it very hard for most managers to raise capital for these strategies in the short-term.

Given our view that a capital raise for Harrier would be difficult for the foreseeable future and that we have other opportunities across our platforms to deploy capital, we have made the very difficult decision to discontinue Harrier's operations. We intend to reallocate most of Harrier's capital to our credit protection business.

This capital combined with expected premium inflows adds to Primus Financial's organic growth capacity and does not require us to raise additional debt capital throughout 2008. Richard will discuss the financial impact of this change, which we will absorb in the fourth quarter.

We were not able to initiate any new managed transaction during the quarter either in our loan or investment grade platforms. The collateralized loan market and synthetic CDOs structured credit market have effectively shutdown in the current turmoil.

However, we were able to use the widening of spreads in the loan and investment grade markets to improve the overall portfolio quality and returns on the five transactions we are managing. All five are performing well, and we have already seen good cash returns on our equity investments and Primus's two managed CLOs.

We are seeing signs of an awakening in both markets and are working with dealers on various transaction structures. Realistically, we do not expect the market for structured credit vehicles to open before the first quarter of '08 at the earliest.

Asset management continues to be a key component of Primus's growth strategy. While the current market conditions for structured credit vehicles are challenging, we are committed to growing our fee-based activities in loan and investment grade corporate asset classes. We have strong teams in place and their track records have been very good.

Additionally, Primus Guaranty continues to have capital available from its $125 million bond offering late last year to invest in these businesses, and we plan to do so.

Before I turn the presentation to Richard, I want to give you my perspective on our GAAP loss in the quarter and the implications it has on our business.

To begin with, I believe that economic result is how you, as shareholders, should measure our performance. It's how our board measures our performance and how it determines our compensation and incentives. A $128 million GAAP loss will attract headlines, and I appreciate that shareholders maybe concerned about the implications to our business and financial stream.

To begin with, it will have no impact on Primus' AAA ratings as our capital models or cash flow models, as Richard mentioned. It also will not cause us to change our credit protection business model. We believe strongly that a buy-and-hold strategy that produces attractive shareholder returns is the right strategy for us.

I do not believe it will impact our counterparty relationships as those institutions are well aware of our business strategy and financial strength. It also does not impact our liquidity position as counterparties have no ability to unwind transactions with us based on a negative mark-to-market.

Having said all that, I understand that the volatility in our GAAP financial results means that not all investors will be comfortable owing our shares. I want to encourage all of our shareholders to attend our Investor Day, which is coming up on December 6th. Again, we will try to use this forum to cover in more detail opportunities and issues in our business that shareholders should have an interest in.

In closing, I want to sum up and leave you with these takeaways for the quarter. We showed a strong increase in premium revenues. We had the highest new transaction volume in five years. We maintained a top quality portfolio with high ratings on new transaction volume. We made a very tough decision on Harrier. We showed good performance on our five PAM managed structured vehicles. We continue to focus on risk management and mixed state volatile and riskier market environment. We had a strong capital base, financial resources and liquidity.

Richard?

Richard Claiden

Thanks Tom. As I mentioned earlier, our economic results for the third quarter of 2007 were $12.6 million, compared to $12.7 million in the year ago period, and $14.9 million in the second quarter of 2007. For the year-to-date, our economic results were $40.7 million compared with $36.8 million for the first nine months of 2006.

Our economic return on equity for the third quarter of 2007 was 11.7%, and the economic book value per share was $9.71 as of September 30, 2007. Going down to the third quarter of 2007 results was Harrier's trading losses of $6.5 million, compared with trading of loss $72,000 in the third quarter of 2006. Most of the trading loses in the strategy were confined to July and August. For the year-to-date through September 30, 2007, Harrier incurred net trading losses of $6.3 million, compared with a trading loss of $209,000 in the first nine months of 2006.

During the third quarter, we saw significant volatility and illiquidity, throughout the various instruments (inaudible) traded by Harrier. While we saw solid performance from our correlation trading strategy, this was more than offset by losses on our credit arbitrage trading activities.

We expect to incur discontinuance costs in the range of $2 million to $3 million, as a result of the decision to discontinue Harrier, which will be taken in the fourth quarter of this year. We anticipate that there will be ongoing savings in the form of reduced future expenses, which will be in the range of $2 million to $3 million annually, going forward.

