D-leverage

Primus Guaranty and the Viability of the CDPC Model

Nice analysis, but...

The Primus stock is suffering from a massive uncertainty discount and that is probably a good thing for the longs, because if the company had greater transparency, it could be trading much lower.

Just like when a company is being worked out, the devil is in the details -- and just like when understanding whether your RMBS is going to pay off, the painful process of understanding each MBS is critical.

You're homework really is quite extensive (and in my view commendable), but here's also my view of the #1 problem with Primus -- we don't know what's in this portfolio of exposures. From what I can tell, the company only discloses industry diversity and ratings diversity -- $23+ billion of notional on $800 million of equity – that’s 18bps of equity on notional – I would feel better with maybe 200bps. Most importantly, I would not touch this thing without more disclosures. Let’s pile on a serious flaw in the business model AND the muddied waters of GAAP accounting to make the problems even worse.

Fortunately for Primus, most exposures are represented by fundamental, corporate ratings, as opposed to ABS/structured ratings, which fly by a different set of rules (model and underlying rating dependent). With 13% of the portfolio written to "Financial Intermediaries", you can't help but wonder if some of that notional is the $120 billion of long-term debt on Lehman's books (or name your favorite overleveraged financial intermediary). Bonds such as these are being supported by a myriad of RMBS/CDO assets that may be on there way to suffering more losses.

Furthermore, on the business model point... Ask yourself: In order to ensure that I get paid when my bonds go bad, would I want my counterparty to be posting collateral or would I want them to NOT post collateral??? A 50T CDS market lives with posting collateral but Primus gets to not post collateral because its triple-A rated and meets some rating diversity and concentration tests??? Posting collateral has been a serious, as of now, life-saving governor on the CDS market. Primus is like the 5’ 1” Lithuanian lightweight women’s team playing against Labron and Kobie -- and Primus is playing with its pants down. One of these CDS players is not like the other...

Take lesson # whichever from the great credit meltdown of 2007 (and beyond) – be awfully careful how much weight is placed on credit ratings for investment decisions.