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Moody’s has downgraded Novo Banco’s long-term senior debt and placed its long-term deposit ratings on review for downgrade over what it describes as plans for a “distressed exchange of bonds” aimed at recapitalising the rescued Portuguese lender.

Moody’s said on Wednesday that it had downgraded Novo Banco’s long-term senior unsecured debt rating from Caa1 to Caa2, levels that imply substantial risk, and placed its Caa1 long-term deposit ratings on review for downgrade, saying senior bondholders were likely to face losses from a planned €500m bond exchange.

The downgrade is a further negative response to a plan announced on Friday to sell 75 per cent of Novo Banco to Lone Star, a US private equity fund. BlackRock and other international asset managers said on Monday that they would seek an injunction to block the sale because of a legal battle over losses on Novo Banco bonds in 2015.

As part of the agreement to sell a majority stake in Novo Banco to Lone Star, the Bank of Portugal also announced a liability management exercise (LME) in which at least €500m of senior Novo Banco bonds will be exchanged for new, higher-risk bonds to strengthen the lender’s capital ratios.

The bond exchange is voluntary, although it is also a pre-condition for the conclusion of the sale to Lone Star. Portugal’s plans to conclude the sale in the coming months would culminate more than two years of efforts to sell Novo Banco, the so-called good bank rescued from the ruins of Banco Espírito Santo in 2014.

Moody’s said it viewed the bond offer as “a distressed exchange”. The LME did not appear to include rated deposits, the rating agency said, but it was placing the lender’s long-term deposits on review for downgrade in the event that “the announced measures prove insufficient to restore the viability of the bank, or fail altogether, thereby increasing the risk of a resolution or liquidation”.

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