Putting a value on character.

In their evaluation process for making loans, banks and other lending institutions look at the five “C’s” of credit. Aside from Capacity, Capital, Collateral, and recently Conditions which include matters like industry structure, technology change, or external factors, there is “Character.” This “C” focuses on a borrower’s track record in paying up credit cards, utility bills, and caterers to indicate his sense of fiscal responsibility. After all, not all those with money to pay actually settle their bills on time.

Is there too in the valuation of a stock a character premium or discount? Do analysts and investors go beyond financial ratios, industry structures, market shares, and historical performance into the leadership styles, succession plans, or spending habits of management?

There is a case to be made for paying attention to the reputation of the principal behind a company. In the new field of behavioral economics, the value of character in a corporation is becoming part of the metric in picking stocks.

Thomas Schelling, a 2005 Nobel laureate in economics, cited for his conflict-collaboration game theory, used the term “egonomics” to refer to self-management in personal matters, weighing costs and benefits of acquisitions and purchases, or being rid of addictions. The ego of a person in the sense of his core personality as well as striving for status can play a role in economic decisions.

On the supply side, ego plays a part too. Is the listed company of a particular player worthy of a premium or a discount? Some positives driving premium pricing includes the management’s track record of transparency and fiscal prudence combined with a working growth strategy. A character discount can involve fuzzy accounting, weak second-tier management, over-the-top spending habits (how many corporate planes?), and a whimsical strategy of acquisitions by the principal.

Characters as stock pickers (demand side) also affect market sentiment. A market maker like Warren Buffet “betting all-in on the future of the American recovery” with the purchase of railroad stocks, like the Burlington Northern Santa Fe (BNSF) four years ago, can make the bears take flight and change market sentiment for certain stocks.

In our small local market, character reigns.

Stocks are identified by their principals and lumped together as the “XYZ” group, if that combination of letters is a person or family. The difficulties that befall one subsidiary can affect even the group’s holding in unrelated businesses. Rumors of a takeover of a company by a particular character are enough to lift a sleepy stock into the stratosphere or make it go on free fall. The research analysts’ valuations, based on future cash flows and acquisition synergy drive up not just the target stock but also the shares of perimeter companies associated with specific characters.

The effect of character on the value of the stock is a tricky connection.

With corporate reputation now driven just by word of mouth and social media with its fake news, the character impact can be overblown. Matters of a lavish lifestyle with yachts and private jets, and opportunism associated with political connections are random stories told of corporate chiefs.

In a small economy where all the characters and their reputations are well known, change in management and ownership matters a lot. Specific personalities dominate the financial space.

Buying into a company through its shares is a declaration of faith in its principals. As my friend and stock market guru, Wilson Sy, puts it, “Buying a stock is like going into a partnership with the principals of a company.”

Character analysis is not a static science as personalities change too. New names come up and quickly grow into conglomerates. Old names drop out of the picture. New tech companies rise and fall. Still, it is the track record, sometimes a very short one that determines whether character will play a big part in the price of the stock.

In a small market like ours it is a small group of players that needs to be watched as closely as the ticker tape.

Fortunately for the character witnesses, there are just a few players to track and they don’t necessarily talk to each other. And when they do… is it time to buy or sell?

A. R. Samson is chair and CEO of Touch DDB.

ar.samson@yahoo.com

Financial inclusion and financial stability

The Bangko Sentral ng Pilipinas (BSP) deserves a lot of credit for diligently aiming for financial inclusion in the Philippines. The BSP defines financial inclusion as the process of providing access to financial services for all — savings, credit, investment, money transfers, and other products. The financial inclusion agenda revolves around three pillars: (1) access to financial products and services; (2) financial education and literacy; and (3) financial consumer protection. These objectives are especially critical to the underbanked and unbanked, people who struggle in an uncertain world of financial exclusion and insecurity. The BSP has been at the forefront of developing the National Strategy for Financial Inclusion, which involves private and public sector stakeholders.

We have to remember though that the BSP is also at the center of efforts to promote stability and efficiency in the financial system. In fact, this is the primary reason for being of any country’s central bank. The BSP promotes price stability so that the country’s financial system is conducive to balanced and sustainable growth of the economy. Its monetary policy is conducted using inflation targeting as a primary tool. It exercises effective regulation and supervision over financial institutions under its jurisdiction. The approach is through a risk-based capital adequacy framework using Basel II/III and compliance with best practice financial reporting standards.

Basel III, for example, will provide regulations by way of stricter standards on banks on the levels of capital they maintain. The regulations will improve the quantity and quality of bank capital through mandated capital ratios. It will also redefine what constitutes core (or Tier 1) bank capital and redefine bank liabilities and risk management standards. Liquidity coverage and funding ratios are tweaked to increase capital and improve liquidity, problems that were encountered in previous financial crises.

While stability is enhanced, the cost of raising capital for small business could be affected. The higher capital ratios and compliance costs, together with the higher cost of capital, will impact the viability of smaller banks. Small banks are more inclined to serve and lend to small business entrepreneurs. This is attested to by the banking community’s compliance with the mandatory lending provisions of the Magna Carta for SMEs, where the thrift banks and rural banks are reported to be most compliant in the micro and small business segment. Regulations that will require banks to assign higher risk weights to small businesses will serve as a disincentive to servicing this sector. Customization of loans to a small business’unique needs also suffers in the process because of the higher costs of doing business. In general, Basel III effects on lending to small businesses are generally expected to be disproportionally negative.

