Brady Bond Primer

Article Index

Brady Bonds (current as of 1996)

  • Named after U.S. Treasury Secretary Nicholas Brady, who in association with the IMF and World Bank sponsored the effort to permanently restructure outstanding sovereign loans and interest arrears into liquid debt instruments.

  • Coupon bearing bonds with fixed, step or floating rate (or hybrid combination of each), having 10 to 30 year maturity.

  • Brady bonds have semiannual interest payments and generally amortize.

  • Principal and certain interest is collateralized by U.S. Treasury zero coupon bonds and other high grade instruments.

  • Creditor banks exchanged sovereign loans for Brady bonds incorporating principal and interest guarantees and cash payments.

  • Debtor governments had their principal, interest and interest arrears reduced.

  • Issued as Registered and Bearer bonds

  • Certain Par and Discount bonds incorporate value recovery rights or warrants.

  • Countries involved in the Brady Plan restructuring:

  • Argentina

    Brazil

    Bulgaria

    Costa Rica

    Dominican Republic

    Ecuador

    Mexico

    Morocco

    Nigeria

    Philippines

    Poland

    Uruguay

  • Potential future candidates for Brady Plan restructuring:

    • Ex-Soviet (Vnesheconobank), Nicaragua, Panama, Peru


What is a Value Recovery Right or Warrant?

Some countries like Mexico, Venezuela, and Nigeria have attached to their Par and Discount bonds rights or warrants which grant bondholders the right to recover a portion of debt or debt service reduction as stated in the Exchange Agreements, should their debt servicing capacity improve. In effect, some are known as Oil Warrants because they are linked to oil export prices and thus to the oil export receipts.

What do Collateral and Rolling Interest Guarantees mean?

The collateral consists of funds maintained in a cash account usually at the Federal Reserve Bank in New York and typically invested in AA- or better securities, for the purpose of paying the interest should a debtor country not honor an interest payment. A rolling interest guarantee (usually 12 to 18 months or 2 to 3 coupon payments) remains in effect as each successive coupon payment is made and the collateral continues to guarantee the next successive unsecured coupon payment. In the event the collateral is used, there is no obligation to replace it.


What is the street valuation methodology?

Brady Bonds carry three risk components:

1. The principal collateral in the form of US Treasury zero coupon principal guarantee.

2. The rolling interest guarantees comprised of securities on deposit with the Federal Reserve Bank.
(By convention no consideration is given to rights and warrants for valuation purposes)

  • Two approaches may be considered for valuation purposes:
  • Use option pricing or probability models to determine the probability of default or
  • Conservatively assume the debtor default and the guarantee used to pay the interest
  • Sovereign risk.

A procedure to value Brady Bonds considers individually the three distinct risk components for each class of bond:

1. The present value of PAR and DISCOUNT principal collateral derived from U.S. Treasury strip yield with comparable maturity.

2. Conservative valuation of the interest component as assumed serviced by the rolling guarantee:

  • For fixed coupon bonds use either the U.S. Treasury Bill or \"AAA\" rates corresponding to the first 2 or 3 coupon dates.
  • For floating coupon bonds compute the equivalent fixed-rate yield on a LIBOR based asset swap or forward rate basis.

3. Value the remaining non-collateralized cash flows

  • Compute the stripped yield or the IRR of the remaining cash flows

4. Sovereign risk is the implied stripped yield (non enhanced by the credit guarantees)

  • Considered as the current Brady bond market price less the value of principal and interest collateral.
  • A blended yield to maturity is the IRR of the bond\'s total cash flows (collaterilized and non-collaterized components)
  • The blended yield will usually be lower than the stripped yield since the value of the guarantees will raise a bond\'s price.

NOTE: for additional information continue with Brady Debt Issue Flavors