Our credit protection business had an exceptional quarter. Primus Financials' third quarter premium income of $22.3 million increased by approximately $4.2 million or 23%, compared with the year earlier quarter of $18.1 million. The increase reflects the continued growth of the credit swap portfolio, which increased by 32% from $15.5 billion at September the 30th 2006, $20.4 billion at September of 30th 2007.

Included in our economic results, our amortized realized gains from the early termination of swaps with the original life of that terminated swap. In the third quarter of 2007, the amortization of realized gains from the early termination of swaps was $1.4 million compared with $1.8 million in the year earlier quarter.

Credit mitigation costs from the early termination of credit swaps at a realized loss were $144,000 in the quarter of 2007 compared with $1.6 million in the third quarter of 2006.

The costs incurred in both quarters are primarily related to the mitigation of actual and potential [LBO] risks.

Net interest income, after the deduction of distributions on preferred securities, is $3.9 million in the third quarter of 2007 compared with $2.9 million in the third quarter of 2006, a 34% increase.

Looking at the components of net interest income, interest revenues were $10.9 million for the third quarter of 2007 compared with $7.1 million in the same quarter of 2006. This $3.8 million increase is primarily due to higher investment yields and an increase in the average investment balances, mainly arising from the investment of the proceeds from $125 million the senior notes issued by Primus Guaranty in December last year.

The weighted average balance on our investment portfolio was approximately $839 million for the third quarter of 2007 compared with $648 million in the same quarter of 2006. Total financing expenses in the third quarter of 2007 was $7 million compared with $4.3 million in the earlier quarter. This increase was due to higher interest rates and higher debt balances associated with Primus Guaranty debt offering, I mentioned earlier.

As many of you know all of the debt and preferred in Primus Financial, which totals $300 million is in the auction rate market. Rates on the Primus Financials Securities, each 28 days to an auction process, whereby investors bid for the paper. If there is insufficient demand clear the auction the interest rates are reset at the predetermined maximum rates and the preexisting holder continues to holds the paper. Beginning in the August 2007, we saw a reduction in investment demand in the auction market, associated with the general turmoil in the credit markets. We were one of over 40 companies whose auction rate debt was affected.

The outcome of this is that our monthly reset have reverted to the maximum rates, which are as follows and the rates are presented as spreads over one month LIBOR in basis points. For our AAA debt, 150 basis points, AA debt 225 basis points, and A preferred 357 basis points. So now securities continue to be set at these maximum rates, we estimate the incremental annual financing costs to be approximately $6 million. We did not expect to see any change in the auction rate market conditions in the fourth quarter of 2007.

And I said that it's very important to note that all of debt and preferred is permanent long-term capital with the first maturing in 2021 for the AA paper, 2036 for the AAA paper, the A preferred is perpetual. In short, this means we are not obligated to repay principal until maturity, unless we choose to do so. In addition there is no impact to our credit protection business capital model from the changes in the interest rates on the auction rate debt. This is because the capital level has always incorporated the maximum rates.

Finally, I would note that $125 million in bonds issued by Primus Guaranty are not part of the auction market. They bear a fixed coupon of 7%, although we have swapped $75 million of the issuance into floating rate debt.

Asset management fees for the third quarter were $1.1 million compared with $542,000 in the year-earlier period. This increase is primarily due to the addition of a second CLO in July of 2007. The 2006 period reflects only the fees from CLO 1, which were approximately $500,000.

Turning to our operating expenses, for the third quarter 2007, operating expenses excluding financing costs were $9.4 million, an increase of $300,000 over the $9.1 million in the same quarter of last year. The major components of the change were increased salary, technology and data costs, offset by a decrease in incentive compensation.

Our data and technology expenses increased by approximately $560,000 from a year ago, resulting from the expansion of our business activities. Compensation expense on a total basis was $4.9 million for the third quarter, which decreased from $5 million over the comparable period in last year. Variable compensation costs were reduced to less than expected results, relative to the 2007 budget.

