Iberia: The road to recovery

Author: | Published: 1 Jun 2011
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Until the financial crisis that started in September 2008, many companies chose debt as the best source of capital. This enabled them, by paying reduced interest for the capital borrowed, to develop investment schemes that in several cases resulted in record profits for shareholders. After September 2008, liquidity constraints implied in certain cases a complete or almost complete closure of debt markets, as a number of credit institutions, mainly banks, were unable to provide capital even to the most creditworthy clients. Portugal and Spain are among the countries which have been most severely suffering the consequences of the financial crisis.

The crisis had consequences on the borrowing capacity of the Portuguese State, leading to a request for financial aid to be submitted within the EC, the European Central Bank and the International Monetary Fund (IMF) in April 2011. On May 3 2011, a memorandum of understanding was executed between Portugal and the rescuing entities. The memorandum determined an accelerated privatisation programme, covering the sectors of transport (Aeroportos de Portugal and TAP), energy (EDP, GALP and REN), communications (Correios de Portugal) and insurance (Caixa Seguros e Saúde). Through this programme, the Portuguese State estimates to receive €5.5 billion ($7.88 billion) by the end of 2012.

In order to increase the liquidity of the banking system, the memorandum establishes the obligation of all banks in Portugal to reach a core Tier-1 capital ratio of 9% by end-2011 and 10% by end-2012 at the latest.

It is also worth mentioning the restructuring of the Spanish financial system in the past months. Due to the fact that certain financial institutions, particularly savings banks, struggled to cope with the crisis, given their exposure to the Spanish real estate market several savings banks were urged to merge and to be converted into banks.

In order to fully understand the extent to which the financial crisis has affected these countries we only need look at the 10-year bond differential between Portugal and Spain in comparison with Germany. As of May 31 2011, the bond differential between Spain and Germany amounted to 231 basis points, while that between Portugal and Germany amounted to around 700 basis points.

With debt markets closed, companies that needed funding to invest or simply maintain their day-to-day businesses had to seek other sources.

In this regard, while Portuguese companies mainly went in the direction of issuing new equity, Spanish companies opted for other methods, such as convertible bonds and high-yield bonds as alternatives to the traditional means of obtaining funds.

Public companies

With regard to Portugal, the financial crisis led to a notorious change in the way companies raise capital, mainly because the debt markets in Portugal plunged in 2008 and have remained a steady bear market since then, thereby increasing the importance of equity in capital structure of companies.

Despite being more costly, equity has the advantage of granting more security to companies' stakeholders as it not only creates a buffer in the balance-sheet but also shows the shareholders' higher commitment to the company's business.

In connection with Spain, companies have opted to issue debt financial products: firstly, the issuance of convertible bonds and, secondly, high-yield bonds (low-credit-rating debt) for those companies without investment grade (company bonds' credit quality rating which entails a relatively low risk of default).

Convertible bonds have the advantage of being hybrid instruments between debt and equity which ease the company's search for capital. Furthermore, there have recently been amendments to Spanish regulations on the accountability of these financial products by financial entities in order for them to be included as Tier one capital.

Finally, as mentioned previously, high yield bonds, which made a remarkable worldwide recovery in 2010, are a kind of financial product that has enabled companies without an investment grade to obtain funds from the general public, although having to pay a higher yield to their bondholders than to companies issuing general bonds because of higher levels of risk.


Share capital increase

The legal framework for the issuance of equity by public limited companies (sociedades anónimas) is subject to the provisions of the Portuguese Companies Code (PCC).

With regard to the capital increase modalities, there are two main ways of raising equity:

(i) through capital contributions in cash or in kind from shareholders or new investors; and

(ii) through the incorporation of profits.

Regarding shareholder's rights on share capital increases, article 458 of the PCC states that in capital increases through capital contributions in cash or in kind, shareholders may subscribe new shares with a pre-emptive right over non-shareholders.

If a company issues several categories of shares, all shareholders will have equal rights of preference in the subscription of new shares, be they ordinary or from a specific category, the right of preference will primarily be conferred upon the holders of shares from the same category, and other shareholders will only be entitled to subscribe these shares from the category not subscribed by those having preferential rights thereto.

As regards the necessary majority to approve capital increases in public limited companies, article 386 of the PCC states that a majority of two-thirds of the shareholders present in the meeting is required to approve a capital increase. Moreover, pursuant to article 383.2 of the PCC, shareholders representing at least one-third of the share capital must be present or represented at a shareholders' meeting in order to approve a share capital increase on first call. On second call, the company may adopt resolutions regardless of the number of shareholders present or represented and the capital which they represent.

Until the publication of Decree-Law 49/2010 of May 19, which amended the PCC, the existence of a nominal capital was mandatory. In fact, article 298 of PCC established, before Decree-Law 49/2010, that shares should not be issued for less than their par value.

