Novo Banco Swaps Panel Rejects Payout on Portugal Bond Shift

  • External lawyers support majority view of ISDA’s committee
  • Ruling follows transfer of $2.2 billion of bonds to bad bank

Derivatives insuring Novo Banco SA debt won’t pay out after the Bank of Portugal’s imposition of potential losses on bondholders.

A panel of three lawyers unanimously ruled that a governmental intervention credit event hadn’t taken place, supporting the dominant view of an International Swaps & Derivatives Association committee, according to a statement from the trade group late Monday. The question was sent for external review last month after ISDA’s own committee of dealers and money managers failed to reach a ruling.

The decision may erode the appeal of credit-default swaps as it was the first test of 2014 rules designed to boost protection against losses imposed by governments or regulators. The ruling, which affects contracts covering a net $397 million of Novo Banco debt, followed the Bank of Portugal’s decision to transfer about 2 billion euros ($2.2 billion) of senior bonds to a so-called bad bank.

“For the average credit-market investor, the results of credit-event rulings are baffling,” said Jeroen van den Broek, head of developed-markets credit strategy and research at ING Bank NV in Amsterdam. “Continued rulings like this must be a negative for single-name credit-default swaps.”

In January, 11 members of ISDA’s committee voted to say that no credit event had occurred at Novo Banco, one short of the 12 needed for a ruling. The other four members said an event had taken place. The question was only the third to be referred to external panel by ISDA.

“A transfer is not essentially similar to a cancellation, conversion or exchange,” the lawyers wrote in the statement. “We have therefore concluded that the ‘No’ position is the better answer.”

Bond Transfer

The Bank of Portugal announced the transfer of the five Novo Banco bonds on the evening of Dec. 29, two days before the introduction of tighter European rules governing state aid to banks. Prime Minister Antonio Costa subsequently told parliament that he was “apprehensive about the systemic effects” resulting from the central bank’s move.

Bondholders, including Pacific Investment Management Co. and BlackRock Inc., have hired lawyers to challenge the debt transfer, according to people familiar with the matter. There are 2,678 outstanding contracts on Novo Banco debt, as of Feb. 5, based on Depository Trust & Clearing Corp. data.

ISDA’s committee is still to rule on a separate question about whether there is a successor to Novo Banco. In successor events, which don’t trigger swaps, contracts are amended so that the insurance is tied to a different entity.

The central bank’s decision caused the five bonds to slump to around 10 cents on the euro from more than 90 cents, as the bad bank is unlikely to repay the debt. The notes have subsequently risen to about 25 cents, aided by a Jornal de Negocios report that said investors may get some compensation.

The Bank of Portugal ordered the bond transfer after European Central Bank stress tests showed a 1.4 billion-euro capital shortfall at Novo Banco under an adverse scenario. The lender emerged from the 2014 breakup of Banco Espirito Santo SA, once Portugal’s largest bank by market value.

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