Following the rejection of provisional presidential decree 1303 by Congress, there is now room for a correction of distortions and a widening of credit spreads on tax-exempt debentures, according to Santander. The bank’s analysts note that, anticipating the decree would eventually become law, both retail and institutional investors had increased their purchases of such securities since June, compressing spreads at a time when similar instruments were relatively scarce in the market.
“Now that the decree has expired without becoming law, we believe the current context creates room for a tactical widening of spreads on tax-exempt bonds,” wrote Santander market strategists Aline Cardoso and Guilherme Motta in a report.
Even so, the index tracking average spreads continues to show slight compression. The analysts add that the prevailing market view is that spreads will likely remain historically tight, supported by a reduced volume of new issuances, structurally strong demand for tax-exempt assets, and a lower perception of regulatory risk.
According to Santander, the possibility of major changes to the structure of tax-incentivized bond issuance directly affected the supply-and-demand dynamics of the market. “While spreads on traditional debentures showed a more moderate compression, tax-exempt bonds experienced a sharp tightening in spreads after the initial announcement of the decree,” they observed.
From a demand perspective, anticipating that the decree would become law, both retail and institutional investors intensified their search for tax-exempt instruments, expecting relative scarcity given the limited number of such securities outstanding.
“This movement was clearly reflected in the spreads of tax-exempt debentures, which began to tighten sharply starting in June. By August, spreads had reached negative levels relative to the NTN-B reference curve, illustrating the attractiveness of net returns after factoring in the tax benefit,” the analysts pointed out.
On the supply side, although the volume of new issuances also increased, it was insufficient to meet the strong demand. Santander’s strategists highlight that high interest rates continue to limit companies’ appetite for new projects, since tax-incentivized debentures must be backed by real investment projects.
“This temporary imbalance between supply and demand further intensified the spread compression, leading to an unusual scenario in which investors, seeking tax advantages and longer maturities, accepted returns below the sovereign curve,” they wrote.
However, the analysts note that the spread tightening has a natural lower bound. Given the current level of NTN-B yields, the equilibrium spread for tax-incentivized debentures is estimated at approximately -2.1 percentage points. “Below that level, after adjusting for the gross-up effect, government bonds would offer a more attractive return,” they explained.
Santander also noted that last week, Brazilian bonds traded offshore underwent a sharp selloff, driven by concerns over a potential credit rating downgrade of Raízen, similar to what recently occurred with Braskem.
Conversely, the domestic debenture market remained largely unchanged. “The demand for Brazilian corporate debt remains exceptionally strong, supported by high real interest rates and the persistent search for yield among institutional investors,” the report states.
As a result, Santander concludes that the recent bond market volatility was viewed as idiosyncratic rather than systemic, with no significant contagion to secondary-market pricing or investor appetite for primary debenture issuances.
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