The reasoning behind this provision was to avoid a new investor from becoming a shareholder of the company having paid less in proportion to other shareholders. Companies, however, started seeing this restriction more as a burden than as protection. Indeed, when a company's equity was lower than its nominal capital, it was simply unable to raise equity from new shareholders, as no one would be interested in acquiring a share for the nominal value when its book value was lower.

In order to avoid this restriction, companies started to develop complex and occasionally costly mechanisms that enabled them to issue equity under the par value. These methods are exemplified by the coup d´accordéon operation that involves a capital reduction in the first stage and a capital increase in the second.

As it became clearer that the obligation to issue shares at a par value was becoming a barrier to companies' funding, jurisdictions started to promote the introduction of no-par shares in articles of association, as Portugal did in 2010.

Decree-Law 49/2010 amended article 298.1 of the PCC, which now states that shares will not be issued for less than their par value and in the case of shares with no-par value, for less than their issue value.

Aiming to explain the nature of the issue value, article 298.3 of the PCC establishes that if the issue value of an issue of no-par shares is lower than the issue value of a previous issue, the board of directors will have to draft a report on the issue value set and on the financial consequences of the issue for the shareholders.

Despite this requirement, the implementation of this Decree-Law in the Portuguese legal system is expected to be very successful among companies, especially taking into account the actual economic and financial outlook and the advantages that this new regime brings to companies with weak balance sheets.

At this stage, and although it is still too early to be able to conclude whether or not this mechanism is likely to promote equity raising, there is an increasing

number of public companies, including some in the Portuguese Index PSI-20, which have already decided to change the nature of their shares to no-par shares, signalling the effective benefits of this regime for corporate finance.

Another source of funding for companies is the issue of preferred shares, which pursuant to article 341.2 of the PCC entitles shareholders to receive a priority dividend of not less than 5% of the respective par value, as the case may be, to be taken from the profits which may be distributed among shareholders, as well as to the priority redemption of their par value or issuing value in the event of the company's dissolution.

According to article 341.3 of the PCC, non-voting preferred shares will, apart from the rights specified in the previous paragraph, confer all rights inherent to common shares, except the right to vote.

In relation to the distribution of dividends, there are certain particularities in the Portuguese framework of preferred shares:

  • Article 342.2 of the PCC states that any priority dividend which is not paid within the financial year must be paid within the next three years, before the dividends for those years, provided that there are distributable profits.
  • Pursuant to article 342.3, if the priority dividend is not fully paid during the two financial years, the preferred shares become shares carrying the right to vote and will only lose this right the year after that in which the priority dividends in arrears are duly paid.
Raising of capital by financial entities

As mentioned above, from the start of the financial crisis Portugal felt the consequences of liquidity constraints. Interest rates on corporate borrowing soared and debt markets shut out many once creditworthy companies, thereby implying the recourse to equity financing.

In Portugal, credit institutions are opting to raise equity in order to comply with the specific capital requirements on Tier one and Tier two ratios, creating equity buffers in their balance-sheets and decreasing the proportion of debt in their capital structure.

Moreover, shareholders that generate profits are consciously deciding not to distribute the annual profits using them instead to decrease leverage and increase the company's share capital through the creation of reserves.

Besides these two ways of corporate financing, there are two other examples of financial engineering that large Portuguese banks have been using to raise capital: swaps of subordinated debt to equity; and the issue of bonds secured by the Portuguese State.

One of the solutions found by credit institutions in Portugal to raise capital was through swap operations according to which subordinated debt was converted into equity, thereby changing their capital structure and strengthening their balance sheets.

In fact, apart from the conditions under which these junior debts were issued, the fact is that even if they are subordinated, it implies not only a decrease in the company's general rating but also a decrease in the rating of each individual issue of debt, thereby causing the cost of the company's capital to soar.

The swap of subordinated debt into equity is therefore deemed to be a satisfactory solution to strengthen balance-sheets, enabling the company to simultaneously decrease the amount of debt and increase its equity, with significant benefits for its financial health.

Issue of bonds secured by the Portuguese State

At the beginning of the financial crisis, the Portuguese State approved Law 60-A/2008 of October 20 creating a €20 billion package to secure corporate borrowing, namely by credit institutions.

The purpose of this package is to ensure reasonable levels of liquidity in the market and to avoid a hike of credit institutions' systemic risk, thereby preserving the country's financial stability.

The State's guarantee was most welcomed by companies in general and mainly by credit institutions, among others, large Portuguese banks, which have already proposed the issue a total of around €4 billion in bonds secured by the Portuguese State.

