16 Mar 2010, Mark Pengelly, Risk magazine
New York-based credit derivatives product company (CDPC) Primus Guaranty is planning a new venture to write credit default swap (CDS) protection on corporate and sovereign debt and some AAA rated structured credit.
CDPCs were originally set up to take credit risk from bank balance sheets. But, as with monoline insurers, many have closed their doors amid rating downgrades and questions over the use of such vehicles to lay off credit exposures.
Primus has also received downgrades due to turmoil in its existing portfolio, which is now in amortisation. In particular, the firm took heavy hits from credit events on government-sponsored mortgage lenders Fannie Mae and Freddie Mac, and Lehman Brothers, Washington Mutual and several Icelandic banks. It has also suffered from chunky exposures to structured credit.
Since July last year, the company has completed four transactions designed to limit the risk in its CDS portfolio, which comprised $17.5 billion in notional by December 2009. The most recent came on February 12, with the firm announcing the termination of CDS protection worth $300 million in notional. The CDSs referenced three structured credit transactions, and were terminated in return for a fee of $35 million.
So far, the firm has paid a total of $66.5 million to terminate or amend CDS transactions, with the aim of building a floor under the value of the credit protection business. The company says it plans to carry out a small number of similar transactions throughout 2010 to reduce its exposure to certain sectors, such as monoline insurers.
On March 30, Primus announced it has no single-name CDS exposure to Ambac Assurance Corporation, which was ruled to have suffered a credit event on March 25. Exposure within two collateralised debt obligation (CDO) tranches is not expected to lead to cash settlement payments, the company said.
"There are about 500 names in that portfolio and the vast majority are names we're delighted to have in there. But there are a small number of names we think we've got too much exposure to," explains Tom Jasper, the firm's New York-based chief executive.
Despite the problems facing the portfolio, Primus remains determined to set up a new credit risk transfer vehicle. "We are very focused on building a new credit protection business," he says. In doing so, the company is stepping into a void created by the departure of monolines, other CDPCs and traditional insurers such as American International Group.
Previously, the firm had been exploring the possibility of selling credit protection in collateralised form without a credit rating. The experiment went well, Jasper says, but the idea did not meet with enough demand from clients. Instead, the new credit protection vehicle will be structured like an insurance company and will not post collateral. Primus is also seeking a much broader range of clients for the new vehicle that extends beyond the major derivatives dealers.
"It is going to be a rated financial guarantee vehicle that does not post collateral. It will be selling protection primarily to banks, to other insurance companies and to the capital markets," says Jasper.
Reflecting this ambition, Primus announced on March 12 it had hired Robert Lusardi to accelerate the development of the new business. A member of the firm's board, Lusardi has a long record in insurance, having previously served as a senior executive at Bermuda-based White Mountains Insurance Group and XL Capital. Lusardi joins Douglas Renfield-Miller, a former chief executive of Ambac's UK subsidiary, who has also been acting as a senior adviser to Primus in connection with the plan.
Jasper says he wants to exploit Primus's strengths in corporate credit by writing protection on single names and AAA rated collateralised loan obligation (CLO) tranches. Although the CLO market largely closed to new issuance after the US subprime mortgage crisis struck, Primus believes it will reopen in the US over the next year. And while some new entrants in the monoline insurance industry have shown an interest in wrapping municipal bonds, no other firms profess an interest in wrapping structured credit. "The monolines are really focused on muni risk, to the extent they're even operating. There isn't anybody wrapping AAA pieces of CLOs. I don't necessarily believe there's going to be a great demand for those products this year, but we believe the CLO market will open up in the US and Europe eventually, and that there will be demand for people who can wrap that kind of paper," says Jasper.
Avoiding the pitfalls experienced by monolines, the venture would not branch out into other asset classes such as subprime residential mortgage-backed securities or CDOs, he emphasises. The company has also warned shareholders that, while the vehicle's creation ranks among its strategic priorities for 2010, it expects no significant earnings from it this year.
Another area of focus for Primus is its $21.2 billion asset management unit. Having fully acquired Boston-based CypressTree Investment Management last July, Primus recently seeded two new credit funds. With a possible opening of the CLO market in 2010, the firm is also hoping to manage at least one new deal by the end of the year.
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