Brady Bonds are sovereign debt securities issued by developing countries to finance the existing debt of foreign commercial banks denominated in United States dollars (USD) and backed by US Treasury bonds or other high-grade securities.
This type of securities got its name in honor of Nicholas Brady, the former US Treasury Secretary, who proposed to restructure the sovereign debt of several Latin American countries in 1989 after a number of them defaulted on their debts.
The Brady bond mechanism was to convert the debt of developing countries into special securities that would be backed by Treasury bonds with maturities of up to 30 years. Thus, the country purchased zero-coupon bonds from the US Treasury, the maturity of which would correspond to the maturity of an individual Brady bond. In this case, the zero-coupon bond was held by the US Federal Reserve until maturity, after which it was sold to pay off the principal. Thus, in the event of a default, the bondholder received the underlying collateral on the maturity date.
There are several basic types of Brady bonds:
1. Bonds sold at par (Par Bonds);
2. Bonds sold at a price below par (discount);
3. Bonds of "new money" (New Money Bonds);
4. Debt Conversion Bonds.
The main risks of this type of bonds are interest rate risk, credit risk, sovereign risk. Most bonds of this type are rated below investment grade.
Among the countries that have successfully realized the potential of Brady bonds is Mexico, which not only became the first country to restructure its debt in this way, but also fully met its obligations in 2003. By 1996, about $190 billion worth of Brady bonds had been issued by developing countries. However, the experience of using this type of bond cannot be unambiguously called positive: for example, in 1999, Ecuador defaulted on Brady bonds.