John Uhlein, founder and managing principal of Grenadier Capital, answers SCI's questions

Q: How and when did Grenadier Capital become involved in the structured credit market?
A: I put together a team of six credit professionals, including myself, to fill the void created by both the decline of the financial guarantors and the loss of credibility by the rating agencies. My team has extensive credit assessment, valuation and quantitative skills in most of the structured/ABS/commercial products. Three people worked with me previously at Ambac; one is a PhD/JD with extensive quantitative and valuation skills, and the other is from the life insurance side of the business.

I am looking to use this talent in two very complementary ways: to invest in distressed-priced assets (today) as well as new issues, and provide fixed income investors with the underwriting, surveillance and remediation that was provided in part by both the rating agencies and guarantors. Investors are seeking an alternative to both and we're aiming to provide it.

The idea is to invest in the mezzanine tranches of these deals - at a level where we are comfortable and comparable to where we attached at Ambac, but unleveraged and without tail risk - at the same time as providing investors with our credit analysis, surveillance and remediation capabilities. In other words, we will have 'skin in the game' - investors would buy senior to where we are investing.

Q: What, in your opinion, has been the most significant development in the credit market in recent years?
A: Looking at the securitisation landscape, many investors have lost faith in the rating agencies and are disillusioned with the process. The monoline model has also been severely damaged: no entity is likely to take on as much leverage or guarantee everything above the BBB/A level again.

It was the tail risk, and not being paid for it, that finished financial guarantors in the end. With the exception of ABS CDOs, most of the transactions they insured are still performing well. The industry became too comfortable with the concept of low frequency of risk in the CDOs they insured, without understanding the potential severity if something went awry.

Q: How has this affected your business?
A: This scenario prompted us to think about what the new paradigm might be for the securitisation market. Obviously, banks have shut down their channels of credit to most structured finance asset classes and many transactions aren't getting financed, while mezz tranches are typically being retained by originators to demonstrate alignment of incentives with investors.

The rating agencies have also tightened their criteria, so many deals that would have been rated triple-A before the crisis are typically now only rated triple-B. These factors are making it very difficult for issuers to come to the market.

We're a small team, but hoping to expand and aiming to be the best in class at risk underwriting. Clearly, there is demand for this skill; plus, we'll get paid for the investment.

Q: What are your key areas of focus today?
A: We're still in the formative stages of the business, which means going out to potential investors and and generating interest from private equity and hedge funds. Many are looking to deploy assets in this area, with attractive risk and returns.

Q: What is your strategy going forward?
A: As well as being risk underwriters, the other side of the business that we're developing is advising on and valuing assets. Whereas monolines are buy-and-hold investors and their investments weren't marked to market, except when in CDS format, we're aiming to ensure that we're not overpaying for assets and can divest them where necessary.

We will manage money for investors with certain criteria; for example, they want to buy a piece of a given transaction. However, the idea is to also focus on valuations because we care where an asset is trading today.

We could ultimately also become involved with refinancings, but the terms of the transactions will have to be different. For instance, covenants will have to be stronger and the equity piece greater.

It's an exciting period for the industry, but there aren't that many teams of true risk professionals out there yet. We're confident that the flow of investors will increase. While we don't necessarily have to make an investment to do the advisory work, doing so gives us additional strength.

Q: What major developments do you need/expect from the market in the future?
A: The major challenge to the business is from a regulatory perspective. We're not trying to replace rating agencies; we are complementary to them - which could be an obstacle for some investors unwilling to spend resources on both. Nevertheless, the in-depth analysis and surveillance of individual transactions isn't really provided by rating agencies, so this is where we intend to pick up market share.

Looking ahead, there is no question that ABS activity is picking up, but there won't be as many banks participating in the sector as there were before the crisis. Consequently, the industry will need more specialty finance companies focusing on junior risk to enter the market. Investor-driven retention levels will also be required, which I think is a good development.

Ultimately, I believe it is possible to revitalise the market for many asset classes. But it will take time - and expense - before we even get close to the volumes seen before the crisis.

CS