Mark Hale, Paul Levy, Charles Pardue and Malcolm Perry of The Prytania Group answer SCI's questions

Q: How and when did The Prytania Group become involved in the structured credit market?
Malcolm Perry, ceo: Prytania was established five years ago - with backing from JPMorgan - by Charles Pardue, who was one of the original members of the bank's structured finance team. The move was driven by the realisation that there was a limited amount of buy-side expertise in the structured credit space; that is, many investors weren't in a position to properly analyse such instruments.

Charles Pardue, managing partner: We wanted to build an analytics platform that could handle the data inconsistencies rife in the market: not only was gathering all relevant data problematic, but also having the capability to run appropriate analyses was. Our clients come to us because they may not be able to find an accurate model and in some cases what they hold in their portfolio may not even be visible. We've created tools that rapidly run thousands of scenarios to get a more accurate picture based on probabilistic analysis.

Q: What is your strategy?
MP: Prytania's business is based on two core activities: asset management and risk advisory, both undertaken by Prytania Investment Advisors. Our proprietary analytics are used extensively by Prytania Investment Advisors, but are developed and managed by a different subsidiary, Prytania Services. We spent a number of years building our proprietary analytics platform, with the aim of analysing both individual transactions and portfolios and hopefully licensing it to other institutions. We were also preparing our first fund during this time.

But at that time, during the height of the bull market, we found that there was little interest in analytics because it wasn't seen as a necessary differentiator. So, in a way, what followed was a blessing for us because we'd already developed the necessary tools and expertise to help clients. We advise customers on what to buy, hold or sell, as well as de-mystifying their existing portfolios.

In September 2007, we were among the first firms to take on advisory roles during the current credit crisis - two of which have since become asset management mandates after it became apparent that it's more efficient for us to manage the portfolios directly. When Lehman Brothers defaulted, there was a material kick-up in advisory work because the market came to the conclusion that there is no shame in admitting to its problems.

Paul Levy, partner: Investors are increasingly looking for independent valuations and expertise outside of the investment banks. The problem is that investment banks have not only lost some of their credibility, but they also have very siloed expertise - that is, they are unlikely to be able or willing to provide detailed advisory across a number of different asset classes.

Mark Hale, chief investment officer: It may be too late to deal with certain portfolios, but for others we advise on risk management and hedging matters, as well as changing asset allocation strategies. In terms of restructuring portfolios, this might entail reducing the leverage or taking out the positions altogether. However, it is often difficult to get consensus for such changes.

CP: The risk advisory activity is very complementary to our asset management business. Through the advisory work, we see lots of paper that we haven't purchased to date, but analysing and understanding these positions gives us a better sense of the opportunities in those asset classes going forward.

Q: Which market constituent is your main client base? Do you focus on a broad range of asset classes or only one?
MP: The analytics were originally designed for cash and synthetic CDOs and CDO-squareds. But our investment activity has mostly been focused on cash product.

Q: How do you differentiate yourself from your competitors?
PL: The analytics are designed with a long-term perspective and so are robust and scaleable. We are different to many of the recent start-ups seen entering this space because it takes time to build the necessary infrastructure.

Also, we are differentiated from the sell-side firms because their models have typically been developed with solely deal origination in mind. Modelling deals from an origination perspective is completely different to modelling them from a surveillance and relative value perspective.

In this regard, you need to be able to consider the complexity, number and variety of the different underlying assets, as well as the degree of overlap across a portfolio. You also need to be able to provide various sensitivities and emphasise the underlying fundamental credit issues.

The market essentially became blinded by the complexity and forgot about understanding fundamental credit risk. Analysing large, diverse portfolios of structured credit assets requires a difficult combination of depth and breadth that few firms are able to cohesively bring together.

CP: On the documentation side, for instance, you can't simply rely on cashflow models to anticipate what will happen. The results are in some sense binary and identify structural issues rather than credit issues.

Having worked as structurers at investment banks, Paul and I are experienced in digging down into detailed documentation and so can usually identify the critical elements. For example, we looked at 25 different transactions for one client and three of them had material risk issues arising from the documentation - though it's painful work, documentation issues can be a significant source of risk.