Let’s look at the situation from the other side. A liberal approach to financial inclusion by way of relaxation of credit standards, especially for the underbanked, can backfire. The reason for being underbanked or unbanked is not a simple supply problem, and may be an issue of borrower creditworthiness, the character and capacity to pay external debt. The sub-prime mortgage lending situation in America that led to the global financial crisis is a recent example of an aggressive foray into the underbanked gone awry. This is a classic moral hazard, where both lenders and borrowers behave in accordance with the incentive structure of the liberalized credit environment.

The policy dilemma is clear. These two policy objectives — financial inclusion and financial stability — are both important, but they demand actions that may lead to consequences at cross purposes with each other. And these outcomes may even be totally unintended. The behavioral effects are not necessarily consistent and in harmony.

This is precisely the focus of a recent study by Cihak, Mare, and Malecky. The authors conclude that “on average, financial inclusion and financial stability are negatively correlated, and thus linked more through tradeoffs than synergies… While tradeoffs could dominate the inclusion-stability nexus, synergies could arise with almost equally high probability.” They add, “rapid increases in credit to previously informal firms that enter the formal sector should be monitored for potential threats to financial stability.”

The bottom line here is the need for greater policy coordination and astute management by our BSP leaders in achieving the right balance. In which areas can synergies be achieved? What are the risks and tradeoffs when one objective is pursued at the sacrifice of another?

Aiming for both inclusion and stability is a responsibility in which the BSP, a constitutionally independent body, needs support from a number of other government agencies for effective policy coordination. But since the BSP has assumed a mantle of leadership here, its efforts must be lauded, encouraged, and sustained. The next BSP leader must be cognizant of these tradeoffs and the potential synergies.

Benel D. Lagua is executive vice-president at the Development Bank of the Philippines. With an AIM-MBM and a Harvard-MPA. He is a part-time faculty of the College of Business, De La Salle University.

benellagua@alumni.ksg.harvard.edu

From the Strategic to the Personal:

Abe’s Visit to the Philippines

Japanese Prime Minister Shinzo Abe’s Thursday visit to President Duterte highlights the continuing importance of the Philippines to Japan’s relationships in East Asia. As a long-time partner for the Philippines in areas both political and economic, Abe’s visit to the country is significant to our new government as the first among world leaders. In addition to helping seal the two countries’ deep ties, Japan’s support is especially meaningful as the country takes the stage as the 2017 Chair of the Association of Southeast Asian Nations (ASEAN).

Although the Philippines has pursued friendly relations with all of its regional neighbors this year, the results of elections around the globe last year have introduced new uncertainties in the geopolitical environment. To world leaders, the importance of the Philippines as an active player in the community of peaceful and law-abiding nations cannot be discounted. More than ever, the Philippines is in a position to strengthen its partnerships in pursuit of the national interest.

JAPAN’S ECONOMIC RELATIONSHIP WITH THE PHILIPPINES

During his visit, Prime Minister Abe announced a $8.7-billion aid package. To be delivered over a five-year period, the aid reportedly targets infrastructure improvements across the country. The package is the latest in the sequence of Japanese overtures to the Philippines. Last year, President Duterte returned from his state visit to Japan with $1.8 billion in pledged investments.

Japan has been one of the Philippines; most important international partners for several years. Historically, there are close economic and political ties between the two countries. Japan is the Philippines’ top trading partner. The government reports that in 2015, two-way trade with Japan accounts for $18 billion, or 14.4% of the country’s total trade. Philippine exports to Japan that year were valued at $12 billion. Most of the country’s exports to Japan are made up of electronic products (30.2%) and woodcraft and furniture (23.2%).

Japan was also the second-largest source of Official Development Assistance (ODA) in 2014, the latest figures available. ODA from Japan makes up 23.15% of the Philippines; total ODA portfolio, largely coming in the form of low-interest loans for government projects throughout the Philippines. Of course, Japan is also a major donor to the ADB, which is the third-largest source of ODA to the country (19.96% of the portfolio).

In reach of Japan’s ODA extends throughout the Philippines. They underpin projects spanning from hydroelectric and wind power projects in northern Luzon, to geothermal energy and arterial roads in the Visayas, to transmission lines, port terminals, and irrigation lines in Mindanao. Given the depth of Japan’s assistance to and partnership with the Philippines, there is every reason for President Duterte to repeatedly reaffirm the two countries strong relationship. In the President’s words, Japan is a friend closer than a brother.

THE PHILIPPINES-JAPAN STRATEGIC PARTNERSHIP

Moving beyond the economic backbone to the relationship, the Philippines and Japan elevated their ties into a “strategic partnership” in 2013. Although Japan is not obligated to come to the Philippines’ defense in case of an armed conflict, Japan has nevertheless invested in helping the Philippine government boost its security capabilities. As both countries are archipelagos and have territorial disputes with their neighbors, maritime security has been an important component of the two countries’ cooperation. There is a natural common ground in the two countries’ security objectives.

The Philippines and Japan joint statement on President Duterte’ visit to Tokyo is indicative of the priorities in the relationship. Immediately after reaffirming the two countries’ partnership and basic values, the joint statement makes several points related to maintaining and promoting peace and stability in the region. Japan’s multi-year effort to help the government boost the Coast Guard is a concrete manifestation of the two countries’ cooperation.

Finally, beyond the strategic reasoning, Abe made the effort to show a personal relationship with Duterte. The President is known to have strong personal views on foreign policy, as evidenced by several of his outbursts last year.

With the rise of the term “independent foreign policy,” the Philippines’ traditional partners have had cause for concern for their place in the Philippines’ roster of close friends. For this reason, it has become more important for Tokyo to demonstrate that its relationship with Manila extends beyond diplomatic documents and into real life. It’s hard to beat a visit to the President’s personal bedroom.

Angelica Mangahas serves as the Deputy Executive Director of Stratbase-ADRi. AFP