THE body that oversees the financial derivatives market has ruled that AIB is in default on its subordinated bonds.
It comes after the bank launched an offer to buy €2.6bn of its own bonds at prices as low as 10 cent in the euro on June 9.
Last night, the International Swaps and Derivatives Association (ISDA), a banking industry trade body, ruled that the offer should be considered a "credit event", industry language for default.
The ruling only affects the financial derivatives market. It does not mean AIB is facing bankruptcy and has no bearing on the bank's other debts or on deposits.
The ruling was expected and follows a similar decision last November regarding Anglo Irish Bank after that bank launched a similar "burden sharing" buyback offer. Holders of Anglo's subordinated bonds were able to recover 82 cent in the euro if they held bond insurance, as a result of the ruling.
AIB is offering to buy its subordinated bonds at prices as low as 10 cent in the euro.
The deal has been structured to impose even bigger losses on bondholders that reject the offer, if the deal is backed by a qualified majority of bondholders.
Unsurprisingly, the ISDA, which oversees the market for credit default swaps (CDS), considers those terms punishing enough to be regarded as a default.
CDS contracts pay bondholders if the bonds they have invested in end up in default.
State-owned AIB has been ordered to raise €13.3bn in fresh capital to meet the Central Bank's rules on capitalisation.
The buyback helps meet the target because the difference between the price paid and the face value of the bonds acquired is considered a profit. AIB could raise €2bn from the buyback.
The derivatives market has its own mechanism for ruling on default events. ISDA acts as the market's referee in such cases.
The ruling means international banks that sold insurance to AIB's subordinated bondholders have to pay out. The payout price will be determined at an auction.
The decision may even help the bank, because bondholders who know they are insured are more likely to back the buyback deal.
Holders have insured around $507m (€352m) of AIB's €2.6bn of subordinated bonds, so only a small minority of bondholders stand to benefit.
Bondholders in 15 of AIB's 18 sets of subordinated bonds had until midnight last night, New York time, to accept.
Two sets of AIB bonds are tied up in a legal challenge taken by Aurelius, which wants to overturn a court order that allows the Finance Minister to force losses on bondholders if they resist the buyback.