Brady Bonds

Brady bonds refer to United States sovereign debt securities backed by the U.S. treasury bonds. Developing countries issue it to restructure their external commercial bank loans in the U.S. dollar (USD) denomination. Its prime aim is to reduce the external debt of developing nations.

It is sometimes called United States treasury bonds, giving the buyer regular and periodic interest plus a principal payment. They have a high liquidity rate with a maturity period of 10-30 years. Commercial banks and lenders use Brady bonds to convert default loans into zero coupon bonds which they collateralize and store in the U.S. Fed until maturity. At maturity, either bank sells off the bond for loan payment, or the borrowers pay the principal to the lender.

• Brady bonds definition describes a bond backed by the U.S. treasury, issued by a developing nation against its foreign debt to reduce its debt burden.
• These bonds have - a maturity period of around thirty years, a high liquidity nature, and a greater risk for investors.
• These bonds are mainly of five types - par bonds, discount bonds, new money bonds, front-loaded interest-reduction bonds, and debt conversion bonds (DCBs).
• They entail three major risks for the investors - sovereign risk, interest-rate risk, and liquidity risk. 

Brady bonds are a financial instrument issued by developing nations in the U.S. dollar denomination (USD) in the form of U.S. sovereign bonds. It helps mitigate their external debt and encourages investing. The former U.S. Treasury Secretary Nicholas Brady formulated the Brady bonds in 1989 to tackle the large debt defaults of Latin American countries. These bond price movements depicted the market sentiments towards developing countries. Among the Latin American countries, Mexico was the first nation to utilize these special bonds for restructuring its foreign debts in the late 1980s. 

Later the following countries adopted it-

• Brazil
• Costa Rica
• Ecuador
• Peru
• Jordan 
• Argentina
• Nigeria
• Poland
• Uruguay
• Venezuela
• Vietnam, and 
• Russia

It allows commercial banks to replace their debt with bonds of equal denomination. In a way, the bonds convert the non-performing assets (NPA) of the banks into U.S. treasury-backed tradeable financial instruments paving the way to remove the NPAs from their balance sheet. As a result, the developing country reshaped their external debt as U.S. treasury bonds and reduced their debt burden and concentration risk.

The bond issuing country purchases zero-coupon bonds from the treasury of the U.S. These bonds have the same maturity period as the Brady bonds. Then the U.S. treasury holds these bonds until their maturity, i.e., around thirty years. After the bonds mature, the developing nation sells them off to repay the debt principal. Moreover, if the developing nation defaults on debt payment, the bondholders get the bond's collateral rights after maturity. 

The United States and multilateral lending agencies like the International Monetary Fund (IMF) and the World Bank supported the Brady Plan by cooperating with commercial bank creditors.

They come in many types like: 

1. Par Bonds- Bonds that traders sell or trade at par, i.e., at its face value. Its coupon rate is identical to the market rate.
2. Discount Bonds - Bonds sold at a below-par price or face value. So, traders and exchangers trade them in secondary markets.
3. New Money Bonds - Bonds related to 'new money.' Issuers issue it to finance the costs of eligible products.
4. Front-Loaded Interest-Reduction Bonds – Bonds that facilitate a temporary reduction in interest rates.
5. Debt Conversion Bonds (DCBs) – Bonds used for existing debt into new money bonds. They yield interest payments and hence are called fixed-income corporate debt.

Let us use Brady bond examples to understand the subject matter more clearly.

Example #1

The example of Brady bonds Argentina deals with using the particular bond by Argentina. In Argentina, lenders issue treasury bills called 'letes.' They entail discounts having maturity periods of three, six, and twelve months. Then, every month, financial institutions hold actions for the letes.

Example #2

Another example deals with the use of the particular bond by Mexico under Ajustabonos. These bonds were long-term, with 3 and 5 years of tenure, and foreign investors got tax exemption for these bonds. The Mexican treasury issued it, indexed concerning inflation, and used to pay a real-time return on the Mexican consumer price index.

Example #3

Russian Brady bonds example infers that the world viewed Russia as a credit-worthy country due to its low debt. It topped the chart for oil and gas exports too. But recently, it failed to make two interest payments on its dollar bonds.

In March 2022, it was its first default since 1998. It defaulted on a total interest payment of $117mn on two of its bonds.

Further, Russia will reach an agreement after negotiating with the government and bondholders regarding the debt. Then they will do debt restructuring. Eventually, they will exchange the old defaulted bonds with new Brady bonds like instruments with a longer repayment schedule or lower interest payments.

Although the U.S. Treasury backs these bonds, these bonds have certain risks. An incident related to Brady bonds Mexico is famous for the related bond risks in the 1980s. Moreover, the risks may be in the form of liquidity risk, interest rate, and sovereign risk. 

1. Sovereign risk – Sovereign risk is associated with the- high inflation rates, volatile exchange rates, higher unemployment rates, and turbulent geo-political & economic situations arising in the bond issuer country. As a result, the investors in such bonds issued by these countries have the risk of a debt default because these bonds tend to be speculative. Developing and emerging countries face it more.
2. Interest-rate risk - Interest rate risk is inversely proportional to bond prices. If Brady bonds' market prices increase, the bond's value will drop. As a result, the investors will get a lower rate of return on investment in the bonds. All bond investors face this risk.
3. Liquidity risk – Liquidity risk arises when the bond-issuer cannot unwind its dealings of the bond, leading to liquidity risk for the bondholders. For example, it was apparent when Brady bonds Mexico failed to honor their bonds as the Mexican peso plunged in value.

Despite risks associated with this type of bond, they are highly attractive to investors due to the following:

• They give higher returns on investment.
• Provides profitability due to spread tightening on account of long-term maturity.
• The anticipation of high economic growth is also a plus point.

This article is a guide to What is Brady Bonds & its definition. Here, we explain its types, examples, incentives, and risks. You can also go through our recommended articles on corporate finance –

• Green Bonds
• Green Bonds
• Performance Bonds