Indranil (Neil) Basu, managing partner of Pearl Diver Capital, answers SCI's questions

Neil Basu

Q: When did your company become involved in structured credit?
A: Pearl Diver Capital came together in September 2008, to take advantage of the dislocated credit markets. The objective is to build a business around a thorough understanding of corporate credit and provide investors the opportunity to participate in corporate credit, either directly or through derivatives of corporate credits, such as CLOs and corporate credit securitisation tranches.

The team brings together skills in structured credit products and leveraged loan/corporate credits, and spun off recently from Wachovia's European Structured Finance unit. The members have significant expertise from diverse buy- and sell-side firms, including Nomura, Deutsche Bank, Citi, John Hancock and BNP Paribas.

Our team adds value through a number of aspects: rigorous loan-by-loan re-underwriting capabilities in leveraged loans; structural analysis skills with proprietary analytical models; deep industry contacts; relative value trading skills through secondary trading; special situation investments; and participations in restructuring and re-rating of transactions to protect or optimise investments.

Q: What, in your opinion, has been the most significant development in the credit market in recent years?
A: The last seven years from 2002 to 2008 can be broken up into two separate chapters, with the first five years until the end of 2006 seeing unprecedented growth in leveraged loan financing to private equity sponsor-led transactions, fueled by a growing appetite from a new class of institutional investors, namely the CLO/structured credit products vehicles.

From mid-2007 until the end of 2008, the market dislocation that primarily began with CDO/structured products backed by US sub-prime mortgages led to an unprecedented deleveraging in the financial markets, hedge fund redemptions and liquidations of market value structures. This in turn drove valuations of leveraged loan downwards from near par to as low as 70 cents on the dollar.

The lack of availability of cheap leverage effectively closed down the primary CLO issuance market, completely removing a significant investor base for leveraged loans. Combined with a growing recession in the US and Europe, default expectations in leveraged loans have now risen to 25%-30% for the next four years, with lower recovery expectations. CLO tranche valuations have fallen across the board, with triple-As trading in the 70-80s, mezzanine tranches anywhere from 15-30 cents on the dollar, while equity trades are occurring between 5-15 cents on the dollar.

Q: How has this affected your business?
A: The drop in CLO tranche valuations has been across the board and has tainted performing CLOs managed by top-tier managers with the same brush as non-performing CLOs from tier-two managers. This presents a unique opportunity for investors who are looking for exposure to the leveraged loan asset class, and our business is built around this central theme.

Q: What are your key areas of focus today?
A: Our current fund seeks to invest in CLO tranches that represent significant value due to current market prices, while benefiting from structural protections that allow for sustainable returns under very harsh default scenarios.

Q: What is your strategy going forward?
Going forward our objective is to build a sustainable asset management business around the corporate credit asset (both speculative as well as investment grade) class. Our aim is to provide investors with the ability to participate in this class directly or through derivatives, taking advantage of any relative value that may exist.

We are not a hedge fund, employ no leverage and our funds are not subject to redemption features that plague hedge funds. We will continue to focus on raising private equity-style long-term institutional capital that is more geared towards the illiquid asset classes that we are active in.

Q: What major developments do you need/expect from the market in the future?
A: The deleveraging process that started in 2007 is expected to continue into 2009 and early 2010. The current recession is consumer-led and over time, as economies start to come out of this, we would like to see a stabilisation of asset values and improvement in employment statistics - leading to the re-emergence of investments (government-led) and spending (consumer-led). This would in turn provide the impetus for growth and fresh corporate lending activity.

About Pearl Diver Capital
Pearl Diver Capital is a structured finance asset management company backed by stable and long-term private equity-style institutional capital. Within the global structured finance arena it specialises in finding and capturing the rare and resilient nacre of value that only a select few are poised to exploit. Pearl Diver Capital is regulated and authorised by the FSA.