Turning to our capital position, Primus Guaranty consolidated net cash capital was approximately $845 million at the end of the third quarter. Specific to Primus Financial, cash capital in our AAA subsidiary was $679 million at September the 30th. Primus Guaranty, a parent company, had $71 million in capital and Harrier had $65 million in capital at the end of the quarter.

This has been a very challenging quarter in many ways, given the turbulence in the credit markets overall. We were disappointed by Harriers performance and have made the painful decision to discontinue it.

However, we were pleased with the resiliency of the credit protection business, the fact that volumes and spreads have risen, and we believe that the reallocation of capitals with credit protection business will serve the company and its shareholders as well.

We have now finished our prepared remarks, and we'll open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instruction). And your first question comes from the line of Ken Zerbe of Morgan Stanley. Please proceed.

Ken Zerbe - Morgan Stanley

Great. Thanks. Can you just talk a little bit about, given that we've seen such dramatically higher credit spreads in the quarter line to the large mark-to-market loss, it didn't seem like those higher credit spreads are reflected and the spreads that you received on new business, it was always written in the third quarter, can you just talk about the differences there?

Tom Jasper

Hi, Ken. It's Tom. Yeah, I mean the difference is clearly what we for the last two quarters have been focused on increasing the portfolio quality, the overall quality in portfolio. So our focus during this past quarter was on this the A+ and higher-rated sector of the marketplace.

Clearly, that to us is very attractive, because it offers us very, very good risk adjusted returns. And particularly, given our outlook than in '08, we can see a deterioration in credit fundamentals. We think that's the right thing to do for the portfolio.

That being said, I appreciate that with credit spreads bouncing around as they did and certainly widening to the extend that they did as reflected by the index, that perhaps you would have thought that the average spreads would have been higher. But we are very pleased with our activity and our ability to sell protection at those levels.

Ken Zerbe - Morgan Stanley

Okay. The other question I had, I think you mentioned that there were three deals on the ABS side that were downgraded to below investment grade, do you quantify how much in terms of the par are we talking about these three deals?

Tom Jasper

I think it's, let's get the exact number for you, but I think it's 15 million.

Ken Zerbe - Morgan Stanley

Okay. And has the deterioration changed your view on whether or not you want to participate in this market? I know you are going back a little bit, but --

Tom Jasper

Well, that's a good question, I think that the answer is, what is most important to us is to believe that all the bad news is out of the market. Now, clearly we don't have that due today. We think there is more bad news to come.

That being said, there is an attraction in that market in the fact that it does add diversification to the portfolio, if the rating levels settle down and such that you understand what's in those portfolios.

We would view it as an opportunity to go back into the market at that point in time. So, we certainly view it as continuing to be a part of the market that we would like to do more business once the risk return parameters in that market are better defined.

Ken Zerbe - Morgan Stanley

Okay. Great. And then the last question I had, just a clarification, did I hear you right saying that if your financing cost off stay the max spread, that would result in the $6 million annual increase in your total financing cost?

Richard Claiden

Yes, that's correct, Ken.

Ken Zerbe - Morgan Stanley

And when are you going to find out or when is sort the next auction rate that you are going to see how this spreads?

Richard Claiden

It basically occurs roughly 28 days between the mid of the day to auction at different days. But basically it's between the middle and the end of each month.

Ken Zerbe - Morgan Stanley

Okay. All right. Great. Thank you very much.

Richard Claiden

Thanks, Ken.

Operator

Your next question comes from the line of Darrin Peller of Lehman Brothers. Please proceed.

Darrin Peller - Lehman Brothers

Thanks. Can you just review real quickly, again, the leverage rate now, it seems like, from an economic book value perspective it is around $430 million, including the tranche business that puts you well under 40 times. Am I missing something, or and I guess maybe you can help us again understand what that can go to and how you can grow the portfolio from this level?

Richard Claiden

Yeah. I think, what you are missing, Darren, is the fact that we also got the debt and preferred in Primus Financial.

Darrin Peller - Lehman Brothers

Right.

Richard Claiden

So, the total capital of Primus Financial is something in the order of $670 million.

Darrin Peller - Lehman Brothers

Okay. So $670 brings -- so what's the actual ratio right now?

Richard Claiden

The actual ratio is just still about 30 times ratio. I think its just 30.1 or some such, but basically a 30 times ratio...

