Upcoming challenges and opportunities in the Spanish debt market

November 2020 | EXPERT BRIEFING | BANKING & FINANCE

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In the first days of March before lockdown was imposed in Spain, and in anticipation of the adverse effects that coronavirus (COVID-19) would have on companies, Spanish financial entities reacted swiftly to make available vast amounts of preapproved loans to their clients – mainly small and medium-sized enterprises (SMEs) and the self-employed – as a mechanism to ensure short-term liquidity during the uncertain months ahead.

The Spanish Royal Decree-Law 8/2020 of 17 March on urgent and extraordinary measures to confront the economic and social impact of COVID-19 (which came into force on 18 March 2020), approved a set of extraordinary measures to confront the economic and social impact of COVID-19 in Spain. Among the specific provisions targeted to ensure liquidity and access to finance by companies and the self-employed to sustain their economic activity, it provided a line of public guarantees on financing granted by financial institutions to companies and the self-employed for a maximum amount of €100bn.

By the end of August, Spanish banks had injected over €99bn into large enterprises, SMEs and the self-employed by granting loans secured by the public guarantee scheme. A substantial part of these loans includes one-year interest-only periods.

Despite the efforts that have been made, the unprecedented economic shock of the COVID-19 outbreak is expected to have a significant impact on the quality of banks’ loan portfolios and to result in an increase in bad debt by the end of the public guarantees scheme and the moratoriums granted. The increase in bad debt brings a new challenge for banks in a context of reduced margins and supervisors calling for efforts to reduce costs and improve efficiency.

The effects of the COVID-19 outbreak remain largely unpredictable, both for their complexity and incomparability with previous economic downturns. Notwithstanding, current conditions are expected to prompt debt refinancings and restructurings, an increase in secondary loan trading and distressed debt transactions, which will bring challenges and opportunities for a wide range of financial institutions and funds.

Debt refinancing and restructuring

During the last decade, the Spanish Insolvency Law has been amended in order to introduce incentivising tools for out-of-court restructuring, including: (i) a four-month delay to file for insolvency upon communicating to the court that the debtor is negotiating a composition or refinancing agreement with its creditors; (ii) safe harbours from clawback risk for refinancing agreements of existing debt subject to compliance with specific formalities and majority thresholds; (iii) cramming down debts of dissenting creditors subject to the refinancing agreement being sanctioned by the court and; (iv) the sale of business units within insolvency proceedings.

These reforms, along with the pandemic-induced temporary amendments to the Spanish Insolvency Law (incentivising new money injections from sponsors or specially related parties, promoting out-of-court restructurings while mitigating directors’ duties to filing for insolvency and liquidating distressed companies), as well as the drafting of the consolidated Spanish Insolvency Law (approved by Royal Legislative-Decree 1/2020, of 5 May, which came into force on 1 September 2020), modifying certain institutions and clarifying certain rules, should pave the way for creditors and companies to tackle challenging debt restructurings with success.

Despite the urgent liquidity facilities that have been granted to companies that operate in sectors severely affected by the COVID-19 outbreak, large restructuring transactions are expected to ignite in the coming months.

Secondary loan trading

Since the current environment raises doubts on the business prospects and the economic and financial sustainability of certain sectors and companies affected by the COVID-19 outbreak, secondary trading of corporate loans and private debt is expected to gain traction.

Loans can be transferred in Spain by assigning the contractual position (with the new lender acquiring all the rights and obligations of the existing lender under the loan agreement) or by way of assigning the credit rights held by the assignor against the borrower (not the contractual obligation the assignor assumed toward the borrower). Usually assignment agreements are governed by Spanish law and formalised in a public deed granted before a Spanish notary (even when parties execute Loan Market Association (LMA) secondary debt trading documentation), since from a Spanish legal standpoint, the transfer date must be certain for it to be fully effective against third parties, although no specific formalities are required for the loan transfer to be effective between the assignor and the assignee.

Financial institutions, funds and non-financial entities on the buy or sell side need to consider certain key legal issues when trading loans subject to Spanish law or secured by collateral governed by Spanish law.

Usually, loans governed by Spanish law provide certain standard restrictions such as transferee eligibility criteria, borrower consent requirements and a specific form of assignment.