According to the structure of these secured bond issues, if the borrower defaults in its payments, the State will secure their performance, reducing the risk for the lender. In this case, the State is entitled to swap its credit over the bank – acquired through the subrogation of the original lender – for an equity stake in the bank, thereby going from guarantor to shareholder of the bank.

In the worst case scenario, the Portuguese State will become a shareholder of the defaulting bank, which can be seen as a sign of the confidence in the capacity of credit institutions to remain financially stable.


In 2010, Spanish issuers were, in the same way as their Portuguese counterparts, hit by the crisis suffered by Spanish sovereign debt. The credit constraints arising as a result of this sovereign debt crisis have implied that Spanish companies are struggling to obtain financing from credit institutions and, consequently, have led Spanish companies to raise capital from other sources.

Spanish financial institutions were also hit by the real estate market crisis. As a result, the government had to manage a remarkable restructuring of the financial system, approving public aids for those entities which were suffering the crisis on a larger extent (mainly Spanish savings banks).

Within this framework, Spanish companies, in general, and financial institutions in particular, have mainly opted for the issuance of bonds as main source to raise capital. This financial product implies that bondholders become company's creditors with the right to receive interests agreed and redemption once bond maturity has elapsed.

Specifically, Spanish companies have opted for the issuance of two kinds of bonds to raise capital: convertible bonds and high-yield bonds. This new trend shows the need to find and create different and alternative means to raise capital due to constraints in debt markets and investor aversion to subscribe share capital increases as a result of the market's instability.

Convertible bonds

As a general rule, the issuance of convertible bonds entails the right of the subscribers of these financial products to receive interest over the capital invested subject to the terms and conditions set out in the relevant issuance information. Likewise, depending on the kind of convertible bonds, conversion of the bonds into company shares could be either a bondholder's right or an issuer's right (compulsory convertible bonds).

There are two procedures regarding convertible bonds: direct, when the issuer of the convertible bonds offers its shares in the event of conversion; and indirect, when the issuer offers other company's shares should the subscriber choose to convert his/her bonds.

Moreover, convertible bonds may be classified regarding their exchange system: fixed or unsettled. The former implies that the number of shares to receive when conversion is fulfilled is set forth before the issuance of the convertible, irrespective of the market price of shares when conversion takes place; on the other hand, unsettled or per relationem rate means that the number of shares to be given when conversion is carried out will depend on the market price at that moment.

This is an important matter regarding solvency requirements for financial entities as further explained below.

In connection with legal requirements for issuance of convertible bonds, the relatively new Companies Law (Ley de Sociedades de Capital) sets forth the following:

(i) general Shareholders' resolution establishing characteristics and means of the conversion and approving a capital increase for the amount necessary;

(ii) issuance of directors' report explaining the characteristics and means of the conversion, together with an independent expert's report appointed by the Commercial Registry;

(iii) convertible bonds cannot be issued under their par-value; and

(iv) as a general rule, bondholders may ask for conversion at any time. In this case, within the first month of each semester, the company's directors will issue shares related to bondholders who had asked for conversion.

As mentioned above, amendments to Spanish regulations in connection with financial entities have recently changed the accountability of financial products such as bonds or preferred shares, which will have a significant implication in the near future as a result of the new capital requirements set out for these entities.

Specifically, the legal framework for financial entities has changed very much in the last few months. The following new regulations have been passed:

(i) Law 6/2011 of April 11, which modifies Law 13/1985 of May 25 on the requirements of preferred shares to be deemed equity, transposing European Directive EC/2009/111 into the Spanish legal framework.

(ii) Royal Decree 771/2011 of June 3, which amends Royal Decree 216/2008 of February 15, on the equity of financial entities.

According to Additional Provision Two of Law 13/1985, as amended, in order for preferred shares to be included by financial institutions as equity, the financial products must comply, among others, with the following requirements.

(i) companies' board of directors may decide, on a discretionary basis, whether to pay interest rates set out in the relevant issuance information. This discretionary power is unlimited.

(ii) compulsory non-payment should the company not comply with equity requirements.

In connection with convertible bonds, the main issue to record these financial products in the books as either equity or debt refers to the exchange system: fixed or unsettled rate. In this regard, fixed exchanged rate convertible bonds will be recorded in the company's book as equity.

This is not a straightforward issue and, in practice, this matter should be discussed with the Bank of Spain.

According to recent experience in Spain, convertible bonds have become one of the most likely means to raise capital by Spanish companies.

Specifically, in 2010, the issuance of convertible bonds represented €968 million, even though this amount is lower than that of 2009 (€3.2 billion), when the financial crisis hit the Spanish market more critically.

Among those Spanish companies which have opted for this kind of capital increase, the following are worth highlighting: Abengoa, Fomento de Construcciones y Contratas, Pescanova, Sacyr Vallehermoso and Telvent Git.

