Toyota: Unlocking Exposure in Times of Crisis

A series of devastating natural and economic catastrophes around the world have heavily impacted the global economy in 2011. Events include the massive flooding across the Australian state of Queensland, the earthquake and tsunami that struck the north-east coast of Japan in March, the drama of the Arab Spring uprisings, and the escalating sovereign debt crisis in Europe.

Every one of the above events – perhaps barring the last – was unpredictable, making counterparty assessment of exposures to major corporates affected by crises difficult in the extreme. Yet we think such an analysis of the impact of unpredictable events is possible given the breadth of information available. In our view, analysts should therefore consider a range of indicators to gain a full picture of the entity’s risk profile and creditworthiness. Such an analysis should include the financial profile of the entity’s debt and equity securities, its exposure to the sovereign – depending on where it’s domiciled – and to related industries and industry sub-sectors.

But it should also extend to an understanding of how such indicators are correlated – perhaps using cross-asset class data and analytics to offer further clues to the company’s financial performance and credit health.

Toyota’s Fortunes

All of these factors come into play when examining the fortunes of Toyota – Japan’s largest company and biggest taxpayer, as well as the company potentially most affected by the natural disaster that struck the country in March. Following the tsunami, Japan suffered heavy disruption to its infrastructure and manufacturing industry, with many counterparty manufacturers around the world only able to resume normal production levels six months after the event.

Toyota was no exception. The company produces or sources most of its manufactured components in Miyagi prefecture, which was one of the areas worst affected by the disaster, alongside Fukushima and Iwate prefectures. The resulting damage led to significant production cuts, just as record high petrol prices increased demand for the fuel-efficient vehicles Toyota now specialises in. Certainly, the group is unlikely to compensate fully in coming months for the loss of potential sales over the spring and summer, which will probably result in the company being temporarily displaced as the world’s biggest carmaker by General Motors and Volkswagen.

Exposure to an Entity’s Securities

Such disruptions can affect both a corporate’s fundamentals and – just as importantly – perception of the company in the marketplace. And this, in turn, has an impact on its debt and equity positions. With respect to Toyota, every security linked to the entity was heavily impacted. For instance, the company’s share price fell 21% between 11-15 March, while the risk premium on much of its issued debt in the bond markets shot upwards.

In fact, the task of establishing the exposures to these securities is a complex task for an entity the size of Toyota. It is the ultimate obligor to over 1,000 securities, of which many are issued by its subsidiaries, or even their subsidiaries. In fact, some are issued by a separate entity but linked to Toyota by obligation.

To reliably resolve this issue, analysts ought to scrutinise a large universe of securities data, which can be accessed through database products such as CUSIP Global Services’ CABRE Directory. This organises securities according to issuers, obligors and counterparties. Armed with this universe of data, counterparties are then able to account for their exposure in the event of a crisis.

Exposure to the Sovereign

Added to risk from supply chain disruption, an entity’s financial portfolio can be impacted by the credit health of its sovereign base of operations. This is particularly the case for a highly-centralised business such asToyota, with much of its operations – as well as those of its counterparties – based in one country.

With regard to Japan, 2011 began with Standard & Poor’s (S&P) ratings services reducing its sovereign debt rating for the first time since 2002, on the basis that the government has failed to demonstrate any coherent strategy for dealing with its budget deficit. And six weeks after the tsunami, S&P also downgraded Japan’s sovereign credit-rating outlook – estimating that the programme of reconstruction would cost the country up to ¥30 trillion (US$390bn). The economy, which contracted in the aftermath of the disaster, has since returned to growth as rebuilding gets underway. However the recovery already shows distinct signs of proving short-lived, with most Japanese firms expecting zero growth over the coming year and a minority anticipating renewed recession.

And in the event that Japan’s credit profile further weakens, Toyota can expect to suffer a lower availability of credit and a higher cost obtaining it (as we saw in the price of its issued debt in the secondary market).

Looking Across the Profile

As the Toyota example demonstrates, the ability to look across an entity’s entire financial profile is essential – particularly when attempting to assess the damage inflicted by a single, unexpected, and potentially catastrophic event. Such a requirement is certainly demonstrated by Toyota’s experience since the disaster. Assessing the extent of the fall-out – from the perspective of a counterparty assessing its exposure to a corporate across its financial portfolio and business dealings – requires monitoring a range of indicators to gain a full picture of a company’s risk profile and creditworthiness.

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