Although in Spain security (and guarantees) are accessory rights to the obligation they secure (the loan or credit facility), in order to ensure enforceability of the security and guarantees, certain formalities are required. The assignment of mortgages needs to be documented in a public deed (triggering stamp duty) and requires registration at the Land Registry. To the extent trusts are not recognised under Spanish law, it is worth mentioning that security is granted in favour of all lenders (individually) participating in the loan and that not all types of creditors can benefit from some Spanish security interests (floating mortgages and financial guarantees).

In addition to intercreditor arrangements regarding traded loan and related security and taxation on interest payments, other relevant legal issues to focus on are listed below.

Enforcement mechanisms. Since beneficiaries of securities in Spain are not allowed to appropriate or dispose assets pledged or mortgaged in their favour (other than in respect of cash, marketable securities or other financial instruments pledged in favour of financial institutions pursuant to Royal Decree Law 5/2005, 5, of 11 March on urgent reforms to encourage, among others, productivity and improve public procurement), enforcement proceedings will be necessary to sell the asset and use the proceeds to repay the secured obligations.

Corporate benefit. This may arise in relation to the security or guarantees provided by group companies in the context of a group financing.

Financial assistance. Spanish corporate law prohibits Spanish companies financing, advancing funds, granting security or guarantees, or assisting in any manner that contributes to the purchase of their own shares or of their parent company (in the case of Spanish public limited liability companies) or of any of the group companies (in the case of Spanish private limited liability companies), Infringement of this prohibition would render any such financing, security, guarantee or assistance null and void.

Clawback risk. This may arise in relation to the security interests or guarantees granted by a Spanish company if it becomes insolvent.

Potential subordination. Under Spanish law, credit rights may be subordinated by operation of law or by agreement.

Distressed debt transactions

Spanish banks have made a huge effort to clean up their balance sheets by selling non-performing loan (NPL) exposures largely linked to the real estate sector and real estate owned properties (REOs). Prior to the pandemic, Spanish banks were at the lowest NPL ratios of the last decade.

NPLs market watchers expect that distressed debt transactions will increase over the next few months. Taking into account that current circumstances may delay the workout plans of funds that acquired NPLs and REOs, an increase in secondary portfolio operations seeking new buyers is also expected, driven by both bilateral transactions as well as securitisations.

Although portfolio sales in Spain are similar to transactions of this nature in other jurisdictions, there are practical issues derived from certain legal particularities that should be taken into account, such as: (i) the need to obtain complete documentation of the underlying loans (in order to accurately ascertain if the expedited mortgage procedure for foreclosure is feasible); (ii) the need to confirm if the REO is registered at the Land Registry in the name of the seller; (iii) confirmation on certain insolvency related issues (such as purchaser position and risks arising from the debtor’s insolvency proceedings); (iv) the potential existence of first acquisition and pre-emption rights; and (v) taxation implications.

Alternative sources of financing

The liquidity and financing challenges faced by companies operating in the industries most impacted by COVID-19 can also bring opportunities outside traditional financing sources.

Private debt funds are expected to play an important role in the coming months. The complexity of bespoke loans is expected to increase, and funds are able to offer sophisticated solutions through a wide range of instruments.

Certain Spanish sectors holding large portfolios of real estate assets are an opportunity for real estate funds. Sale and leaseback deals are expected to increase in the coming months since they provide companies with real estate assets a way to access capital without increasing indebtedness. These transactions involve the sale of one or more real estate assets to an investor for a lump sum payment and the immediate lease of such property by the investor back to the seller for a specific period, usually long term.

The current environment may also drive Spanish companies with exhausted debt capacity and an urgent need for liquidity to sell certain non-income generating and non-core businesses or assets which may be fit for opportunistic funds.

The pandemic environment may bring opportunities in the Spanish debt market for financial institutions, private debt funds, distressed debt funds and private equity funds, but capitalising on these opportunities will require the ability to properly identify the relevant legal issues in order to confirm that the return expectations at the time of investment are realistic and to secure proper execution.

Toni Barios is a partner at Cases & Lacambra. He can be contacted on +34 (628) 279 526 or by email: toni.barios@caseslacambra.com.

Toni Barios

Cases & Lacambra