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Managing Portfolio Credit Risk in Banks Arindam Bandyopadhyay
Emerging market bank lending and credit risk control : evolving strategies to mitigate credit risk, optimize lending portfolios, and check delinquent loans 1st Edition Onyiriuba
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Acknowledgments
CHAPTER 1 Hedge Funds and the Credit Market
CHAPTER 2 High Yield Bonds
CHAPTER 3 Stressed and Distressed Investing
CHAPTER 4 Bank Loans
CHAPTER 5 Convertible Bonds
CHAPTER 6 Sovereign Debt
CHAPTER 7 Legal and Structuring
CHAPTER 8 Operational Due Diligence Program for Credit Hedge Fund Investing
CHAPTER 9 Risk Management
CHAPTER 10 Financing
Notes
Key Takeaways and Questions
Index
Acknowledgments
I have been fortunate to be able to work alongside some of the most exciting and brilliant minds in the investment arena. My work as a credit strategist and portfolio manager has placed me in the driver‘s seat through different investment and economic cycles, and I am profoundly grateful for the opportunity to get to know so many thoughtful and dedicated men and women. I would like to express my deep appreciation for the individuals who have in one way or another been teachers, mentors, colleagues, and friends. Their generosity with their advice, time, thoughts and expertise regarding the credit market and the hedge fund industry has influenced this book as well as my journey and growth as an investor. Errors and opinions expressed in the book are my own.
A most emphatic thank you goes to the following individuals: Steve Blauner at Solus Alternative Asset Management, LP for his advice on distressed investing as well as for some of the most fascinating stories on bankruptcy cases. Christopher R. Hebble at Cerberus Capital Management, LP for sharing his expertise and thoughts on less liquid and distressed investment opportunities. Gunther Stein and Jenny Rhee at Symphony Asset Management for their candid advice on the credit market and hedging techniques. Joseph Naggar, Ted Roosevelt V, and Vanitha Milberg at GoldenTree Asset Management for sharing their thoughts and market savvy regarding the bank loan, high yield, and structured products markets. Richard D. Holahan, Jr. at Caspian Capital Partners, LP for sharing his wealth of legal and operational experience with credit and distressed hedge funds. John Zito at Apollo Global Management, LLC for sharing his investment acumen as he navigates through the complexities of the credit world. Alicia Sansone and Meredith Coffey at the Loan Syndications and Trading Association (LSTA) for their tireless work on behalf of loan investors. Cathleen M. Rittereiser, Co-Author, Foundation and Endowment Investing and Top Hedge Fund Investors for her advice on the writing process and keen observations on the hedge fund industry. John Dyment, Mike Carley and Paul Greenberg at Lutetium Capital for their comments and thoughts regarding financing method as well as on trading and investing practices in the credit market. Ioana Barza at Thomson Reuters LPC for her work in the leveraged credit market. Wingee Sin at State Street Global Advisors for her friendship and sage advice regarding the alternative
investment world. Bryan Dunn at MidOcean Partners for his insights on relative value strategies and hedging techniques. Tad Flynn at Houlihan Lokey for his thoughts regarding valuation and liquidity management techniques. Andrew Gordon at Octagon Credit Investors, LLC for sharing his years of experience as an investor in the leveraged credit market and his expertise in the CLO market. Aditya Divgi at New York City Retirement Systems for educating me about investor priorities and concerns. Sabrina Callin at PIMCO, LLC for her advice on the writing process as well as her thoughtful comments regarding the investment management industry.
Craig Ruch at Matlin Patterson for his insights on liquidity, trading, hedging and credit risk in the credit market. Shawn Wischmeier, CIO, and Rodney Overcash, Director of Credit Strategies, at the Margaret A. Cargill Philantrophies, for sharing their astute observations and candid perspectives on investing throughout the cycles.
I would like to thank the partnership at PAAMCO for their vision, leadership and continuous support. Thank you for letting me join in the adventure! My colleagues for sharing their wealth of knowledge, in particular Philippe Jorion, Ronan Cosgrave, Sam Diedrich, Josh Barlow, Marc Towers, Leslie Macdonald, Charlie Nightingale and Max Rijkenberg. Most of all, a personal and deeply heartfelt thank you goes to Rodrigo Pascualy for his never ending support, love and friendship.
Hedge Funds and the Credit Market
Hedge funds have often been classified as an asset class. This definition is changing as many investors are becoming more familiar with hedge funds and recognize hedge funds as a specialized breed of active asset managers. Hedge funds provide investors with ways to access various asset classes and are not restricted to a specific asset class. Some hedge funds are focused on one or two specific asset classes such as convertible bonds, while others invest in a wide range of assets. A multistrategy hedge fund provides a good example, as it may invest in interest rates, sovereign and corporate bonds, equities, and currencies.
Hedge funds also have the flexibility to invest across geographical areas and in various markets around the globe ranging from developed to developing and frontier markets. Hedge fund managers‘ investments may cover a wide range of investment and trading styles, such as fundamental bottom-up, trading oriented, macro, and relative value. Hedge funds also invest in instruments across different markets—exchange traded and over-thecounter as well as in cash and derivatives.
The inefficiencies in and across different financial instruments and markets provide opportunities for hedge funds to add value through active management. We will point out particular inefficiencies that are unique to the credit market. These inefficiencies provide both challenges and alpha opportunities to select credit investors that are able to differentiate among different credits.
BERNIE MADOFF—HEDGE FUND MANAGER?
―Mr. Madoff was not running an actual hedge fund, but instead managing accounts for investors inside his own securities firm. The difference, though seemingly minor, is crucial. Hedge funds typically hold their portfolios at banks and brokerage firms like JPMorgan Chase and Goldman Sachs. Outside auditors can check with those banks and brokerage firms to make sure the funds exist.
―But because he had his own securities firm, Mr. Madoff kept custody over his clients‘ accounts and processed all their stock trades himself. His only check appears to have been Friehling & Horowitz, a tiny auditing firm based in New City, N.Y. Wealthy individuals and other money managers entrusted billions of dollars to funds that in turn invested in his firm, based on his reputation and reported returns.‖
Source: Alex Berenson and Diana B. Henriques, ―Look at Wall St. Wizard Finds Magic Had Skeptics,‖ New York Times, December 12, 2008
HEDGE FUNDS—HISTORY AND INDUSTRY GROWTH
Alfred Winslow Jones, a journalist, was credited with founding A.W. Jones & Co., the first hedge fund, in 1949. He formed a limited partnership with four of his friends to invest in common stocks using leverage and short selling. The structure was exempt from registration under the Securities Act of 1933 and the Investment Company Act of 1940; the partnership shares were offered as a private placement.
In the late 1980s and early ‘90s, the managers of the endowments for universities such as Harvard, Yale, and Duke started looking into hedge fund investments. These managers were banking on the idea that better risk-adjusted return could be achieved by managers who have fewer investment restrictions than managers who are subject to the ‘40 Act.1
In 2002, the California Public Employees‘ Retirement System (Calpers) and Pennsylvania State Employees‘ Retirement System (PennSERS) were two of the first state pension plans to invest in hedge funds. Their motivation was to diversify their investment portfolio beyond the traditional asset allocation mix of bonds and equities.
In the two intervening decades since Calpers and PennSERS started their foray into hedge funds, the industry has changed dramatically, and some hedge fund managers have become household names. George Soros became ―the man who broke the Bank of England‖ in 1992 through his short bet on the British pound. John Paulson was known by his short subprime trade in 2007 and 2008. Unfortunately, another household name related to hedge funds is Bernie Madoff and his $50 billion Ponzi scheme. After the fraud was uncovered in 2008, the ripple effect was felt across the hedge fund industry, and investors went back to the drawing board to reassess the risk management process both internally and of their asset managers. As of the time of this book‘s writing, much of the hedge fund assets are concentrated in the world‘s largest hedge funds. Figure 1.1 shows the world‘s top 20 largest hedge funds, which collectively manage 25 percent of the total estimated $2.25 trillion total assets managed by hedge funds.
Figure 1.1 Top 20 largest hedge funds
Source: PAAMCO, Hedge Fund Intelligence
PORTABLE ALPHA
Portable alpha investing is a strategy where the investor separates the alpha and beta exposure of the portfolio. Alpha is the portfolio return achieved over and above the return resulting from the correlation between the assets in the portfolio and the broad market (beta). The investor usually obtains beta exposure through a swap and separately obtains alpha through investing in absolute return investments such as hedge funds.
During the same time period, there have also been many changes to institutional investors‘ attitudes about hedge funds. Over time, many other state and corporate pension plans have overcome their initial reservations about hedge funds as the hedge fund industry started to implement better practices on governance and transparency. Institutional investors such as large corporate and state pension plans have also introduced some innovations into the alternative investment landscape such as portable alpha investing.
