Sell Primus Guaranty on High Risk

Primus Guaranty Ltd. (PRS - Analyst Report) reported a GAAP net loss of $670.1 million or $14.85 per diluted share for first quarter 2008, due to high unrealized mark-to-market losses in the credit swap portfolio. However, the economic results of $22.1 million or $0.49 per diluted share were substantially ahead of estimates, due to higher premium revenues, asset management fees and lower credit mitigation costs.

We suspect that higher mark-to-market losses will continue to impact the results in the coming quarters, though the company may be able to grow its credit protection business at attractive prices as the credit spreads continue to widen. Based on the first quarter 2008 results, we are increasing our FY08 and FY09 estimates to $1.59 and $1.70 per share respectively.

PRS has Credit Default Swaps (CDS) on Asset Backed Securities (ABS) portfolio of $75 million, (which though, represents less than 0.3% of total CDS portfolio of $24.3 billion as on March 31, 2008). As a result of downgrading of ratings on some of the residential mortgage backed securities referenced by credit default swaps written by PRS (notional principal of $45 million) to CCC or below, a credit event was triggered and therefore, the counterparties to the credit swap now have the right to present the underlying security to PRS in exchange of the cash notional value of the credit swap.

At the current price level, the shares of PRS are trading at 0.51x its first quarter 2008 economic book value of $9.58 per share; a 16.4% discount to the peer group median, which looks stretched given a ROE [return on equity] of 4.6, a 61.9% discount to the peer group median of 11.9. Since the company has a higher risk profile and we suspect that any change in rating methodology by the rating agencies may result in higher capital requirement or the risk of downgraded ratings; we feel that the shares should continue to trade below the peer group median multiple for some time.

Our six-month price target of $4.50 per share equates to about 0.46x our September 30, 2008, estimated economic book value of $9.80 per share. We are maintaining our Sell recommendation on the shares of PRS.

Read the analyst note on PRS.