Over the past two years, derivatives veteran Tom Jasper bet the farm by going long credit risk. Now, his firm's $23 billion credit portfolio is losing hundreds of millions of dollars per quarter as corporate credit fears multiply. The wild part of the story is that Jasper is not a hedge fund manager, and he still has a job, despite such abysmal performance. As CEO of Primus Guaranty ( PRS), Jasper remains safe and well-paid, while the company's stock has tumbled to $4 from its $13.50 IPO price in 2004. Primus Guaranty -- which reported a $404 million loss in the fourth quarter, its largest ever -- remains a relatively unknown company that is nonetheless a major player in the credit default swap market. Primus essentially does only one thing: sell credit default swaps on single-name corporate bonds. Credit default swaps, or CDS, are insurance agreements against defaults on corporate bonds and asset-backed securities. The swaps allow parties to bet on credit views without taking interest rate risk. Primus' main problem is that most of its credit default swaps were sold at a time when credit risk was low. The bulk of the company's recent quarterly losses have been on paper only, relating to the its markdown of credit default swaps based on deteriorating market values as credit spreads widen. Primus isn't set to blow up in a liquidity crisis. The problem, rather, is that the company's cost structure is too high and its book of business was created at a horrible time -- raising questions about how much earnings will actually be left at the end of the day for shareholders. Primus' writedowns in the fourth quarter wiped out the firm's shareholders equity (it is now negative $93.5 million). Against this book value is the $23 billion of notional default swaps outstanding -- meaning the firm is very highly leveraged. "If Primus was a hedge fund, it would be gone," says one industry observer. However, Primus remains in better shape than your average highly leveraged hedge fund that owns corporate credit, because the company's financial subsidiary, which sells the swaps, has a Triple-A credit rating. This means Primus is able to avoid margin calls, since it is not required to post collateral for trades.
Primus did not return calls seeking comment for this story. The only time Primus experiences realized losses is when it unwinds its swap agreements or there is an actual credit event that triggers certain protection payments. In the fourth quarter, the firm experienced its first credit event, recording a $41 million charge related to swap protection it sold on residential mortgage securities that S&P downgraded. (Primus' assumption is that it will have to be pay out this dollar amount to swap counterparties).