Primus CEO: Fannie/Freddie Impact Minimal, CDS Will Endure

Includes: PRD, PRSG
by: James Cullen

Monday, Primus (PRS) CEO Tom Jasper made a presentation at a Lehman Financial Services Conference; this is an extraordinary coincidence of timing given all the questions regarding the settling of credit default swaps [CDS] on the various pieces of Fannie (FNM) and Freddie (FRE) capital. A settling of CDS contracts (which appears likely given comments by ISDA, the International Swap and Derivatives Association) would be the largest such action ever taken, and this has people nervous.

As Primus' 8-K filing Monday suggested, however, it really should be close to a non-event for all the CDS on references above the government's new senior preferred stock. Those have become "full faith and credit" obligations of the US government, and should therefore trade at a very tight spread to regular Treasuries – and because the loss on a CDS contract equals the payment (par value) less the recovery value (extremely close to par), Primus' $215 million in notational swaps on the senior and subordinated debt of Fannie and Freddie shouldn't net out to any significant losses.

Jasper made an off-hand comment that he didn't understand why ISDA would go through such a huge settlement process when the impact on the senior and subordinated debt seemed to be minimal in an absolute sense and, relatively speaking, positive for CDS sellers. One possibility: this is a large-scale but low-stress dress rehearsal in case there comes a point in time when the CDS market needs to settle a default of another entity with huge notional values outstanding… because next time, the government might not be assuring the impact is minimal.

The other major focus of Jasper's presentation was to outline the current conditions in the CDS market, and where that market will be moving longer-term. Right now, there is an unwillingness by larger swap dealers to transact with Primus and other small companies because they've been burned by monoline exposure and are lumping Primus in with that segment. Jasper has continued to argue that Primus is substantially different than the monolines, and the company has been able to transact a bit of business this quarter while suggesting that CDS market is still a few quarters from full recovery. Jasper has been extremely vocal in saying that the CDS market is a crucial part of the financial system, and he expects it to fully recover in terms of dealers and level of demand. Ultimately, Primus should be able to deliver a mid-to-high teens return on equity while using a reasonable degree of leverage on its capital base.

From my perspective, I've modeled the expected equity value of Primus in a run-off with no new business, so any future profitability is a bonus. I've also looked at the standing of various credit derivative products companies [CDPCs] with the ratings agencies and market.

Finally, it was nice to hear Tom making some comments about the divergence between the stock price and the company's underlying financial metrics. And, while I appreciate the conservative management style of the company in terms of conserving capital, it was good to know that the possibility of a buyback of either the equity or debt has been thoroughly discussed and would be undertaken should Primus deem themselves sufficiently overcollateralized against potential claims.

Read the Primus Guaranty Stock Report for more, or see Tom Jasper's presentation.

Disclosure: I own shares of PRS and PRD.

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