The rapid growth of the hedge fund industry as measured by the assets under management and number of funds can be seen in Figure 1.2. The chart reflects estimated data, as hedge fund managers have not been required to report the amount of assets they manage. Since 2000, the amount of assets invested in hedge funds is estimated to have grown from $491 billion to $2 trillion in first quarter 2011, and the number of hedge funds has been estimated to grow from 3,800 to more than 9,000 in first quarter 2011.
Figure 1.2 Hedge fund industry assets under management and number of funds
Source: Hedge Fund Research
Today, many investors are still trying to recover from the market downturn of 2008. The need to meet a return target and do so in a risk-controlled manner has turned many institutional investors toward hedge funds. Institutional investors have made allocation to hedge funds to complement their long-only portfolios. For example, long/short equity and credit strategies have been considered as part of their global equity and fixedincome portfolios. Similarly, event-driven hedge funds have been added to complement traditional growth or value equity exposures. In the effort to further diversify the sources of risk and return, investors have also turned to hedge funds and funds of hedge funds to engineer portfolio solutions that can fill a particular need in an institution‘s investment program, complement existing investments, or provide access to newer or more complex hedge funds and investment strategies.
HEDGE FUNDS IN THE CREDIT MARKET
There are inefficiencies in the credit market, and hedge funds are particularly well suited to benefit from these inefficiencies. In general, the
reasons behind the credit market inefficiencies can be broken down into three main groups. The first group is inefficiencies that stem from the nature of credit investors, such as siloed investor bases and leverage in investors‘ balance sheets. The recent rise of daily liquidity vehicles such as exchange traded funds (ETFs) has also magnified the difference in pricing between issues that are traded in the index and those that are not, creating investment and trading opportunities for hedge funds. The second is the inefficiencies that come from the nature of corporate credit issuers and issuances, such as complex capital structure and leverage on issuers‘ balance sheets. Last, there are also inefficiencies related to certain market features such as the prevalence of private 144A issuances and over-thecounter trading.
All of these reasons can give rise to significant mispricings in credit, but some of them tend to be more pronounced in certain pockets such as small and midsize issuers as well as for off-the-run and nonindex names. Due to their structure, hedge funds benefit from highly flexible mandates, the ability and willingness to do the necessary legwork to sort out the wheat from the chaff, and the ability to use leverage and short sell to add value for their investors.
SILOED NATURE OF CREDIT INVESTORS
The siloed nature of investor groups in credit where large amounts of capital invest under certain fairly strict constraints such as ratings limitations give rise to opportunities for unconstrained credit investors. There will be opportunities when particular credit instruments fall outside the specific investment parameter and the investment manager will have to sell the instrument, potentially at noneconomic prices. For example, certain investment mandates may have rules that are intended to focus the investment on certain credit quality as measured by rating. The investment manager may only be able to invest in investment grade bonds or may only have a limited amount of bonds rated CCC or below. In an environment of economic downturn where there are widespread ratings downgrades, many bonds may see their credit ratings downgraded by the rating agencies. Many of these bonds may be held by banks, which are subject to capital requirements based on the amount of risk-weighted assets on their balance sheets. Lower-rated bonds receive higher risk weighting, and more equity needs to be held for every dollar of exposure. From time to time, as banks need to improve their capital standing or meet a new regulatory regime, many have sought to reduce their exposure to lower-rated or otherwise
non-capital-efficient bonds, creating opportunities if select bonds become oversold.
The market saw this opportunity playing out during the European peripheral crisis of 2011 and 2012. As banks in both Europe and the United States stared down the barrel and saw Basel III, they faced a very real need to sell risky assets from their balance sheets. The U.S. banks were the first movers to sell assets from their balance sheets. The European and Asian banks were soon to follow. Throughout the crisis, there were opportunities for hedge funds to enter into attractive opportunities ranging from capital relief trade to purchase of whole loans from banks.
Another example of silos among credit investors is in the bifurcation between institutional investors and retail investors. The retail bonds have smaller face value to accommodate individual investors and are pari passu to the bonds issued to institutional investors. However, during periods of market dislocations where retail investors have higher risk aversion and are seeking liquidity, despite having the same rights and seniority as the institutional bonds, the retail bonds can trade at a discount compared to their institutional counterpart.
STRUCTURAL CHANGES IN THE MARKET—LACK OF DEALER CAPITAL
Post Lehman, new regulatory regimes such as Basel III and the Volcker Rule translate into higher capital adequacy ratios and ban on proprietary trading for banks, which has been translated into reduced willingness and availability of banks to take trades onto their own balance sheet. The market implication of this is that there is a marginal buyer base missing in parts of the corporate credit market, particularly for bonds that are smaller, have lower credit quality, or have a complex investment thesis. Banks acted as broker rather than dealer they would take the trade only if there was the opposite side of the trade. In the past, the bank would step in to provide a bid when a particular name was underpriced. As of late 2012, dealers‘ inventories are estimated at $45 billion, roughly half a percent of the $8 trillion total U.S. corporate bond market, compared to $250 billion in 2007. The reduction in dealer inventory is expected to be permanent, and this creates opportunities, particularly in names that are not in indices (i.e., not large, not liquid, and likely to have some degree of complexity related to the credit usually described as ―off-the-run‖). This opens up room for patient, flexible capital such as credit hedge funds.
STRUCTURAL CHANGES IN THE MARKET—RISE OF DAILY LIQUIDITY VEHICLES
One of the largest new forces expected to change the landscape in credit investing is the rise of daily liquidity vehicles, specifically exchange traded funds (ETFs). Since their inception in 2007, the market has seen new ETFs that invest in the bonds and loans of levered borrowers. ETFs add liquidity and bring additional investment options to the investing public, and at the same time, they change the trading dynamic of certain parts of the corporate bond market. This dynamic is expected to present opportunities to credit hedge fund managers.
ETFs focus only on a certain part of the high yield bond market, typically large, liquid ―marquee‖ bonds smaller bonds are often overlooked. The lack of coverage from research desks of investment banks, compounded by the lack of dealer capital, often translates into opportunities in names that are excluded from ETFs and bond indices. Figure 1.3 shows the percentage of the ETF holdings by issue size it shows that the ETFs are largely focused on holding very large to mega issuance sizes, at least $600 million and larger, with the highest percentage ownership seen for issuances larger than $2 billion.
Figure 1.3 High yield ETF holdings by issue size
Source: Morgan Stanley
Although high yield ETFs only represent $30 billion of the market or over 3 percent of the size of the total high yield market, it is important that ETFs may cause disproportionate impact in trading volume and volatility for the bonds in the ETF basket. Although there seems to be mixed data on whether ETF bonds are definitively more volatile than non-ETF bonds, ETF bonds as a group show higher internal correlation there is little differentiation between bonds in the ETF basket.2 Lower correlation between non-ETF bonds offers opportunity for credit pickers to add value through credit selection.
LEVERAGE
Most credit hedge funds invest in levered credit, (i.e., capital structure of companies with significant leverage on their balance sheets). Leverage inherently adds volatility, both to the value of debt and equity. Furthermore, market appetite for leverage and the amount of leverage that the market is willing to tolerate on companies‘ balance sheets is cyclical. When the economy is strong and the credit market is wide open, there will be more debt in companies‘ balance sheets. However, leverage magnifies any negative impact of a company‘s performance, and when high leverage is applied to cyclical businesses, the combination tends to be particularly volatile. During periods of economic contraction, default rate increases and recovery rate falls along with higher investor risk aversion, leading to a process of deleveraging. As companies go through the economic cycle and the financial market cycle, different parts of the capital structure go through the cycle of value creation and destruction. Investors such as hedge funds, whose investment mandates tend to be flexible, have the ability to capture opportunities in levered credit when the market overreacts both on the way up and down.
In addition to leverage on the companies‘ balance sheets, there is also leverage on the part of the investors‘ balance sheets. For investors with leverage, whether they hold them in non-mark-to-market or mark-tomarket facilities makes a difference in whether leverage at the investor level adds to the volatility. Non-mark-to-market leverage facilities are less prone to the mark-to-market pricing fluctuation of the assets in the market.
Structurally, during the previously unseen volatility of the market in 2008, cash flow collateralized loan obligations (CLOs) were more robust
compared to mark-to-market CLO structures. In a cash flow CLO, it is much less likely that price decline in the underlying loans alone would trigger an unwind of the facility (an ―event of default‖) as long as the cash flow from the underlying loans is sufficient to service the CLO liabilities. Mark-to-market leverage facility includes prime brokerage and repo financing, which tend to focus on the more liquid parts of the credit market and where there is a more dynamic and transparent, continuous process for price discovery in the market. For a balanced market, having a mix of markto-market and non-mark-to-market leverage facilities is important. Similar to the credit market for corporate issuers, leverage availability for credit investors also tends to be cyclical. During periods of economic expansion and easy access to credit, investors also have more access to leverage and often at lower cost. A disciplined and judicious use of leverage, both on the part of the issuer and the investor, is the goal. Nonetheless, seasoned market practitioners have observed again and again that this is not necessarily always the case.