Darrin Peller - Lehman Brothers

And that you still think you can go to about what 35 or--?

Richard Claiden

Yeah. That's a target that we are assigning for ourselves at the moment.

Darrin Peller - Lehman Brothers

Okay. Thanks. And then, just another question on the CDS of ABS business, there is a lot of misunderstanding on really how that actually works. Can you help us understand really what the total risk is about. We know there is about $80 million, I guess we are trying to really further understand where the risk is there and how bad it could be, if that market does considerably deteriorate, under fully understanding that you're portion is a lower tranche risk.

Richard Claiden

Yeah. Darrin, I think it’s couple of things. First off, this is a business where we are selling protection on individual bonds. Okay, so this is countrywide 2005 series five. I am just making that up by the way. So, we're selling protection on an individual bond, so it’s a business where you're analyzing who the originator was, what's in the portfolio, et cetera.

And then, obviously, where do you want to -- what slice of the capital structure do you want to take of that bond? And as we said, we have, that’s a business for us, it's always been at BBB or better. And so from the standpoint of defining what your risk is, it is very clear that our maximum risk exposure in that market is $80 million. We've had $15 million in bonds that have been underlying bonds to the CDS that we saw a protection have dropped to below investment grade, which is certainly something we are monitoring very closely. But it is a business which relative to -- we are not selling protection on CDOs, that’s not the business. This is selling protection on individual bonds. Those individual bonds could be part of a CDO, but again that’s not our business model. Is that clear?

Darrin Peller - Lehman Brothers

That makes sense, yes. And then, I guess just lastly, can you explain exactly the credit swaps undertaking the [out side] risk is that associated with the CDS of ABS risk that was taken on this quarter with the down grades or?

Richard Claiden

That’s was more to do with the tranches rate actually where we actually bought some protection against some of the tranche exposure that we have, this is a very limited amount as you can see.

Darrin Peller - Lehman Brothers

Yes. And how does that flow through, there is -- the actual premium that you are paying now is what exactly?

Richard Claiden

About $80,000 a month.

Darrin Peller - Lehman Brothers

That goes through as a counter revenue item or?

Richard Claiden

Yes.

Darrin Peller - Lehman Brothers

Okay. Alright, thanks guys.

Richard Claiden

Thanks.

Operator

Your next question comes from the line of Geoffrey Dunn of KBW. Please proceed.

Geoffrey Dunn - KBW

Thanks. Good morning. With what's happened in the CDO market, I was curious as to whether or not your thoughts of the long-term attractiveness of ramping up an asset management business still holds?

Richard Claiden

Absolutely, Geoff, I think the loan market is a market that is very attractive to us and so that’s one. We have a very good team, we are certainly looking, as I said, at various structures currently and there is a lot going on in that marketplace, which again, we are hopeful that in '08, we will see an opportunity to do more of the CLO type transaction that we've done two currently. It’s an attractive business to us in terms of the fees that it generates, and an attractive business to us in terms of the returns on our small amount of capital we have invested in that business.

On the synthetic CDO market, again that’s investment grade corporate risk. So there is no ABS in it, it's all corporate risk, and I think that again we feel that the investment grade corporate market is a very attractive market and I think part and parcel of what will have to happen for that market and the CLO market to open up, it's just a sort of a better feeling within the credit markets, which is clearly not the case currently. I mean there is a lot of volatility, there is a lot of anxiety, I mean there is a lot of headlines we read everyday. But we think that that market will also open up. So, the long and the short of it, we view both markets as asset classes that we are committed to for the long-term and we want to do more CDO, CLOs in them.

Geoffrey Dunn - KBW

Very helpful, thank you.

Operator

(Operator Instructions) And your next question comes from the line of Mark Lane of William Blair.

Mark Lane - William Blair

Hi, good morning. Say for instance on a pro forma basis, you were saying that at the end of the third quarter, if you were riding at 35 to 1 that could support, whatever $23.5 billion portfolio, excluding the additional contribution from Harrier of $65 million?

After 35 to 1 that you are still well above the rating agency capital requirements, I mean how much of a cushion is there? Is it $10 million or is it $50 million? I mean under the assumption that you would always want to maintain some cushion, but what is the cushion?

