This solution is all about how Toyota Motor Credit Corporation addressed the SEC’s new regulations in the prime money market fund operating structure. Although these regulations are not due to take effect until October 2016, TMCC is already very well-prepared to leverage the opportunity to enhance yield on its substantial investment portfolio without compromising liquidity or credit quality.
Photo of Alec Small, Toyota Motor Credit Corporation.
Toyota Motor Credit Corporation (TMCC) is the US financing arm of Toyota Financial Services, which is a subsidiary of Toyota Motor Corporation, the world’s largest car maker.
In 2014, the US Securities and Exchange (SEC) Commission adopted new regulations which fundamentally changed the $1.5trn prime money market fund (MMF) operating structure. Most notably, institutional prime MMFs will be required to change from a current stable net asset value (CNAV) of $1.00 to a floating net asset value (VNAV).
“While these changes do not take effect until October 2016, we had been planning for this transition by considering new policies, procedures and technology,” says Jason Katzen, Treasury Manager at TMCC. “With up to $1trn expected to leave prime MMFs, we set out to explore alternative investment solutions that would provide an opportunity to enhance yield without compromising liquidity and credit quality.”
After considering several options, the TMCC treasury team decided to expand its internal credit analysis process. The goal of this initiative would be to identify investment opportunities which offer attractive yields relative to their downside risk potential.
The solution consists of two primary components – a formalised approval process and a new relative value investment model. First, a corporate issuer approval process was created that involved both a quantitative and qualitative component.
The screen criteria narrowed companies down based on core financial ratios including: leverage, leveraged adjusted sales to assets, leverage adjusted cash flow to assets, and leverage adjusted working capital to assets. The quantitative component is then paired with a qualitative assessment. The qualitative analysis includes key items such as details of the company’s operations, potential forward-looking risk factors and an internal analyst recommendation.
In building out its relative value model, the team decided to focus on two different methods to quantify credit risk: credit default swap (CDS) spreads and Bloomberg’s proprietary default risk model.
The two models calculate their respective default probabilities, and combined with a benchmark risk-free rate, provide the users with two separate investment recommendation scores. The end result is a user friendly tool that provides a ratio of excess return per unit of risk, where a positive value is marked green and signals ‘buy’ and a negative value is market red and signals ‘do not buy’.
After over six months of hard work, the result was a new, real-time metric that quantifies credit risk for a given corporate issuer.
Best practice and innovation
In following this strategy, TMCC not only prepared themselves for upcoming MMF reform changes, but also enhanced the ability to increase the overall portfolio yield. Upon the inception of a new strategy (Q216) average absolute out-performance over the internal benchmark was 230% larger than the average of the previous ten quarters.
That performance remained fairly consistent across the recent time period as all three quarters outperformed the highest prior out-performance over the ten quarters. “If this holds, this increase will be able to generate an additional $5m in income per year,” says Alec Small, Analyst at TMCC.
“TMCC internally manages an $8-10bn high quality, short-term fixed income investment portfolio,” says Small. “This portfolio ensures we can meet known and unknown obligations should the wholesale funding markets become inaccessible. Therefore, capital preservation and liquidity are paramount. Utilising a robust qualitative and quantitative approach that relies on dynamic, forward-looking market indicators, we have improved our capabilities to buy credit.”