During a period where many mark-to-market leveraged vehicles have to be unwound,3 heavy additional supply of credit instruments presents both risk and opportunities. Investors with existing leverage in the balance sheet will have to watch their leverage facility and defend against certain parameters to stay in compliance with the financing terms. As the forced sellers come into the market, even investors that are not asset sellers will be affected by the downward pricing pressure, hedge funds included. One way credit hedge funds mitigate this risk is by keeping leverage at a low to moderate level regardless of the maximum amount of leverage that‘s available to them prior to the crisis. This is an important aspect that many hedge funds focus on when managing risk in a levered credit portfolio because the higher the leverage, the higher the likelihood that the investors won‘t be able to control their own destiny during a market crisis (the determination to sell an asset is not in the investor‘s hands and, in many cases, is made at a time that is least attractive to the investor).
Furthermore, credit hedge funds can also add value by having a portfolio manager, risk manager, and back office that are all focused on managing leverage risk. The trader and back office for the credit hedge funds can add value by being actively involved and engaged in tracking market sentiment and appetite for liquidity as well as managing the relationship with their leverage providers. During a crisis, investors that have available spending power (―dry powder‖) during crisis periods can control their own destiny and benefit from selective asset purchase at very attractive prices. Credit hedge funds are not tightly tied to a benchmark and do not have to stay
close to fully invested all the time, which gives them the flexibility to stay disciplined when markets are overpriced and the ability to preserve their buying ability until a market correction takes place.
COMPLEX CAPITAL STRUCTURE
In a capital structure, the value of a company is not distributed evenly. From the senior secured loans in the top of the capital structure to common equity, each layer provides different risk/reward propositions for different investors. In the event of distress, a company‘s creditors receive higher priority of payment they are ahead in line relative to the equity investors, who are in position to reap more of the upside in an optimistic scenario. Different parts of the capital structure are not always fairly priced relative to their respective riskiness. Credit hedge funds, with the ability to invest in a concentrated portfolio and flexible mandate, can dedicate the time and skills to determine the part of the capital structure that offers the best reward/risk proposition.
Furthermore, the composition of capital structures tends to vary over time as the appetite for different asset classes changes. As such, the amount of leverage at different parts of a capital structure can vary.Figure 1.4 shows the range of different capital structures for a hypothetical levered borrower. For example, from 2003 to 2007, there was an increase in leverage on the borrowers‘ balance sheets, and second, the mix of that debt was changing with more of the leverage being located at the senior debt level. The implication for investors is that the thicker loan tranche pushes the high yield bond lower down in the capital structure. Later, when the high yield bond market experienced heavy capital inflows from 2010 to 2012, many levered issuers issued bonds to repay their covenant-heavy bank loans (a ―bond for loan‖ swap). Given this market dynamic, investors such as credit hedge funds need to carefully assess the value of the company and the security package when considering investing in a high yield bond to ensure that the expected return for the high yield bond is adequate compensation for the deeper subordination. The opportunities fluctuate over time, across market cycles, and across companies. In cases where leverage and debt burden on the company is low relative to revenue, cash flow, and growth expectation, certain hedge funds that generally invest in credit may have the flexibility to invest in equity (e.g., multistrategy credit funds and distressed debt funds).
Figure 1.4 Various capital structures for a levered borrower
Source: PAAMCO
As investors are faced with more complex capital structure, this presents greater opportunity for astute credit hedge fund managers to add value from a thorough understanding of the capital structure.Figure 1.4 shows variations of a basic capital structure of an issuer with a single entity (i.e., with no parent or holding company relationship). In practice, many issuers are part of a corporate structure with many entities, some of which may reside in different countries and issue debt outside their domiciled address and in foreign currencies. Take, for example, a corporate structure with one parent entity and a single subsidiary. In market parlance, the parent company is often referred to as the holding company, or ―holdco,‖ and a subsidiary is often referred to as the operating company, or ―opco.‖ Although the liability of the holdco level is technically senior secured and first lien, credit hedge fund managers would likely consider it more ―junior‖ to the bond issued by the opco. All things equal, credit hedge fund managers tend to seek to be as close to the assets as possible, and in this example, the real value-generating assets are located at the opco level while
the assets collateralizing the liabilities at the holdco level are limited to the parent‘s claim on the subsidiary.
Key Takeaway on Corporate Structures
When investing in a corporate structure, understanding the value of a credit instrument involves understanding where value lies within the capital structure of a business unit as well as among different business units.
To take the example further, Figure 1.5 shows the summary corporate structure for Lehman Brothers Holdings International.4 In Lehman‘s case, the sheer number of the corporate units and the global nature of its presence alone present a significant amount of complexity (the chart is simplified—interim holding companies have been omitted). Each subsidiary may issue debt against its own assets, and the assets may or may not be subject to claims of creditors of the parent company in addition to the creditors of that particular subsidiary. In addition, there are complexities regarding guarantees from the parent company (Lehman Brothers Holdings International) to various subsidiaries.
Figure 1.5 Summary corporate structure for Lehman Brothers Holdings Inc.
Source: Lehman Brothers Company Overview. H denotes subsidiaries whose obligations are guaranteed by Lehman Holdings, Inc. (LBHI)
Key Questions on Corporate Structures
If you are investing in the loan or debt of a subsidiary, what are the assets of that subsidiary? Does that subsidiary have assets beyond the assets on its own balance sheet such as parent guarantee or guarantee from another subsidiary? Does that subsidiary have off-balance-sheet liabilities or provide guarantee to the parent or other units?
PRIVATE ISSUANCE AND FLEXIBLE STRUCTURES
In any investing situation, there is always an issue of information asymmetry between borrower and lender. However, the information asymmetry in the secondary market may be more pronounced for leveraged corporate credits due to the prevalence of private issuance and the number of smaller issuances.
Many corporate credit instruments are issued on a private basis. Some bonds, namely investment grade and the largest high yield issues, tend to be publicly issued, but many are not. The bank loan market is still predominantly a private market, and a large slice of the high yield bond market is also private. Private companies are estimated to represent roughly 85 percent of issuers in the loan market and 35 percent in the high yield bond market.5 Rule 144 allows for private issuance to sophisticated investors, while Rule 144A improved the secondary market liquidity for bonds, as trading of the privately issued bonds can happen between sophisticated investors who are no longer restricted by the two-year holding period. In the primary market, an investor in a 144A private placement benefits from the access to management‘s projections and certain details of internal historical analysis that are not typically available in a public offering. In the secondary market, investors can select whether to remain in the public realm (―outside the wall‖) or to receive access to material nonpublic information (be brought ―inside the wall‖). If they have access to material nonpublic information, investors are restricted from trading the public securities of the issuer. In the secondary market, the lack of publicly available information provides some opportunities because some investors would be precluded from buying due to lack of familiarity with the issuer or with a particular issuance. Because most of the deals are privately negotiated between investors and issuers, the terms of the investment (coupon, maturity, amortization, covenants, security package) are highly negotiable and as such can be
widely variable across different deals. This structural flexibility accommodates the needs of both issuers and investors, who may demand customization that suits their regulatory or structural needs or may accept the issuer‘s request for a unique structure if they believe that they are adequately compensated for the risk. The differences in the investment terms and investors‘ rights mean that a new investor interested in buying credit instruments in the secondary market needs to have the time, expertise, and access to the information network in order to properly assess the investment opportunity.
Standardization of terms tends to reduce the information asymmetry between borrowers and lenders as well as among lenders and increase secondary market liquidity. Among other factors, the greater extent of variation across deals and the fact that waivers and renegotiations can change the terms of a deal over time create a higher amount of complexity, which makes the information asymmetry a particular feature of the corporate credit market. The information asymmetry tends to be more pronounced in cases where there is no or little publicly available information about the borrowers. An example would be where the borrower is privately owned and has no public equity or bonds in the capital structure.
Opportunities and challenges in dealing with this asymmetry are two sides of the same coin. Credit hedge funds can benefit from the limited buyer base willing to invest in a situation that is difficult to understand and where information is limited. Leveraged companies also face higher probability of needing covenant waivers or to restructure their debt from time to time (see earlier point on leverage). In such a case, lenders and borrowers will need to engage in a negotiation process to restructure the terms of the investment and additional capital infusion may be needed to keep the company as a going concern. In this stage, some investors typically exit the position. Some investment managers may be restricted by their mandate (they are unable to invest in a company in default), others may not be able to participate in adding capital (they have no access to additional funds or ―dry powder‖ or run funds with very little cash); others sell because the liquidity profile of their investors does not match the investment horizon (funds with daily liquidity tend to exit early and be rather price insensitive at the exit). Consequently, credit investors with the ability and willingness to do a deep dive on the investment case, engage in negotiations and workout, and hold investments that need time to work out can benefit from the structural limitations that preclude many other investors from participating in these opportunities.
