If you are an investor with at least $107,500 who can afford to take a real credit risk, who likes high yielding bonds or who has a large position in junk bonds and is looking for an investment that would be beneficial for "tax swapping," here's a bond suggestion: the $18 billion, nonrated United Mexican States, collateralized 6.25 percent senior secured bonds, due in 2019. They are better known as the Mexican Brady bonds that were issued in 1989 as part of Mexico's debt restructuring agreement with its commercial bank lenders.
The principal payment of the Brady bonds is collateralized by underlying U.S. government zero-coupon bonds that will mature at par in 2019. The bonds also have 18 months of interest payments, collateralized by double A- or better-rated securities. The Brady bonds come in minimums of $250,000 and, for Americans, are issued in U.S. dollars. They are currently selling for $430 per bond, or $107,500 for a $250,000 bond.
Salomon Brothers Inc. expects the Brady bonds to receive a double-B rating from one of the U.S. rating agencies by year-end. This rating will reflect three factors: Mexico's strong fundamental credit and economic improvement under President Salinas; Mexico's debt restructuring agreement with its bank lenders, making the handling of its large external debt much more manageable; and the anticipated closer economic integration of Mexico's economy with the U.S. economy through a free-trade agreement, which would be similar to the U.S.-Canada agreement.
As a sovereign country, Mexico has unique policy resources to offset financial shocks that corporations do not have, i.e., the ability to tax, monetary policy controls, external financing resources and the use of exchange rates to affect export policies. Consequently, the "ability to pay," or service, its debt is most important.
Also important is Mexico's "willingness to pay." Key here is political stability and leadership, plus Mexico's commitment to integrate its economy into the world economic and financial system. With the 6.25 percent Brady bond selling around 43 ($430), the yield to maturity is 14.86 percent. If Salomon Brothers's analysis is correct, the credit risk might not be as bad as it seems, and the rewards will be great too.
There is a real difference in the role of interest rates in the current recession and the recessions of the last 20 years. The last recession was in 1982, a period of record high interest rates. In an effort to control inflation, the Federal Reserve under Paul Volcker tightened credit by raising short-term interest rates until a credit crunch occurred. In fact, all of the post-World War II recessions were Fed-induced.
The key federal funds rate, the rate controlled by the Fed and the rate at which member banks lend to one another, reached 20.50 percent in December 1980. The much higher short-term rates produced negative yield curves with lower returns available in the longer maturities. (A yield curve is a graph that plots interest rates to show if short-term yields are higher or lower than long-term rates.) On March 7, 1980, a negative yield curve of 261 basis points existed. (A basis point is one one-hundredth of a percentage point.) By June 1980, a positive yield curve of 113 basis points was in place. But after the presidential election, the steep negative yield curves returned in 1980, '81 and '82, which induced the 1982 recession.
Contrast that experience with what is occurring today. The federal funds rate peaked at 10 percent in April 1989 when the yield curve was a negative 52 basis points. It remained slightly negative during September through November and has been positive ever since. This has prompted Bill Sullivan, senior vice president of money market research at Dean Witter Reynolds Inc., to say, "I take issue with anyone who thinks interest rates are too high." The difference today is that the tightness of credit is coming from the banking system itself, and not from the Fed.
Since the beginning of the year, bank regulators have been diligent in seeing that the savings and loan fiasco doesn't hit the banking system. Lending regulations were made more stringent, and with many problem loans already on their books, banks have curtailed their lending. But not because of high interest rates.
Sullivan believes that the recession will be a shallow one, and long-term interest rates may be close to their lows. His reasons: Interest rates are already low; we have had a positive yield curve for the past 12 months; today's cheap dollar is boosting exports, and the federal budget is providing stimulus. Consequently, Sullivan believes that business owners are free to plan into mid-1991 or early 1992 without fear that the Fed will tighten credit. If Sullivan is correct and the economy rebounds more quickly than anticipated, you would not want to buy Treasuries beyond seven years.