Issue: Oct 2011

Toyota: understanding exposures at times of crisis

by Ed Richardson

Stuart Mead Stuart Mead, Vice President – Global Data Solutions, S&P Capital IQ, discusses the challenges of analyzing financial exposures in the current market environment.

The Eurozone sovereign debt crisis, the Japanese tsunami, the Arab Spring, the US debt negotiations: these events have tested the nerves of the credit markets in 2011, as well as those of corporate treasurers.

Multinational companies, especially in the automotive sector, are complex entities with convoluted supply-chains and elaborate financial arrangements that can easily be disrupted by external circumstances. Toyota’s experience neatly demonstrates the breadth of impact from an event of the scale of Japan’s March 2011 earthquake and tsunami. In order to prepare for future impact events – such as a tsunami or sovereign debt crisis – it is critical that counterparties have access to a sufficient breadth and depth of financial information, and that these datasets are sufficiently integrated to allow for what we call cross-asset class and cross-market analysis.
Exposure to an entity’s securities

Defining exposure to a company the size of Toyota is complex. Toyota is the ultimate obligor to over 1,000 securities, and many of these are issued by its subsidiaries, or their subsidiaries. Some are even issued by a separate entity but linked to Toyota by obligation. To resolve this issue, analysts require access to a large universe of securities data. This can be achieved through products such as CUSIP Global Services’ CABRE Directory, which organizes securities according to issuers, obligors and counterparties.

Using this data counterparties are then able to instantly account for their exposure in the event of a crisis. As we saw with Toyota, every security linked to an entity can be heavily impacted. For instance, the company’s share price fell 21% by March 15th, while the risk premium on much of its issued debt in the bond markets shot upwards. Meanwhile, Japan’s sovereign credit rating was revised by Standard & Poor’s to a negative outlook and the cost of insuring against a Japanese sovereign default dramatically increased.

Exposure to the sovereign
Many corporates are significantly affected by the credit health of the states they operate in – especially if, like Toyota, they are highly centralized businesses, with much of their operations – as well as those of its counterparties – based in one country. Six weeks following the tsunami, and as a result of the likely negative impact to Japan’s long-term credit profile, Japan’s sovereign credit rating outlook was revised from stable to negative by Standard & Poor’s. In the event that Japan’s credit profile significantly weakens, Toyota can expect to suffer a lower availability of credit and a higher cost obtaining it. 

Meanwhile, the cost of insuring against a Japanese sovereign default – as measured by spreads in the Credit Default Swaps (CDS) market – spiked on March 15th following an announcement by TEPCO – the operator of Fukushima nuclear power plant which was shut down in the wake of the tsunami – that it was to initiate rolling blackouts. As of June 2011, CDS spreads for Japan were still at levels below what would usually be associated with Japan’s sovereign credit rating.

Exposure to related industries and sectors

The tsunami also had a major impact on Toyota’s supply chain. Toyota produces or sources most of its manufactured goods in Miyagi Prefecture, one of the worst-affected areas alongside Fukushima and Iwate Prefectures. The damage led to significant production cuts that – certainly, in the opinion of analysts from Standard & Poor’s – could erode Japanese automakers’ market shares and competitive positions. Estimates suggest that Toyota will suffer a production loss as high as 400,000 vehicles – adding further volatility to the company’s probability of default on its fixed-income securities.
Exposure to downgrades

While credit ratings and measures of probability of default speak to the longer term prospects for an entity’s credit risk, CDS spreads and share prices speak to shorter term market and volatility risk. Recent events show these indicators can influence or be influenced by the performance of each other. The most robust analysis now understands that exposure to market sentiment as a response to these triggers must be considered alongside exposure to the events themselves. Certainly, counterparties and credit analysts must understand that every element of exposure has consequences for the entire company and for the company’s counterparties. By extension, missing or inaccurate data may also represent exposure. In order to effectively mitigate the dynamic nature of risk, the ability to look across an entity’s entire financial profile is therefore essential – exploiting and cross-referencing all available data.

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