MARKET STRUCTURE
Unlike the public equity market, the corporate credit market does not have a centralized marketplace where buyers and sellers can meet and conduct trades. Most publicly traded equities trade in stock exchanges (physical or electronic) around the globe, while secondary trading in the corporate credit market largely takes place in the over-the-counter market. The market is fragmented, where trading takes place with various brokerdealers and in the inter-broker-dealer market. Trading in the bond market typically is dominated by large institutional investors and dealers. Large institutional buyers and sellers need to negotiate the trade either directly or through a broker.6
At the time of this writing, the need to deleverage and an expected increase in capital requirement for banks have largely led to banks being more likely to act as brokers rather than dealers. For example, an institutional investor wants to sell a bond in the secondary market and calls the bond desk in an investment bank. The investment bank can act as a broker or as a dealer. As a broker, if the bank already has a buyer, the bank will act as the middleman that matches the buyer and the seller. If the bank does not already have a buyer, it will try to find a buyer, and a transaction occurs only if a buyer can be found. As a dealer, if no buyer can be found, the bank may buy the bond from the seller and put it in its inventory because it believes that it will be able to find a buyer at the same or higher price later. In the latter case, the bank uses its balance sheet capital to provide liquidity to the market and takes some risk of the event that the price of the bond declines.
The absence of the capital buffer has a twofold effect: on one hand, it means potentially even more ―patchy‖ liquidity and higher volatility in certain parts of the corporate credit market. On the other hand, it translates into opportunities for credit hedge funds, which now play an even more important part as the marginal buyer of levered corporate credit. Having a flexible investment mandate, trading skills, and ability to capture some liquidity premium can translate into alpha.
RANGE OF INSTRUMENTS EQUALS MORE LEVERS TO PULL
Given the nonuniform nature of value distribution and the wide range of instruments within a corporate capital structure, a credit hedge fund can
draw from a variety of tools to express its view depending on investing style and background. A fundamental credit investor may prefer to go long on the most attractive credit instrument in a capital structure while shorting the least attractive part of another issuer. A relative value credit investor has the option to pair long exposure with short exposure to another part of the capital structure of the same issuer, which provides a natural way to hedge the overall company risk of the long exposure. For example, hedge fund managers may pair a long/short trade to reflect their view on the relative value of two bonds from the same issuer but with different maturity or subordination. They may also use equity, equity options, and other equity derivatives as liquid alternatives to hedge the credit exposure. In addition to the cash instruments, there are a variety of credit derivatives to choose from. Credit default swap (CDS), option on CDS (CDS swaption), and CDS indices (CDX) in many cases also provide a liquid, capital-efficient way to obtain long and short exposure to particular corporate credits. When shorting bonds on credit default swaps, the protection buyer may not need to post any margin or need to post only a minimal amount of margin (lower than what would be required if shorting the cash bond). This is another option available to credit hedge funds, which can choose how to express their view depending on their view on liquidity, technicals, cost of shorting, and cash management preferences.
LIMITED UPSIDE ON SHORTS
The unique feature of many credit instruments is the limited amount of price upside (downside for short exposure). Unlike an equity short position where the downside is theoretically unlimited, when one is shorting a bond that is trading at par or near par, the upside/downside is very attractive, as the upside price movement is limited while the price can theoretically move to zero.
CONCLUSION
• Many opportunities arise in corporate credit investing because of the inherent volatility of leverage, both on the borrowers‘ and investors‘ balance sheets.
• When looking at a particular bond or loan, just like equities, other parts in the same capital structure or similar instruments from comparable companies can provide some indicator of value.
• When comparing two bonds, in addition to the financial health of the issuers, an investor needs to discern where the bond lies in the capital structure, relative rights, and specific terms attached to each bond.
• The complexity in the corporate credit market (whether from capital structure or the nature of negotiated deals) combined with market structure that relies more heavily on over-the-counter trading and leverage means that comparable instruments often don‘t move together.
• Due to structural reasons, pricing inefficiencies and value dispersion may exist for longer periods before being arbitraged away. Investment managers who are disciplined on their entry points and who have the ability to hold the investments until the expected catalysts materialize can realize alpha in corporate credit investing.
High Yield Bonds
Corporations form one of the largest groups of bond issuers1 and thus are a source of many investing opportunities. In this chapter, we will discuss how credit hedge funds can capture the inefficiencies in the market for leveraged (―high yield‖) companies.
Out of more than 2,000 current outstanding issuances in the U.S. high yield bond market, approximately two-thirds of the issuance by number is smaller than $500 million. Figure 2.1 shows the market by issuance size. Due to the significant percentage of high yield bond issuance done via 144A private placements2 (i.e., the issuers do not have to file public registration statements with the SEC), there are pockets of greater information asymmetry in the high yield bond market relative to the investment grade bond or public equity markets. A greater amount of complexity and information asymmetry in the space can give rise to investors who are able to do the deep dive to add value through credit selection coupled with hedging the main exposures, thereby capturing alpha. Outside of the United States, the Western European high yield bond market is estimated at $381 billion3 and the Asian high yield bond market is estimated at $41 billion.4
Figure 2.1 The U.S. high yield bond market by issuance size
Source: PAAMCO, Bloomberg
Therefore, many investors see value in having a meaningful exposure to hedge funds whose core expertise and investment skill sets are focused on high yield corporate bonds. Unlike traditional assetmanagement, the hedge fund structure offers investors additional flexibility via the ability to gain short credit exposure, the ability to go to pockets of the market that are overlooked by traditional benchmark-bound investors, the ability to use a wider variety of synthetic instruments, and the ability to use higher levels of leverage when the opportunities warrant it.
HIGH YIELD BONDS
Many institutional investors largely classify the corporate bond universe into two categories. Using ratings as a standardized template with which to compare various bond issuances, the corporate bond universe is largely split into investment grade and below investment grade issuances. Bonds with ratings below investment grade (anything rated BB– or Ba and lower) are often referred to as ―high yield‖ or ―junk‖ bonds. Many investors have some degree of familiarity with investing in investment grade and high yield bonds, albeit perhaps not through the hedge fund structure.
According to the Securities Industry and Financial Markets Association (SIFMA), on December 31, 2010, the U.S. corporate debt market exceeded $7.5 trillion, making it the third largest fixed-income market within the United States after Treasuries and mortgages. Out of the total corporate U.S. debt market, more than $1 trillion is in the form of corporate debt with ratings below investment grade. Relative to the European, Asian, and emerging markets, the U.S. high yield market is currently the largest and broadest, with more than 1,000 corporate issuers and 2,100 securities in more than 60 industries.5 However, given the triple-digit percentage growth in the market for European, Asian, and emerging market high yield debt in 2009 and 2010, investors can expect continued new opportunities in this particular asset class.
In the early days of the high yield market, most of the high yield bonds were investment grade at issue but later downgraded (i.e., ―fallen angels‖). Leveraged companies at the time had little choice when they needed financing their financing choice was largely limited to borrowing from the banks. Indeed, the heavier reliance on bank lending is a phenomenon that we still observe in other markets where the high yield market is not yet as developed as the U.S. market, such as many emerging markets.
However, in the 1980s the high yield desk at Drexel Burnham Lambert, led by Michael Milken, popularized sub-investment grade bonds to a whole new group of investors. Mutual funds, insurance companies, and specialty finance companies were attracted to the market by the higher yield on these bonds, which more than compensated for the higher losses from default. Investors‘ demand for new high yield issuance increased, and a new mainstream asset class was born. Corporations and bankers responded to the demand for this new asset, and the 1980s saw the creation of some of the most innovative financing methods for leveraged issuers. Leveraged buyouts and other corporate activities such as mergers and acquisitions or dividend recapitalizations were popularized. One seminal example of a leveraged buyout transaction was Kohlberg Kravis Roberts‘ (KKR) taking RJR Nabisco private in 1989. The winning bid was for $25 billion, with $4 billion issued in the form of high yield bonds. Figure 2.2 shows the growth of the U.S. high yield market since 1989.
Source: Credit Suisse Leveraged Finance
In this chapter, we will discuss hedge fund investment strategies that involve instruments that typically fall below bank loans but ahead of common and preferred equity in terms of seniority. Figure 2.3 shows the capital structure of a corporation in terms of seniority. When credit hedge funds refer to high yield bonds, they are usually referring to senior
Figure 2.2 Growth of the U.S. high yield bond market
unsecured debt as well as junior unsecured or subordinated debt. Given that naming of a bond is not always consistent with its features, this chapter will use the phrase high yield bond as a broad term. The key driver for risk and return in high yield investing is the need to do due diligence on the specific features of an issue, as the rights of investors can vary significantly on a case by case basis. For example, although notes typically refers to instruments that are less than 10 years in tenor (time until maturity) when issued, there are notes with 20 and 30 year tenor.
