Brady Bonds are
sovereign debt and complex credit-enhanced bonds issued under the Brady Plan Agreements.
These involve an exchange of commercial bank loans (which may, or may not, be in default)
into securitized bonds as part of an effort to restructure and reduce the debt of emerging
market countries. As part of these agreements, these countries have reformed their
economic policies and are achieving economic growth to the point of being better able to
make timely payments on their now reduced debt.
Brady Bonds are named after former U.S. Secretary of
the Treasury, Nicholas Brady. In an effort to resolve the "debt crisis" of many
Emerging Markets countries Mr. Brady offered U.S. government official multilateral support
in obtaining debt and debt service relief for those countries saddled with enormous
foreign commercial bank debt. This help was available if these nations committed to a
comprehensive program of fiscal reforms, supported by the International Monetary Fund and
the World Bank.
There are several
options for Brady bond structuring that may be chosen by creditors providing debt and debt
service relief to sovereign debtors.
Par and Discount bonds:
These bonds can be either fixed- or floating rate
collateralized bonds.
These represent the most common type of Brady bond
issued.
Par bonds are issued for the original face value of
the loans for which they were exchanged. However, par bonds have a fixed interest rate
that is below the market rate (at the time of issuance).
Discount bonds have a floating market interest rate,
and are issued at a discount to the original face value of the original loan.
In general, both par and discount bonds have their
principal at maturity collateralized by U.S. Treasury zero-coupon bonds. Both types also
usually possess additional collateral as a specified cash amount that can be used to pay
interest for a number of months (usually 12 to 18) in the event that the sovereign country
misses an interest payment. Thus, this collateral provides "rolling" interest
payment protection (often called "RIG", or rolling interest guarantee) that can
be applied to guarantee the nearest dated interest payments of the instrument.
Debt Conversion Bonds (DCBs) - New Money
Bonds (NMBs) - Front Loaded Interest Reduction Bonds (FLIRBs)
These issues tend to be amortizing bearer
instruments, characterized by shorter maturity and average life than the Par and Discount
bond types. They also lack collateral securing the principal.
Only the FLIRBs carry collateral securing interest
payments (generally for 12 months).
FLIRBs carry a fixed, below-market interest rate
which rises incrementally over the initial 5 to 7 years of the life of the bond, and is
then replaced by a floating rate coupon for the remaining life of the bond.
Creditors using the combined DCB/NMB option in the
restructuring agreement are able to exchange their loans for DCBs at face value and earn a
floating market interest rate. In exchange for this, creditors accept a commitment to
extend new funds to the sovereign debtor in a fixed percentage of the original face value
of the loans. These new funds are extended in the form of short-term, floating rate bonds:
NMBs.