Tom Jasper

Ken, I think that we have not disclosed the cushion, but let me give you a benchmark. We are thinking about it. We have talked in the past about the fact that if you look at our rating agency capital models for the AAA ratings, that we have done a lot of analysis as to what is the last incremental dollar of risk that we put on in terms of leverageable risk before it would trip, we moved to AAA.

And we have said that that number is somewhere in the mid-40s. And the reason we say somewhere in the mid-40s is it clearly depends upon the portfolio quality. So, if your portfolio quality goes up, clearly, your ability to leverage goes up too. So we'll say mid-40s.

Right now, as Richard said, we are operating around 30 to 1. And we have said that the level that we are comfortable with its moving or targeting is 35 to 1. So, I think that that spread differential between the two should give you pretty good indication as to what kind of capital cushion there is over time that we have been managing.

Mark Lane - William Blair

Okay. And then just to clarify, Tom, what you said was that you could support portfolio growth with current capital till the end of the first quarter '08, and then Richard said through '08. So does the latter imply or include the benefit from the additional $65 million?

Richard Claiden

Absolutely.

Tom Jasper

Yes.

Richard Claiden

And again, what we're trying to address here is, we're trying to say, look, we have said for a long time that there are two risks at the growth strategy in Primus Financial. Number one is the availability of capital. The other is counterparty capacity. And we've also said in the call that or I said that, you know, when we talk to our bankers currently, there is no clear approach or path to raising additional capital on PFP certainly in the near-term. By near-term, I am talking about over the next three to four months.

So, from our perspective, one of issues that we've looked at is given the overall volatility in the credit markets is it is to be able to take one of the risks of the growth strategy off the table, i.e., capital availability to grow the portfolio is the right thing to do. And so the plan is to reallocate the capital that's freed up from Harrier into our credit protection business.

Mark Lane - William Blair

And how much -- you said you had $71 million to parent company, is that correct?

Tom Jasper

That's correct.

Mark Lane - William Blair

How much liquidity do you generally feel like you need there?

Tom Jasper

Under the terms of it, we agree with the rating agencies. We keep just under $20 million there. Basically, it's two years worth of debt financing costs.

Mark Lane - William Blair

So that's a little bit of cushion as well.

Tom Jasper

Yes. So it's about $17.5 million in practice that we keep there. So effectively, we've got just over $50 million we could redeploy from the parent company.

Mark Lane - William Blair

And just to follow up on the question about, I mean conceptually, I understand that if you are going to write higher credit quality business and everything else is equal, the premium rates are going to be lower. But, even adjusting for the move to credit quality, I mean you are saying the average credit rating on new business written was A+/A2. What was it last quarter? I mean was it similar or was it even lower than that?

Richard Cladien

It was more or less, it was similar. But again, last quarter was really focusing on the tranches. This is the second quarter. And this quarter was really focusing on the single names. I think if you look at the indices, the average quality within the indices, as I recall, is more or less BBB, BBB+. So it's substantially below that sort of A+ and above level that we have been writing.

Mark Lane - William Blair

But did you write a lot of business in July before spreads really blew out?

Richard Cladien

We commented our single name activity, Mark, was over $700 million in July.

Mark Lane - William Blair

Okay. Over $700 million, so pretty equally spread.

Richard Cladien

Yes.

Mark Lane - William Blair

Okay. All right. Thank you.

Operator

Your next question comes from the line of Gregory DiMarzio of Century Capital. Please proceed.

Gregory DiMarzio - Century Capital

Hi, guys. I just wanted to know as far as engaging the investment banks to raise capital, probably I would guess there is a preference for debt, but I wanted to see if you have started conversations to I think strategic investors.

I know that that’s tough to swallow with the stock below book value, but clearly that’s the most powerful lever to the stories to raise some capital and really ignite growth?

Tom Jasper

Greg, I want to make sure that I understand the question. I mean a couple of things. We certainly have always felt that the ability to raise debt within Primus Financial and to be able to leverage off the equity obviously boosts the returns in Primus Financial. So that was very much a good thing for shareholders. I think relative to looking to raise capital at the PGO level, either equity or some form of equity again, we are obviously very concerned about where the stock is trading, and as Richard has already said, we have a significant amount of capital up at the PGO level, so we have not seen the need really to look at that sector. I'm not sure that’s answering your question though.