Figure 2.3 Capital structure of a hypothetical corporate issuer
Source: PAAMCO
High yield corporate bonds are typically issued on an unsecured basis, although in 2009, some less known, more highly levered, or fundamentally weaker issuers issued more secured bonds in place of senior secured loans. Unlike unsecured bonds, which fall under general obligations of the company, secured bonds are backed by specific collateral. Unsecured bonds are not backed by particular assets, however bondholders retain a general claim on the issuer. In liquidation, unsecured bondholders are classified as general creditors of the company. Holders of unsecured bonds may reap some benefit from the value of the company‘s assets, even assets that have been pledged to secured lenders. This is because the assets that have been pledged as collateral to secured lenders can be used to satisfy general creditors, but only the value in excess of the secured claim. Without the assets of the borrower pledged as collateral and providing an additional layer of protection, holders of bonds typically require a higher coupon payment than bank loan lenders, whose loans are collateralized by the assets of the borrower.
Key Takeaway on the Naming Convention of Bonds
Assuming where a bond lies in the pecking order based only on its brief description can sometimes result in an incorrect analysis. The key point is for fund managers to understand the pecking order of the bond they are holding relative to other ―IOUs‖ of the issuer and the asset coverage relative to that pecking order.
The rights of bondholders are contained in bond indentures, which may have provisions prohibiting the borrowers from certain acts that may have a negative impact on the value of the bondholders‘ claims. The indenture of a bond can limit the borrower‘s ability to incur more indebtedness, particularly at the same seniority level as the original bond. Typically less stringent are the provisions that allow the borrower to add borrowing on a subordinated basis, and the borrower may be subject to certain tests such as having to stay below the maximum allowable amount of total leverage as measured by the ratio of total net debt to earnings.
Another provision that may be contained in the indenture of an unsecured bond is the negative pledge provision, which may be found for issuers that have no secured debt on the balance sheet at the time of the unsecured bond issuance. A negative pledge may specify that should the borrower decide to issue secured debt in the future, the existing debt will be secured on a pro rata basis with the debenture. This gives the bondholders (technically an unsecured debt) equal claim on the company‘s assets with the secured debt that is issued later. This protects the claim value of the unsecured debt holders by preventing future secured lenders from leapfrogging to the front of the line in terms of the seniority of claim on the borrower‘s assets.
Many leveraged corporations, when they are prohibited from issuing more unsecured bonds, may also issue subordinated bonds. The term subordinated implies that these bonds are below unsecured bonds in seniority. One of the sweetener terms to make these bonds more attractive to investors is sometimes the addition of convertibility provisions, which allow the holders to convert the value of their bonds into equity at a certain conversion rate. This gives the holders of these bonds the benefit of the upside when the equity price of the company increases.6 (Please see Chapter 5 for a separate discussion on convertible bonds.)
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operator then takes hold of the patient's hand and the other electrode is passed over the muscles of the neck, back, trunk, and extremities.
When the patient is in bed, as in the regular rest treatment, this method has to be modified, and then the best treatment is by direct muscular faradization. Two sponge electrodes are employed. The sponges are moistened, so that the current may pass through the skin and reach the muscles. Both electrodes are taken in one hand, the handle of one, pointing backward, being between the first and second fingers, while the handle of the other is between the third and fourth fingers. In this way the distance between the points of application can be readily altered. The current is then applied to the muscles everywhere, beginning with those of the feet. Muscles should be relaxed before passing the current through them. The whole body can be gone over in this way in the course of half an hour.
The hydropathic treatment of hysteria is one that has much in it to be commended. Jolly approves the systematic external application of cold water; Chambers advocates the daily morning use of showerbaths, holding that the bracing up of the mind to the shock of a cold shower-bath is a capital exercise for the weak will-power of the hysterical individual, and some admirable results have been reported by Charcot in inveterate neurasthenics and hysterics. Hydrotherapeutic treatment, continued perseveringly for a long time, says Rosenthal, “diminishes the extreme impressionability of hysterical patients, strengthens them, and increases their power of resistance to irritating influences, stimulates the organic functions, combats the anæmia, calms the abnormal irritability of the peripheral nervous system, and by diminishing the morbid increase of reflex power relieves the violence of the spasmodic symptoms. Even chronic forms which are combined with severe paroxysms of convulsions are susceptible of recovery under this plan of treatment.”
The hydrotherapeutic treatment may be contrasted with the treatment by seclusion, rest, massage, and electricity. Undoubtedly,
one class of hysterical patients is greatly benefited by the latter method systematically carried out; these have already been described. In other cases, however, this method of treatment is useless; in some of them it has a tendency to prolong or aggravate the hysterical disorder, while in the same cases a well-managed hydrotherapeutic treatment will answer admirably. This is applicable in hysterical patients who eat and drink well, who, as a rule, preserve a good appearance, but whose mind and muscles are equally flabby and out of tone, and need to be stirred up both physically and mentally
Dujardin-Beaumetz recommends prolonged warm baths of from one to two hours' duration, and believes that the therapeutic virtues of these baths are augmented by infusions of valerian.
In order to obtain satisfactory results from hydrotherapy, as well as from massage, electricity, etc., it is best to remove patients from their family surroundings. Good sanitariums near our large American cities where hydrotherapy and other special methods of treatment can be carried out are sadly needed. Hydrotherapeutic treatment is much more efficacious when conducted at a well-regulated institution, for several reasons. Measures troublesome in themselves are here carried out as a matter of daily routine. Numerous patients permit of the employment of competent attendants. The change is often of great benefit. The close personal supervision which hysterical patients are likely to have in a hydrotherapeutic establishment is also to be taken into consideration. Better modes of living, proper forms of exercise, regulated diet, etc. also enter; but still, a fair share of the good which results can be attributed to the water treatment.
While, however, it is better to remove hysterical patients, for hydrotherapeutic as well as for other treatment, from their family surroundings, and to place them in some well-regulated establishment, it is not by any means impossible to carry out such treatment in private practice, particularly in a house supplied with a bath-room. Many of our hydrotherapeutic institutions are in the
hands of charlatans or of individuals who are not practically well fitted for their work. Not infrequently, however, good results are obtained even under these circumstances. Much more can be done in this direction with modest buildings and appliances than is generally supposed. It is not necessary to have numerous apartments: three or four rooms in a well-appointed house, if the arrangements for carrying out the hydrotherapeutic treatment are of a proper kind, will suffice for a large amount of good work. In almost any house provided with bath-rooms with hot and cold water some useful hydrotherapy may be attempted. The spinal douche or pour can be used by placing the patient in a sitz- or ordinary hip-bath and pouring the water from a spout or hose held at a certain height, the distance being regulated according to the patient's condition. Again, the patient sitting in a tub, water can be poured upon her, beginning at first with a high temperature and gradually lowering it. The shower-bath may also be used. An extemporaneous shower-bath can be provided by an ordinary watering-pot. Whole, three-quarters, or half baths at different temperatures can be given. One method of carrying out the wet pack is very simple. A comforter is spread upon the bed; next to this is placed a woollen blanket, and over the blanket a wet linen sheet, upon which the patient rests, with the head on a low pillow. The wet sheet, blanket, and comforter are then wrapped closely about the patient, bottles of hot water being placed at the feet. The cold drip-sheet method is another easily used. It consists in placing about the patient, while sitting up or standing, a sheet wet with cold water, and then vigorously rubbing her through the sheet.
Baths to the head may be used in some cases; cool head-baths are most frequently applied. One method of using these baths is to have the patient lie in such a position that the head projects a little beyond the edge of the bed and over a basin or receptacle of some kind. Water of a suitable temperature is then poured gently or squeezed out of a sponge over the head. For some forms of insomnia or some of the disorders of sleep in hysteria this treatment is a valuable auxiliary to other measures.
For the hysterical spine cold compresses may be used along the spine. On the other hand, hot fomentations may be found of benefit in some cases. Where hydrotherapeutic measures are employed attention should be paid to the condition of the circulation, particularly in the extremities. If the feet or hands are cold, hot applications or frictions should be used.
For certain of the vaso-motor disorders of hysteria, such as cold or hot feet, flushings, etc., local hydrotherapeusis will be of service. In hysterical contractures local stimulation by the douche method or by the steam bath may be tried. For the excitable rectum cold enemata in small quantities, so as not to be expelled, will be found to be very efficacious. For spasmodic attacks, whether purposive or involuntary, the use of the wet pack or the plunge-bath will sometimes be found of good service. In neuralgias and other painful local disorders of hysteria, frictions, fomentations, Turkish or Russian baths, and the wet pack are often very beneficial.
When hysteria is complicated, as it very often is, with disorders of the liver and stomach, hydrotherapeutic measures will be of added efficacy. When it is associated with genito-urinary disorders, even though the latter are not regarded as the cause of the former, special beneficial effects, both local and general, can be obtained from hydrotherapeutic measures. Locally, sitz-baths, hip-baths, douchebaths, hot and cold injections, and foot-baths may act as revulsives, astringents, or local tonics, while at the same time they are measures which tend to strengthen the system as a whole.
Sea-bathing is often of the greatest value, although it is sometimes difficult to induce hysterical patients, who are willing enough to go to the seashore, to resort to surf-bathing. Few measures are better calculated to bring up the tone of the nervous system of an hysterical or neurasthenic patient than well-directed sea-bathing. Where seabathing cannot be employed sea-water may be used indoors. Seawater establishments, where baths at various temperatures may be had, are now to be found at all the best seaside resorts. In a few cases the internal use of large quantities of either hot or cold water,
or of the ferruginous mineral waters, may be associated with the external treatment.
