AIB’S DECISION not to pay out on subordinated bonds has triggered a new “failure to pay” credit event that will force sellers of insurance against default to cover some losses incurred by the bondholders.

A new ruling by the International Swaps and Derivatives Association, the trade body that oversees the credit default swaps market, ruled that a failure to pay credit event – a financial markets term for a default on a payment or breach of a bond covenant – had occurred at AIB.

The association said senior and subordinated auctions would take place after ruling last week that a “credit event” had taken place.

The ruling means that bondholders will be able to recover some of their losses as a result of insuring against a default by the bank.

There is a net notional value of $507 million (€353 million) in credit default swaps contracts on AIB debt.

The payout is expected to be higher and more straightforward under a “failure to pay” credit event than under a restructuring credit event. This has no cost to the State as neither AIB nor the Government are party to the contracts.

The derivatives association said that the failure to pay credit event took place on June 19th after AIB, which is 93 per cent owned by the State, said that it did not intend to pay the coupon on a subordinated bond due to be repaid on June 5th and had a 15-day grace period.

The Government is seeking to pass about €5 billion in losses at the banks on to their subordinated bondholders through either voluntary deals deemed coercive due to the terms of the offers or through court orders to change the terms of the bonds, making them virtually worthless.

Only subordinated bondholders at AIB have been subjected to a court order – the Subordinated Liabilities Order under the Government’s emergency banking legislation, the Credit Institutions (Stabilisation) Act 2010 – to force losses on to these lenders.

(Additional reporting – Reuters)