Puerto Rico now over 2x Philippines in bond yield

In early 1898, Spain still controlled islands in both the East Indies and the West Indies that still qualified it as an empire on which the sun never set, until later that year, when the United States took over the best-known of these islands as commonwealth territories. The eastern ones became independent in 1946 as the Republic of the Philippines, and are still the US’s only significant former overseas colony, while the western ones have remained an unincorporated US territory (and currently the most populous one by far, even at only about 1/30th that of the Philippines) as the Commonwealth of Puerto Rico.

Today, these two former Spanish colonies may seem similar to some, but by many other measures are worlds apart in more ways than simple geographic distance. History may increasingly be the main topic in which these two former colonies are mentioned in a single sentence, but there are several other notable similarities as well: both are rated “BBB-” by Standard and Poor’s [Source: Trading Economics, EMMA], and both have heavily agricultural economies supplemented remittances from many workers who find higher paying jobs at nearby mainlands.

Despite the similar bond rating, their respective bond and credit markets are also worlds apart. The Philippines is a sovereign nation that, for much of its independent history, has been considered a high-risk emerging market, with double-digit bond yields as recent as 2006 (and revisited in late 2008, see 2nd chart). Much of the buying power for Philippines’ USD bonds, the story goes, comes from overseas remittances which flood Phil banks with USD funding which in turn are told they can get the pick-up for its own country sovereign bond’s without any risk penalty. (Although given the success of the Global Peso Bond Issues, there is clearly offshore demand as well). Puerto Rico, on the other hand, is still a dependent territory of the world’s only superpower, and is one of many municipal issuers in a multi-trillion dollar market with a very special benefit: most Puerto Rico bonds are tax-exempt for taxpayers in the world’s largest economy.

So imagine how someone who looks at both of these markets sees the relative value between these two: receiving 2% taxable from lending to the Philippines vs. 7% tax free (equivalent to a taxable bon yield over 11.5% for a top-bracket US taxpayer) from lending to Puerto Rico for 5 years:

[Source: ADB, EMMA]

Chart 2 shows how the Philippines success story, part of the broader emerging markets and Asia growth story of the past decade, has dropped 10-year bond yields from over 15% to under 4% since 2001:

[Source: Trading Economics]

What I found more remarkable during much of the European debt crisis was how much less risky global credit markets consider the Philippines than even Spain, and even now Spain is priced as over twice as risky over the next 5 years vs. Phil:

[Source: Deutsche Bank Research]

Puerto Rico was a very different story than Spain, and for much of 2011 and 2012 it continued to benefit from low yields and the tax exemption, but the big divergence happened this summer after the default of Detroit, but seemed to accelerate earlier this month:

[Source: EMMA]

I will continue watching this spread, and wishing I had enough time to continue looking at all the different provincial and local government stories within Asia that might be comparable but uncorrelated Puerto Rico-scale opportunities…