The climatic treatment of hysteria has received little or no attention; undoubtedly, much could be said in this connection. In a great country like ours a climate suited to the requirements of almost every form of disease can be had. The climate of those regions, either of the seaboard or inland, particularly well suited to cases of lung trouble, will often be useless, and sometimes harmful, to neurotic patients. For a certain class of hysterical patients a sojourn at the seashore, if not too protracted, will prove of great value. On the whole, for most hysterical patients of the neurasthenic type the best plan is to go first to the seashore for a few weeks, and then resort to an inland hilly or mountainous country, but not at too great an elevation. I have known the climate of some of the high altitudes of Colorado to be of positive injury by depressing the nervous system. Resorts like Capon Springs in West Virginia, out of the reach of steam and worry, with prevailing south-west winds, are desirable places.
The treatment of hysteria by the method of metallotherapy is worthy of some consideration. It is a method by no means new. It was known and practised by the ancients with rings and amulets. Popularized at the beginning of the present century by certain travelling charlatans, it was later, for a time, wholly ignored. In recent years it has been received with considerable attention. One Burq for many years practised metallotherapy in Paris disregarded or scouted by the profession, but claiming many remarkable cures. Finally, Charcot was induced to give him an opportunity of demonstrating the truth or falsity of his claims at Salpêtrière.124 Cases of grave hysteria were submitted to the treatment, and in certain instances with striking results.
124 Lancet, Jan. 19, 1878.
After having determined by a series of experiments the particular metal to which the patient is sensitive, bits of metal may be applied to the surface of the body in various places; this constitutes external
metallotherapy Or the metal, in the form of powder (as reduced iron) or an oxide or some other salt, may be administered; this is internal metallotherapy. That certain definite effects may be produced by the application of metals to the surface of the body is unquestionable. Some of the results which have followed their employment are the removal of anæsthesia and analgesia, relief of hysterical paralysis, improvement in the circulation, removal of achromatopsia, relief of contracture.
Many investigations in Germany, England, France, and this country have demonstrated that the same or similar effects can be produced by the application of other non-metallic substances, such as discs of wood, minerals, mustard plasters, etc. Hammond, among others, has shown this. How the results are obtained is still a matter of dispute. On the one hand, it is claimed, principally by the French observers, that the cures are due to the metals themselves, either by virtue of some intrinsic power or through some electrical currents generated by their application. On the other hand, it is asserted, particularly by the English observers, that the phenomena are best explained on the doctrine of the influence of the mind on the body; in other words, by the principle of expectant attention. Some at least of the effects are to be explained on the latter hypothesis, but it is likely that the monotonous impressions made upon the peripheral senseorgans by different substances applied locally may act reflexly on the brain.
Seguin125 reports a case of convulsion and hemianæsthesia in an adult male cured by metallotherapy; the metal used was gold. Two ordinary twenty-dollar gold pieces were placed in the patient's hands, and afterward on his forearm, cheek, and tongue. Nothing else was suggested or done to him; sensibility returned, and the staggering and other symptoms disappeared. The patient left the hospital claiming to be perfectly well. The same author reports several other successful cases of metallotherapy, all of them reactions to gold. One was a girl sixteen years old with analgesia.
125 Arch. of Medicine, New York, 1882.
Not a few cases are now on record of the cure of hysterical contracture and other forms of local hysterical disorders by the application of a magnet. Charcot and Vigouroux cured one case of hysterical contracture of the left arm by repeated applications of the magnet to the right or healthy arm. Debove by prolonged application of magnets relieved hemianæsthesia and hemiplegias—not only the hysterical varieties, but also, it is said, when dependent upon such conditions as alcoholism, plumbism, and even cerebral lesions. Maggiorani of Rome studied the physiological action of the magnet and laid down the first rules for its therapeutic use. In the case of powerful magnets we have more room for believing that an actual, tangible force is at work in producing the results than in the case of simple metals.
The question has been sometimes asked whether hypnotism can be used with success in the treatment of hysteria. Richer reports a few cures of hysteria through this agency. Braid has put on record between sixty and seventy cases which he claims to have cured by the same means. This list undoubtedly includes some hysterical cases—of paralysis, anæsthesia, aphonia, blindness and deafness, spinal irritation, etc. Both on theoretical grounds and from experience, however, I believe that the practice of hypnotization may be productive of harm in some cases of hysteria, and should be resorted to only in rare cases of mental or motor excitement.
By some, special measures during the hysterical fit are regarded as unnecessary. Jolly, for instance, says that we must merely take care that the patients do not sustain injury in consequence of their convulsive movements, and that respiration is not impeded by their clothing. Rothrock126 reports several cases of hysterical paroxysms relieved by the application of either snow or ice to the neck. The applications were made by stroking up and down either side of the neck along the line of the sterno-cleido-mastoid muscles. He believed that the most probable explanation of the results obtained was the shock received from the cold substance, but that supplemental to this there may have been supplied through the
pneumogastric nerve a besoin de respirer. This measure and the use of the cold spinal douche are both to be recommended.
126 Philada. Med. Times, 1872-73, iii. 67.
Emetics are sometimes valuable. Miles127 reports several cases of severe hysterical seizure in which tobacco was promptly efficient in controlling the affection. He used the vinum tabaci in doses of one drachm every half hour or hour until the system was relaxed and nausea induced, the effects usually being produced after taking three or four doses. Fifteen grains of sulphate of zinc may be used in adult cases. James Allen for a case of hysterical coma successfully used a hypodermic injection of one-tenth of a grain of apomorphia. Recently, at the Philadelphia Hospital this remedy has been successfully employed in two cases, one of hysterical coma and the other of hysterical mania. Inhalations of nitrite of amyl are often of surprising efficiency. This and other measures referred to under HYSTERO-EPILEPSY are also applicable in the treatment of any form of hysterical spasm.
127 Clinical Med. Reporter, 1871, iv. 25-27.
For hysterical convulsions occurring during pregnancy an enema of asafœtida, camphor, the yolk of an egg, and water, such as has been recommended by Braun of Vienna, will often be found promptly efficacious.
Fagge128 mentions a procedure which he had often seen adopted by Stocker—namely, pressure upon the arteries and other structures on each side of the neck.
128 British Medical Journal, March 27, 1880.
For hysterical paralysis faradism and galvanism hold the chief place. Metallic-brush electricity should be used in the treatment of anæsthesia.
Whenever, in local hysteria, particularly of the paralytic, ataxic, or spasmodic form, it is possible to coax or compel an organ or part to perform its usual function long unperformed or improperly performed, treatment should be largely directed to this end. Thus, as Mitchell has shown, in some cases of aphonia, especially in those in which loss of voice is due to the disassociation of the various organs needed in phonation, by teaching the patient to speak with a very full chest an involuntary success in driving air through the larynx may sometimes be secured. Once compel a patient by firm but gentle means to swallow, and œsophageal paralysis begins to vanish.
Mitchell makes some interesting remarks upon the treatment of the peculiar disorders of sleep, which he describes and to which I have referred. When the symptoms are directly traceable to tobacco, he believes that strychnia and alcohol are the most available remedies, but gives a warning against the too liberal use of the latter. A treatment which was suggested to him by a clever woman who suffered from these peculiar attacks consists in keeping in mind the need of breaking the attack by motion and by an effort of the will. As soon as the attack threatens the patient should resolutely turn over, sit up, or jump out of bed, and move about, or in some such way overcome the impending disorder. Drugs are of little direct use. Small doses of chloral or morphia used until the habit is broken may answer, but general improvement in health, proper exercise, good food, and natural sleep are much more efficient.
Fagge says that he has seen more benefit in hysterical contracture from straightening the affected joints under chloroform, and placing the limb upon a splint, than from any other plan of treatment. Hammond129 (at a meeting of the New York Neurological Society, Nov. 6, 1876) reports a case of supposed hysterical contracture in the form of wry neck, in which he divided one sterno-cleido-mastoid muscle; immediately the corresponding muscle of the other side became affected; he cut this; then contraction of other muscles took place, which he kept on cutting. The case was given up, and got well spontaneously about two years later. Huchard130 entirely relieved an
hysterical contracture of the forearm by the application of an elastic bandage.
129 Philadelphia Medical Times, vol. vii., Nov. 25, 1876.
130 Revue de Thérapeutique, quoted in Med. Times, vol. xiii., June 16, 1883.
A lady with violent hysterical cough was chloroformed by Risel of Messeberg131 for fourteen days at every access of the cough, and another for eight days. In both the symptoms were conquered. Nitrite of amyl is useful in similar cases.