Gregory DiMarzio - Century Capital

Yeah, I'm sorry it’s to clarify. I was just trying to see how far could you give more details in terms of where discussions are in terms of raising capital?

Tom Jasper

On the debt side? Richard.

Richard Claiden

I can discuss that. Clearly our intention before the credit turmoil erupted in the third quarter was to raise that capital at PFP in the third quarter. In this term of $100 million to $125 million, that was our plan. Clearly what's happened in the third quarter and continues has made that difficult though, very difficult. So, we basically -- we've had discussion with the bankers, they've indicated that windows do open up, they shutdown again. Windows do open up, so we are basically readying ourselves for an issuance. But when that will occur, I am not sure, I don't think it will occur in the fourth quarter in May, but really, perhaps more likely in the first quarter of next year. But the market is very difficult to predict at the moment, given what's happening.

Gregory DiMarzio - Century Capital

Got you. Thank you very much.

Operator

Your next question comes from the line of Greg Eisen of ICM Asset Management. Please proceed.

Greg Eisen - ICM Asset Management

Thanks. Good morning. Regarding and going back to the question of raising debt capital, you said $125 million was what you were looking for in the third quarter?

Tom Jasper

$100 million to $125 million, yeah.

Greg Eisen - ICM Asset Management

Okay. And then I can multiply that by 35, but I guess what I was going to drive, how leveraged would you want the whole capital structure to be at most in terms of debt capital versus the equity capital before you would feel like you had to come back to the equity market?

Richard Claiden

Traditionally, we were in the sort of one for one ratio between the debt and the equity and clearly we have grown the equity at Primus Financial's through the retention of earnings. So, broadly speaking, we earned about $60 million a year in PFP and growing. So, that enabled us to raise roughly that amount each year and it doesn't work on an annual cycle based a year and half worth of earnings enables us to do raise $100 million in debt.

So, net net we aim for that one to one ratio. Our constraints really is, constrains to one is the availability at the market and I have intimated that's difficult at the moment and second is the capital level, we could actually raise the ratio debt to capital, equity capital, a little beyond the one to one ratio if we chose. But that's been our benchmark.

Greg Eisen - ICM Asset Management

Okay. I understand. And then going back to the ABS products, $15 million was downgraded by the rating agency. Let's take a extreme example which probably isn't that worth of the mortgage behind these ABS's are 100% bad and you have a total loss on this. Would your incurred loss be a number greater than the $15 million?

Tom Jasper

No, the maximum loss we could take on the portfolio, maximum-to-maximum is $80 million. That's just everything, every mortgage in that entire portfolio, because we have an $80 million portfolio and every mortgage was bad.

Richard Claiden

And no recovery.

Tom Jasper

And there was no recovery we had incurred $8 million loss .So that's the extent of the overall loss. Clearly, we don't expect that, but and as we have said we have had the $15 million in bonds that $15 million notional bonds had have been moved to non-investment grade

Greg Eisen - ICM Asset Management

I see. And obviously it's reasonable expectation that a loss would be a partial loss then. (inaudible)?

Richard Claiden

If a credit event occurs, could there be a full loss of the notional amount of the credit swap? Yes, there could be. But one would not expect that. One would expect a recovery value underlying it.

Greg Eisen - ICM Asset Management

Okay. And again, your economic shareholders equity is 437, and essentially 80 million is the number that, I guess the market is panicked over in a general sense. Taking that away, then economic group value is something somewhere around 790 or something like that?

Tom Jasper

Yeah.

Greg Eisen - ICM Asset Management

Okay. That was just my questions. Thanks.

Richard Claiden

Thank you.

Tom Jasper

Thank you.

Operator

And there are no further questions at this time. I would like to turn the call over to Richard Claiden for closing remarks.

Richard Claiden

Thank you for attending our call and for your questions. We are looking forward to seeing you at our Investor Day in New York on December the 6th. Thank you, again, bye.

Tom Jasper

Thanks, everybody.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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