An investor can only be confident when they know how their portfolio will perform. The idea is to give clients a more complete understanding of the range of risks they face, so that they can make certain decisions about their holdings.

Q: Which challenges/opportunities does the current financial environment bring to your business and how do you intend to manage them?
MH: Our challenge is to persuade investors about the value out there. It remains difficult to get investor committee backing and even if a chief investment officer is in agreement, they'll often want evidence of someone else doing it first!

I expect it to become a bit easier to demonstrate that value is being captured as 2009 progresses, deals get called and originators show that they can still refinance. It's important to rebuild confidence in the product and the reopening of the new issue market, albeit even if largely only for government-mandated deals, is a positive step.

In terms of opportunities, clearly structured credit is a narrow field and so we've always wanted to broaden our remit - separate accounts are a good way of achieving this. We manage two funds and two separate accounts, with assets under management of approximately US$900m. We're small but growing rapidly, including by potentially tapping our opportunity fund.

We launched our first fund, the US$400m Danube Delta transaction, in August 2006. It mixes ABS CDO and SIV technology to provide more flexible financing via both bank debt and term debt.

Our second fund, an opportunity vehicle called Athena (see SCI issue 90), was launched in May 2008 with US$65.4m. The timing was a compromise with the client and it took around eight months to become fully invested. The assets range from high quality triple-A bonds at great spreads to distressed assets purchased for a few cents.

After the collapse of Lehman Brothers we've begun to see the authorities use monetary and fiscal policy to underpin the financial system and facilitate liquidity. I think investors are now being properly compensated for the risk.

Doubtless there will be further forced selling, with limited demand, so the opportunities will be great for investors prepared to take some mark-to-market volatility and look at the investment from a long-term perspective. If you choose the right assets, they'll achieve a good on-going yield even before pull to par and amortisation are considered, which can boost returns significantly.

PL: But it has become clear that you need to have a three- to five-year perspective on these assets and that having the right delivery mechanism is as important as choosing the right assets. The market didn't properly appreciate liquidity risk before the credit crunch hit and so it's unsurprising that investors are shying away from market-value structures. A private equity-style structure is best for investing in distressed assets; i.e. taking a longer-term view on realisations and only utilising term leverage, if any.

Q: What major developments do you need/expect from the market in the future?
PL: I question whether we'll see any primary arbitrage deals any time soon. So much needs to happen before structured credit issuance activity re-emerges.

Banks are the primary originators of credit risk and it still makes sense for institutional investors to access credit risk, so the originate-to-distribute model is still valid in an appropriate format. But this will need a distribution mechanism via some form of vehicle and suggests that demand for some form of tranched or unlevered fund will remain.

Another issue is capital treatment and regulatory oversight of the asset class and formats it can be delivered in. The market still needs clarity around this.

MH: I agree that we're unlikely to see much non-government mandated new issuance any time soon and so as the supply/demand imbalance tilts over the next year, this should mean that asset prices rise quite quickly on the rebound. Over the last few months, the markets appear to have moved on from the 'shock and awe' of the crisis towards needing a battle plan for how to deal with their assets and portfolios. Investors certainly seem to have a more coherent approach now.

There seems to be an element of cynicism about government-mandated new issues. But the flipside is that regulators have finally recognised the powerful role securitisation has in the market in terms of getting cash into consumers' hands.

Nevertheless, a significant financing gap remains. To move forward, the market needs to mobilise sources of funds where they're available - i.e. pension funds and insurance companies - and persuade them of the returns, relative liquidity and subordination available at gilt-equivalent volatility for some key senior ABS markets in particular.

At the margin, government-mandated ABS would also be suitable investments for high net-worth investors or private banks. But ultimately, the market needs greater confidence about a self-sustaining environment and the current unease about government interference takes us further away from that goal.

About The Prytania Group
The Prytania Group is a group of global companies focused on the finance industry. It is comprised of Prytania Investment Advisors, an asset manager and risk advisor specialising in structured finance; Prytania Services, a software developer specialising in financial analytic and monitoring applications for the structured finance industry; and Prytania Holdings, a holding company providing administrative support to the two other companies.

CS