131 Allg. Med. Centralzeitung, Oct. 9, 1878.
Graily Hewitt132 reports a case of hysterical vomiting of ten months' duration, caused by displacement of the uterus, and cured by reposition of that organ. The same authority, in a paper read to the London Congress, advanced the opinion that the exciting cause of attacks of hysteria and hystero-epilepsy was a distortion of the uterus produced by a flexion of the organ upon itself, either forward or backward. He believed the attacks were the result of reflex irritation. He recited eighteen cases, all of which were relieved. Flechsig133 favors the gynæcological treatment of hysteria, including castration or oöphorectomy. He reports three cases with good results. His article favors the idea that any morbid condition of the genital organs present ought to be remedied before treating the hysterical symptoms. Zeuner,134 on the other hand, refers to a number of cases in which gynæcological treatment gave either entirely negative results or was productive of positive injury to hysterical patients. He quotes Perreti,135 physician to an asylum for the insane, who gives the details of a number of cases in which gynæcological examinations or treatment were directly productive of injury. He mentions a case of a female patient who had delusions and hallucinations of a sexual type in which the physician was the central figure. He reports cases in which proper constitutional treatment, without gynæcological interferences, led to a full recovery. Playfair, also quoted by Zeuner, states that he has often known the condition of hysterical patients to be aggravated by injudicious
gynæcological interference. Oöphorectomy will be more fully discussed under HYSTERO-EPILEPSY.
132 Med. Press and Circ., June 2, 1880.
133 Neurol., 7 Abt., 1885, Nos. 19, 20.
134 Journ. American Med. Ass., Chicago, 1883, i. 523-525.
135 Berliner klinische Wochenschrift, No. 10.
HYSTERO-EPILEPSY.
BY CHARLES K. MILLS, M.D.
DEFINITION.—Hystero-epilepsy is a form of grave hysteria characterized by involuntary seizures in which the phenomena of hysteria and epilepsy are commingled, and by the presence in unusual number and severity, between the paroxysms, of symptoms of profound and extensive nervous disturbance, such as paralysis, contracture, hemianæsthesia, hyperæsthesia, and peculiar psychical disorders.
SYNONYMS.—Hystero-epilepsy has long been known under various names, as Epileptiform hysteria, by Loyer-Villermay and Tissot; as Hysteria with mixed attacks, by Briquet; as Hysteria major or Grave hysteria, by Charcot. The term hystero-epilepsy has been used with various significations, and often without due consideration, and for these reasons some authorities advise that it should not be used at all. Gowers,1 for instance, refers to epileptic hysteria, hysterical epilepsy, and hystero-epilepsy as hybrid terms which tend rather to hinder than to advance the study of the nature of these convulsive attacks and their relations to other forms of hysteria. He holds that it is a clear advantage to discard them as far as possible, and suggests the use of the term hysteroid, as proposed by W. W. Roberts, or that of co-ordinate convulsions, as describing accurately the character of the attack. These suggested terms do not strike me as improvements upon those which he wishes the profession to avoid. The word hysteroid, while good enough in its way, is certainly objectionable on the ground of indefiniteness. Co-ordinate is proposed, because the convulsive movements are of a quasipurposive appearance; that is, they are so grouped as to resemble phenomena which may be controlled by the will. This meaning of coordinate, however, as applied to the disorder in question, would not be easily grasped by the average physician. When it is impossible to name a disease from the standpoint of its pathological anatomy, the next best plan is to use a clinical term which in a plain commonsense manner gives a fair idea of the main phenomena of the affection. Hystero-epilepsy, if it means anything, means simply a disorder in which the phenomena of both hysteria and epilepsy are to some degree exhibited. Certainly, this is what is seen in the cases known as hystero-epileptic. In forming the compound the hysterical element is, very properly, expressed first, the disease being a hysteria with epileptic or epileptoid manifestations, rather than an epilepsy with hysterical or hysteroid manifestations. A study of the definition of hystero-epilepsy which has been given will show that it is intended to restrict the application of the term in the present article to cases with involuntary or non-purposive attacks, the voluntary or purposive having been considered in the last article.
1
Epilepsy and other Chronic Convulsive Diseases: their Causes, Symptoms, and Treatment, by W. R. Gowers, M.D., F. R. C. P., etc., London, 1881.
HISTORY.—The greatest impulse to the study of hystero-epilepsy in recent years has been given by the brilliant labors of Charcot and his pupils and assistants in his famous service at La Salpêtrière. In his lectures on diseases of the nervous system2 (edited by Bourneville), and in various publications in Le Progrès médical and other journals, Charcot has reinvestigated hysteria major with great thoroughness, and has thrown new light upon many points before in obscurity. He deserves immense credit also for the work which he has stimulated others to do. Bourneville, well known as the editor of some of Charcot's most valuable works, has published, alone or with others, several valuable monographs upon hysteria and epilepsy.3 The most valuable work on hystero-epilepsy, however, because the most elaborate and comprehensive, is the treatise of Richer.4 Richer was for a time interne in the Salpêtrière Hospital, and with Regnard pursued his investigations under the superintendence and direction of Charcot. His book is a volume of more than seven hundred pages, containing a vast amount of information and profusely illustrated, in large part by original sketches by the author. Charcot himself has written for it a commendatory preface.
2 Leçons sur les Maladies du Système nerveux. A portion of these lectures have been translated by G. Sigerson, M.D., and published by the New Sydenham Society of London, and reprinted in 1878 and 1879 in Medical News
3 Bourneville, Recherches clinique et therapeutique sur l'Épilepsie et l'Hystérie, 1876; Bourneville et Voulet, De la Contracture hystérique-permanente, 1872; Bourneville et Regnard, Iconographie photographique de la Salpêtrière. I have made special use of the second volume of the last of these works.
4 Études cliniques sur l'Hystero-épilepsie, ou Grande Hystérie, par le Dr Paul Richer, Paris, 1881.
No article on hystero-epilepsy can be written without frequent use of this work of Richer, and also of the numerous contributions of Charcot. To them we are indebted for new ways of looking at this
disease, as well as for an almost inexhaustible array of facts and illustrations of the diverse phases of this disorder.
While the curious, grotesque, or outrageous manifestations now known as hystero-epileptic have been discussed with more or less minuteness by authors from the time of Sydenham to the present, usually, and more especially in all countries but France, these manifestations have been studied as isolated phenomena. Charcot and Richer, however, present a comprehensive view of hysteria as a disease of a certain typical form, but often manifesting itself in an imperfect or irregular manner This regular type is characterized particularly by a frequently- or infrequently-recurring grave attack, which is divided into distinct periods, and these periods into phases.
This regular type of grave hysteria once understood, a place of advantage is gained from which to study the disease in its imperfect, irregular, and abortive forms. Whatever its pathology may be, such striking symptoms as loss of consciousness with spasm, hallucinations, and illusions show at least temporary disturbance of the integrity of the cerebrum.
Hystero-epilepsy of imperfectly developed or irregular type is a not uncommon affection in this country, but the disease in its regular type is comparatively rare.
VARIETIES.—Hysteria and epilepsy, so far as seizures are concerned, may show themselves in two ways in the same patient; but I believe that it is best that the term hystero-epilepsy should be restricted in its application, as Charcot, Bourneville, and Richer have advised, to the disorder in which hysterical and epileptic symptoms are commingled in the same attack—what is spoken of by the French as hysteroepilepsy with combined crises. The other method of combination is in the affection known as hystero-epilepsy with separate crises, in which the same patient is the victim of two distinct diseases, hysteria and epilepsy, the symptoms of which appear independently of each other.
The fact that hysteria is at times associated with true epilepsy is often overlooked. A patient who is known to have had pure hysterical seizures of the grave type has also a genuine paroxysm of epilepsy, and thus the medical attendant is deceived. I will dismiss the consideration of hystero-epilepsy with separate crises with a few paragraphs at this place, devoting the rest of the article to the disorder with combined crises.
The coexistence of hysteria and epilepsy, with distinct manifestations of the two neuroses, has been most thoroughly considered by D'Olier 5 Beau in 1836, and Esquirol in 1838, first showed this coexistence. Landouzy in 1846 first made use of the name hysteroepilepsy with separate crises.
5 Memoir which obtained the Esquirol prize in 1881, by M. D'Olier, interne of the hospitals of Paris, on “Hystero-Epilepsy with Distinct Crises, considered in the Two Sexes, and particularly in Man,” translated and abstracted by E. M. Nelson, M.D., in the Alienist and Neurologist, April, 1882.
In France the distinct existence of hysteria and epilepsy in the same individual is not, according to D'Olier, a very exceptional fact. Beau has reported it 20 times in 276 cases. The different modes of coexistence have been summed up by Charcot as follows: “1, Hysteria supervening in a subject already epileptic; 2, epilepsy supervening in a subject previously hysterical; 3, convulsive hysteria coexisting with epileptic vertigo; 4, epilepsy developing upon nonconvulsive hysteria (contracture, anæsthesia).”
