Brady Bonds

Stakeholders involved in Brady Bond debt restructuring and transactions. Dollar values on outstanding loans and bonds are illustrative; bonds were rarely issued for less than US$125 million, and lenders frequently accepted either 30–50% losses on face value or reduced interest rates fixed at below-market values.[1] According to EMTA, a financial industry trade association, most lenders that accepted Brady bonds for outstanding loans were smaller US commercial banks or non-US financial institutions, rather than "major money center banks."[2]

Brady bonds are dollar-denominated bonds, issued mostly by Latin American countries in the late 1980s. The bonds were named after U.S. Treasury Secretary Nicholas Brady, who proposed a novel debt-reduction agreement for developing countries.

History

Brady bonds were created in March 1989 to convert bank loans, mostly in Latin America, into a variety or "menu" of new bonds after many countries defaulted on their debt in the 1980s. At the time, the market for emerging markets' sovereign debt was small and illiquid, and the standardization of emerging-market debt facilitated risk-spreading and trading. In exchange for commercial bank loans, the countries issued new bonds for the principal sum and, in some cases, unpaid interest. Because they were tradable and came with some guarantees, they were sometimes more valuable to the creditors than the original bonds.

The key innovation behind the introduction of Brady Bonds was to allow the commercial banks to exchange their claims on developing countries into tradable instruments, allowing them to get the debt off their balance sheets. This reduced the concentration risk to those banks.

The plan included two rounds. In the first round, creditors bargained with debtors over the terms of the new claims. Loosely interpreted, the options contained different mixes of "exit" and "new money" options. The exit options were designed for creditors who wanted to reduce their exposure to a debtor country. Those options allowed creditors to reduce their exposure to debtor nations, albeit at a discount. The new money options reflected the belief that those creditors that chose not to exit would experience a capital gain from the transaction, as the nominal outstanding debt obligation of the debtor would be reduced, and with it, the probability of future default. Those options allowed creditors to retain their exposure.but required additional credit extension designed to "tax" the expected capital gains. The principal of many instruments was collateralized, as were "rolling interest guarantees," which guaranteed payment for fixed short periods. The first round negotiations thus involved the determination of the effective magnitude of discount on the exit options together with the amount of new lending called for under the new money options.

In the second round, creditors converted their existing claims into their choice among the "menu" of options agreed upon in the first round. The penalties for creditors failing to comply with the terms of the deal were never made explicit. Nevertheless, compliance was not an important problem under the Brady Plan. Banks wishing to cease their foreign lending activities tended to choose the exit option under the auspices of the deal.

By offering a "menu" of options, the Brady Plan permitted credit restructurings to be tailored to the heterogeneous preferences of creditors. The terms achieved under the deals indicate that debtors used the menu approach to reduce the cost of debt reduction. Furthermore, it reduced the holdout problem in which certain shareholders have an incentive not to participate in the restructuring in the hope of getting a better deal.

The principal amount was usually collateralized by specially issued US Treasury 30-year zero-coupon bonds purchased by the debtor country using a combination of International Monetary Fund, World Bank, and the country's own foreign currency reserves. Interest payments on Brady bonds, in some cases, are guaranteed by securities of at least double-A-rated credit quality held with the Federal Reserve Bank of New York.

Countries that participated in the initial round of issuing Brady bonds were Argentina, Brazil, Bulgaria, Costa Rica, Dominican Republic, Ecuador, Mexico, Morocco, Nigeria, Philippines, Poland, Uruguay, and Venezuela.

Other Languages
Deutsch: Brady Bond
español: Plan Brady
français: Brady Bonds
italiano: Brady bond
português: Plano Brady