Birth of the A-Bond
Brazil exchanged its benchmark Brady C-bond with a new, improved bond called the A-bond, thanks to some clever liability management.
The Brazilian Treasury
marked the end of an era in emerging markets in August, when it
replaced 80% of its C-bonds with a new bond named the A-bond.
For many years, the C-bond (or Front Loaded Interest Reduction
with Capitalization Series L Bond) was the most liquid
emerging-market bond and the benchmark for the asset class.
But Brazil wanted to rid itself of the stigma attached to
the so-called Brady bonds, issued as part of the debt
restructurings orchestrated in the early 1990s by former US
Treasury Secretary Nicholas Brady. In a deal last month led by
JP Morgan and CSFB, Brazil eliminated the biggest Brady bond of
all and saved itself some money as well.
"The C-bond was trading outside the curve," says José
Antonio Gragnani, assistant secretary at the National Treasury,
"so it was pushing up Brazil's country risk. [The new bond] is
highly beneficial." Investors agree. "This was a win-win both
for Brazil and for investors," says a major US emerging-market
Many institutional investors could never buy the C-bond, even
though it has more than doubled in price since September 2002,
because it was issued as part of a debt restructuring. The
market for the plain vanilla A-bond is therefore much wider.
Furthermore, unlike its predecessor, the A-bond has no cap on
price appreciation. The C-bond was callable at par once every
six months (in April and October). As long as the C-bond traded
below par, this was no problem for investors. The C-bond began
trading above par from time to time starting in 2004, but the
threat of a call at par limited its upward movement. "If you
believe this is an improving credit, as we do, you want that
upside," says the portfolio manager. The market quickly drove
the yield down, with the A-bond trading at 103.25 ten days
after launch. The C-bond was retired at 101.25.
Brazil won an extended tenor in the exchange without
conceding any extra yield. JP Morgan and CSFB set the coupon at
8%, the same as the C-bond, and took bids on the new bond's
tenor. After sounding out the market they set the maximum
extension on the C-bond, due to expire in April 2014, at four
years. In the end, investors were happy to go to the long end
the extension set in the auction was three years and
"Investors simply exchanged a bond worth one price for
another bond worth the same price," says Moctar Fall of JP
Morgan, joint manager. "Brazil gave up the call feature, and
for that investors were willing to extend the tenor. We could
have fixed the maturity and had investors bid on price, but
investors have more ownership of the outcome when you do it
this way. It was very simple and very successful."
Extending the tenor was important for Brazil because
both the C-bond and the A-bond are amortizing bonds. Delaying
maturity by almost four years gave Brazil a payment holiday.
That is significant because Brazil has a heavy amortization
schedule of $6 billion-$7 billion a year between 2005-2007. It
will now be spared two annual payments of $300 million each for
the next four years.
Investors tendered $4.4 billion in C-bonds, out of $5.6
billion outstanding. It seems likely that Brazil will now
exercise its call on the remaining $1.2 billion in October.
Investors expect the Treasury to examine its options for
retiring other Brazilian Brady Bonds, with a market value of
about $7.8 billion. The Treasury is unlikely to take the same
route as it did with the C-bond because these Brady Bonds are
not callable and most trade below par.
The success of the C-bond swap is a demonstration of
investor confidence in Brazil, even though the deal took place
in the middle of a nasty political corruption crisis (see
"Stormy Seas," p.41). Even worse, the day the offer
expired on July 21 was also the day China revalued the renminbi
and London was gripped by a terrorist scare. Far from being
derailed by these events, Brazil's A-bond surged ahead.