The following case, now in the Philadelphia Hospital, illustrates the first of these modes of combination: S——, aged thirty-nine, female, a Swede, came to this country in 1869. She said that her mother had fits of some kind. The patient had her first fit when she was four years old. Her menses did not come on until she was nineteen. With the appearance of her periods she had fainting-spells off and on for two years, and in these spells she would fall to the ground. After two years she improved somewhat, but still would have an occasional seizure like petit mal. Four years ago she had a severe fit, in which she bit her tongue. This was a paroxysm of true epilepsy. It was
witnessed by the chief nurse in the hospital, a competent observer Since then she has had attacks of some kind every month or oftener. She rarely had a true epileptic seizure. Often, however, she had hysterical and hystero-epileptic attacks. These paroxysms have been witnessed by myself and by the resident physician and nurse. Rarely they were epileptic, frequently they were hysterical. Mental excitement will often induce an hysterical spasm.
PATHOLOGY.—Holding that hystero-epilepsy is a form of grave hysteria, the remarks which have been made in the last article on the probable nature of severe convulsive attacks will be applicable here. In hystero-epilepsy with the typical grave attack we have the highest expression of that disturbance of cerebro-spinal equilibrium which constitutes the pathology of hysteria.
ETIOLOGY.—It will also be unnecessary to go at length into the discussion of the predisposing and exciting causes of hysteroepilepsy. In general, its predisposing causes are those of hysteria of any form. Certain causes or conditions, however, predispose to certain types or forms of hysteria. The Latin races are more inclined to the hystero-epileptic form of hysteria than are the natives of more temperate or colder climates. Bearing upon this point, I have already quoted the letter of Guiteras with reference to hysteria and hysteroepilepsy in Cuba and semi-tropical America. Forms of religion which cultivate to an extreme degree the emotional or the sentimental side of human nature tend to produce hystero-epilepsy.
With reference to sex it may be said that hystero-epilepsy prevails to a greater extent among females than males, even proportionately to a larger degree than some of the other marked phases of hysteria. It does, however, occur in men and boys, although rarely. Richer records, from the practice of Charcot, a case in a lad of twelve years. Several cases have fallen under my own care.
Ten years since I saw a case of hystero-epilepsy, which in some respects closely simulated tetanus, in a youth nineteen years old. He was well until seventeen years of age, when he slightly wrenched his back. Shortly afterward he felt some pain between the shoulders.
From that time, at irregular intervals, generally of a few days only, he was subject to attacks of dull pain, which seemed to run up the spine to the head. About two months after this injury he first had a spasmodic attack. A spasm would come on while he was quietly sitting or working. The body assumed the backward-arched position. As his father described the case, there was always space enough under his back for a baby to crawl through. Generally, he would have more than one seizure on a given occasion. He would sometimes have as many as six or seven in one hour. On coming to, he would stare and mutter and work his mouth and lips, at the same time pointing around with his hands and fingers in a wild way. Sometimes he would sleep for several hours afterward if not disturbed, but his sleep was not of a stertorous character. He said that he could feel the attacks coming on; his body felt as if it was stretching, his head going back. He thought he was not conscious during the whole of the attacks, but between the spasms he could take medicine when directed. When first examined he had decided tenderness on pressure over the second, third, and fourth dorsal vertebræ. Pressure in this region would sometimes bring on a convulsive paroxysm. When first seen he had been for three months having seizures every two or three weeks. He was under observation for several months, during which time he was treated with faradization to the spine, the hot spinal douche, tonics, and bromides, and made a complete recovery.
W. Page McIntosh6 has reported several cases of hystero-epilepsy in the male, one of which is doubly interesting because it was in a negro. This patient was twenty-one years old, stout, and previously in good health. He complained of intense pain in the stomach, and soon passed into a violent convulsion. To show the importance of diagnosis in these cases, it is interesting to note that the doctor first thought of strychnia-poisoning, then of acute indigestion, next of tetanus. Soon, however, he decided that he had a case of hysteria. The patient had other convulsions on the day following the first attack. The seizures were evidently hystero-epileptic or hysterical. He was not unconscious, and believed that on a recent previous evening he had been conjured by an old negress. The spell was to
work in three days, which it did. The doctor counter-spelled him with a hypodermatic syringe, after which he promptly recovered. McIntosh reports another case in a man forty years old and the father of six children, who was laboring under strong mental excitement because of the sufferings of a dangerously ill child. His whole form was convulsed, and his body underwent a variety of peculiar contortions. He had had similar attacks before, and had subsequent recurrences.
The following case was observed in the Philadelphia Hospital: W. F. ——, aged twenty-eight years, married, has one child. His seizures began seven years ago, when he had an attack while playing a game of pool. At this time he had, according to his account, a sudden feeling of giddiness or vertigo in which he fell over and had a spasm, during which he thinks he was unconscious. After the seizure he suffered from headache, but had no disposition to sleep.
From that time until the present he has been subject to these spells, though the paroxysms are very irregular in frequency. Sometimes he will have several attacks in a day; again, he will be free from them for days, and perhaps for two or three weeks, but never for more than a month at a time. They have come on him while walking in the street, and on several occasions he has been taken to different hospitals. He was admitted to the Philadelphia Hospital four times. On his first admission he only remained over night; on his second and third he remained for two or three weeks. On the last admission he remained four weeks, and had spasms every day and night after admission. He had, by actual count, from five to six hundred after he went in; and in one evening, from seven P.M. to midnight, he had no less than thirty-eight. These seizures, which were witnessed by myself and two resident physicians, differed but little from each other, although at times some were more violent than others. They began with a forced inspiration; then the patient straightened himself out and breathed in a stertorous or pseudo-stertorous manner. The pulse in that stage became slow, and at times was as low as 48 per minute.
The temperature was normal or subnormal. The arched position was sometimes taken, but the opisthotonos was not marked. The paroxysm ceased by an apparent forced expiration, and the breathing then became normal; the patient remained in a somewhat dazed condition, which was only momentary. During the attack the patient said that he was unconscious of his surroundings. In the interval between the attacks he suffered from headache and from pain over the region of the stomach. He also had tenderness on pressure over the lumbar vertebræ. He never bit his tongue.
Age has some influence in the development of hystero-epilepsy It is of most common occurrence at the period of pubescence; it is rare in old age, but occurs with comparative frequency in middle life; or, rather, it should be said that middle-aged hystero-epileptics are not uncommonly met with, individuals who have for many years been subject to the attacks. In young children, girls or boys, it is certainly rare.
With reference to the exciting causes of hystero-epilepsy, it will only be necessary to say that of those which have already been enumerated in the general discussion of the etiology of hysteria, a few, such as domestic troubles, abnormal sexual excitement, and painful menstruation, are likely to induce the paroxysm, but fright, excitement, anxiety, sudden joy, and other psychical disturbances are the most frequent of the exciting causes of the seizures. A threat or a blow has been known to precipitate an attack. The use or abuse of alcohol is sometimes an exciting cause. Reflex irritation, such as that from intestinal worms, and digestive disorders sometimes produces hystero-epileptic attacks in children.
SYMPTOMATOLOGY.—In considering the symptoms of hystero-epilepsy the subject must be approached from several points of view. In the first place, the disorder can be divided (1) into the regular or typical grave attack; and (2) into the irregular attacks. These irregular seizures can be greatly subdivided, but their discussion will be confined to those types which have been most observed in this country, although I do not think that any variety of hystero-epilepsy is
distinctively American; and this is what might be supposed from the largeness of our country and the different nationalities of which it is composed.
I have seen but few cases of hystero-epilepsy of the regular type. One of these was first described at some length in the American Journal of Medical Sciences for October, 1881. I will here give the case, with illustrations, somewhat condensed from the accounts as first published.7
7 For the opportunity of studying and treating this case I was under obligations to Charles S. Turnbull and J. Solis Cohen, the patient having been for several months under their care at the German Hospital of Philadelphia. Carefully prepared notes of the case were furnished to me by H. S. Bissey and H. W. Norton, resident physicians at the hospital. I was also under great obligations to my friend J. M. Taylor for a series of sketches of the positions assumed by the patient at different stages of the attack.
R——, æt. 21, single, was first admitted to the German Hospital Nov. 13, 1879. Between her ninth and twelfth years she had had several attacks of chorea. During childhood she was often troubled with nightmare and unpleasant dreams; she often felt while asleep as if she were held down by hands. She was frequently beaten about the head and body. Her menses did not appear until she was nearly eighteen. Before and at her first menstrual epoch she suffered severe pain and cramp. During the first year of her menstruation, while at Atlantic City, the flow appeared in the morning, and she went in bathing the same afternoon. She stayed in the water two hours, was thoroughly chilled, and the discharge stopped. Ever since that time she had only menstruated one day at each period, and the flow had been scanty and attended with pain. When about eighteen she kept company with a man for five months, and after having put much confidence in him learned that he had a wife and two children. This episode caused her much worriment. She positively denied seduction. She became much depressed. September 2, 1879, she was seized in a street-car with a fainting fit. On coming to, she found her left arm was affected with an unremitting tremor. Seven weeks later she was admitted to the German Hospital. She had severe
