The two bold takeover initiatives that are animating share trading in Portugal – Millennium BCP’s €4.3bn bid for Banco BPI and the Sonae conglomerate’s €11.2bn offer for Portugal Telecom – are also expected to have a significant impact on the country’s debt market.
“Whether they are successful or not, these bids will increase activity in the debt market because the acquisitions, or the response to them by the targeted companies, will have to be financed,” says Paulo Gray, Citigroup’s country officer in Portugal. “They are a sign of initiative and entrepreneurship that is good news not just for bankers but for the economy as a whole.”
Easier investment
Corporate issuers had already been cheered in November 2005 by the government-approved legislation (Decree-law 193/2005) that exempts non-resident investors from withholding tax on interest earnings and capital gains from Portuguese bonds.
Although the 20% tax could be recovered if investors were resident in jurisdictions with double taxation treaties with Portugal, the cumbersome system created an impediment that was deterring investment in the Portuguese market.
Companies sidestepped the tax limitations by issuing bonds through special vehicles set up outside Portugal. Specific exemptions were also granted from some issues by state-owned companies. But the new law exempting non-residents from the tax has been welcomed as an important boost for the competitive standing of the Portuguese market.
The new legislation establishes an exemption from withholding tax on earnings, including capital gains, from Portuguese bonds issued both by state and private-sector entities for all non-resident investors except those domiciled in tax havens. The new system also establishes a settlement mechanism that ensures the exemption is correctly applied and sets up a tax residency certification procedure.
“Some fine tuning in terms of the certification process remains to be done,” says Mr Gray, who is also head of Citigroup’s fixed income operations in Portugal and Spain and its senior government banker for Portugal. “But overall, this is a positive step that means most companies can now issue directly out of Portugal.”
Fixed income
Fixed income issuance in Portugal is dominated by government debt. Floating-rate notes with maturities ranging from three to five years, for which there is a liquid and active market, are predominant on the corporate debt side of the market.
Portugal has a healthy corporate market focused on privatised utilities such as Portugal Telecom (PT), Energias de Portugal, which is the country’s dominant electricity provider, and Brisa, one of Europe’s biggest toll motorway operators. Demand is also strong for debt issued by state-owned companies such as the railway company CP-Caminhos de Ferro Portugueses, rail track operator Refer, and Parpública, the state holding company.
Telecom issue
A €500m Eurobond offering by PT, the first 20-year corporate issue in Portugal, was one of the highlights of 2005. Citigroup was the single bookrunner for the transaction, which was designed to fund long-term assets with long-term liabilities. PT had already issued two bonds in March 2005, but the planned 20-year maturity was cancelled due to market volatility and weak demand.
Three months later, the long-maturity bond, packaged to offer greater value in a low interest rate environment, was successfully placed amid renewed international appetite for long-dated issues.
Other 2005 transactions, including a €250m, 30-year issue by BES Finance and a €440m Douro SME Series 1 issue with a 34-year maturity provided further evidence of a trend towards longer-dated corporate issues.
Citigroup leads the origination of euros and similar international bonds in Portugal in a market dominated by the big global houses, including Deutsche Bank, Lehman Brothers, BNP Paribas, Morgan Stanley and Caylon. All corporate issuers in this market are rated by Standard & Poor’s, Moody’s or Fitch.
“Issues are usually in excess of €500m, which is considered the benchmark for this market,” says Mr Gray. “Distribution is spread over a wide range of international institutional investors, with Portuguese institutions often representing only a small proportion of the take-up, and there is very active trading on the secondary market.”
The market for domestic bonds has also picked up considerably over the past two years. The issues are smaller than in the Eurobond market and involve second-tier Portuguese companies, which, although not rated, are household names to local investors.
“Liquidity in the secondary market is less,” says Mr Gray. “But growth is being driven by the strong appetite of banks and other Portuguese investors for the value they see in issues by companies that are not rated but which they know very well.”
Portugal’s first covered bond issue is expected later this year following the enactment of new legislation in March (Decree-law 59/2006), which allows for the issuance of bonds backed by mortgages or credits to the public sector. Under the new law, the Bank of Portugal becomes the key regulator for covered bonds with responsibility for issuing further regulations.
“The government listened carefully to all the stakeholders involved when it was drawing up the legislation and has produced a robust law that should create the right environment for a successful programme,” says Mr Gray.
Covered bonds
“There is still a lot of work to be done. Banks are talking to rating agencies and structuring their issues. Some regulations, particularly in relation to how covered bonds will be treated within the issuing banks, still have to be finalised by the central bank. But we expect Portugal’s first covered bond to be in the market before the end of 2006.”
The new law provides for covered bonds to be issued directly by banks or indirectly by special purpose mortgage banks or special purpose vehicles. It also creates a special security over the assets in favour of the covered bonds and determines ongoing maintenance and information requirements, including audits of the portfolio.
To ensure security, the law requires an independent auditor, with specific powers granted by the central bank to supervise and regulate the mortgage bonds market, to supervise the enactment of the legislation.
Bankers expect the first covered bond issue in Portugal to be made by state-owned Caixa Geral de Depósitos, Portugal’s biggest mortgage lender. Liquidity will be a key requirement for the new market and €1bn and upwards is seen as the ideal issue size.
“I think there is a tremendous investor base for this kind of product, particularly among institutional investors, such as central banks, who are looking for high levels of liquidity and low risk,” says Mr Gray.