Regarding financial institutions and in connection with preferred shares, although being very popular in the last few years (for instance, in 2009 almost €13 billion were issued by Spanish entities according to the 2010 Annual Report of the Spanish Stock Exchange Commission), new requirements for financial entities in line with Basel III will presumably reduce the appeal of preferred shares among the general public.

This trend will be in line with 2010 figures when there were no issuances of preferred shares, Spanish financial institutions opting instead for the issuance of convertible bonds.

For instance, financial entities such as Banco de Sabadell and Banco Bilbao Vizcaya Argentaria (2009), Banco Popular (2010), Bankinter, Banco Pastor and Criteria Caixacorp (named Caixabank once fulfilling the restructuring process of this savings bank) (2011) have opted for this means of financing over preferred shares and share capital increases.

High-yield bonds

Within the debt financial products to be issued by a company, it is worth noting a specific kind of bonds known as high-yield bonds or informally called junk bonds, which are those issued by companies without an investment grade.

Due to this fact, their subscription entails for the subscriber the assumption of a higher risk of default, which implies that yields offered are usually higher than those offered by investment grade companies.

Regarding the legal regime applicable to the issuance of high-yield bonds, there are no differences in comparison with common bonds.

Recently, Spanish companies such as Campofrío Food Group and Befesa Medio Ambiente, through one of its subsidiaries, have opted for the issuance of high-yield bonds to finance their activity.

Special case: Spanish savings banks

Spanish financial institutions, in general, and savings banks, in particular, were hit to a deeper extent by both the financial and the Spanish real estate market crisis. Within this framework, the Spanish government and Bank of Spain led a restructuring process of the Spanish financial system by means of the approval of a new legal framework for these entities. The purposes of those measures were:

(i) to create Institutional Protection Schemes (Sistemas Institucionales de Protección) by savings banks in order to manage their merger avoiding the limitations to manage this restructuring as a result of savings banks' special legal regime (the Schemes have eased the reduction of Spanish savings banks from 45 in early 2010 to the current figure of 17);

(ii) to provide public aids through the Fund for Ordered Bank Restructuring (Fondo de Reestructuración Ordenada Bancaria) by means of subscription of convertible preferred shares issued for the new Institutional Protection Schemes; and

(iii) to strengthen the solvency of Spanish financial entities requiring higher levels of capital ratios in line with Basel III.

In February 2011, a new Royal Decree was passed to speed up the restructuring process initiated by savings banks. In this regard, savings banks aiming to received funds from Fund for Ordered Bank Restructuring were urged to transfer their financial activity to a bank because of additional public aids will be managed through subscription of common shares instead of convertible preferred shares.

Finally, several of the Spanish savings banks involved in concentration processes through Institutional Protection Schemes (Bankia, Banca Cívica or Banco Mare Nostrum), which have incorporated banks owned by savings banks, are in the process of becoming public and listed on the Spanish Stock Exchanges.

This shows that share capital increases and initial public offerings will play a significant role in 2011.

About the author

Carlos Costa Andrade has been a partner in the Lisbon office of Uría Menéndez since 2005.

Between 1996 and 1999 he was in-house counsel (Issuers and Market Division) at Euronext Lisbon – Sociedade Gestora de Mercados Regulamentados, S.A. (formerly known as the Lisbon and Oporto Stock Exchange).

His practice includes capital markets, takeovers, IPOs, OPVs, structured bonds and other complex securities, regulated and non-regulated market management entities, M&A, securities, banking, and corporate governance.

Carlos is among the most highly regarded banking and finance and capital markets’ lawyers by Chambers Global Portugal, IFLR 1000 Portugal and Legal 500.

Carlos regularly participates as a speaker at seminars and conferences related to his field of expertise, both in Portugal and abroad.

Contact information

Carlos Costa Andrade
Uría Menéndez

Edifício Rodrigo Uría
Rua Duque de Palmela, 23
1250-097 - Lisboa
t: +351 21 030 86 00
f: +351 21 030 86 01
e: cac@uria.com
w: www.uria.com

About the author

Juan Carlos Machuca joined Uría Menéndez in Madrid in 1996 and has worked out of the firm’s London office since January 2000. He is the current resident partner in the London office.

Juan Carlos’ practice focuses on corporate law, banking, finance, regulatory, investment funds, private equity and capital markets. He also advises clients on M&A transactions and on insolvency and restructuring proceedings.

In 2007, Juan Carlos was one of the winners of the Iberian Lawyer 40 Under Forty Awards, which recognise the achievements of the new generation of top lawyers in Spain and Portugal.

Contact information

Juan Carlos Machuca
Uría Menéndez

125 Old Broad Street - 17th floor
London EC2N 1AR
e: jcm@uria.com
w: www.uria.com