Photo of Richard Parkinson and David Johnson, Toyota Financial Services collecting on behalf of Sylvia Baharet.

The changing and challenging regulatory environment has decreased funding sources and credit availability from lenders. In particular, Basel III established the Liquidity Coverage Ratio (LCR) to ensure banks have adequate amounts of high quality liquid assets (HQLA) to meet liquidity needs for 30 calendar days in a liquidity stressed scenario. These assets include cash, certain government securities and other 0% risk-weighted assets as well as some corporate and structured debt obligations haircut at varying levels.

Banks can either manage this compliance by increasing their HQLA holdings or limit their credit lending. Revised Basel III proposals as of January 2013 call for banks to assume 30% draw-downs on extended credit facilities. Banks have begun reducing their credit commitments based upon the proposed Basel framework.

As Sylvia Baharet, Trader, Derivatives and Structured Finance explains, “we needed a solution which delivered on our guiding principle of providing the lowest cost funding available to the organisation. Our objective was to identify the product and market demand that could deliver on these requirements.”

The goal was to strategically increase TFS’s footprint in the structured notes market and meet market demand from a diversified investor base. Funding obtained from structured notes yielded three benefits:

• Reduced interest expense.
• Broadened funding channels.
• Satisfied investor demand.

Baharet explains, “in FY2013 we issued the equivalent of one USD benchmark deal ($750m), resulting in interest expense savings of $29m for an equivalent duration of proceeds. Moreover, we diversified our funding channels and met both institutional and retail demand for high-quality, non-bank financial names.”

Debt capital markets utilised the company’s infrastructure, capitalising on in-house risk, valuation, operations, legal, tax, and accounting expertise, competitive advantages compared to other captive financials, which allowed for the issuance of structured notes. The unit identified an innovative funding vehicle that allowed TFS to utilise its corporate infrastructure and deliver on its guiding principle of providing the company with the lowest attainable cost of funds.

Structured notes were selectively and methodically issued with suitable structures for retail and institutional investors, and able to meet internal funding mandates. Notes were issued off Toyota Financial Services’ MTN & EMTN SEC-registered shelves, which provide lower funding costs to TFS and increased liquidity to investors rather than Rule 144A (QIB) deals. Structures included fixed rate callable notes, step-up callable notes, and capped-floaters with a fixed rate payment period.

The embedded derivative component within the structured notes did not discourage TFS from using the product as a funding vehicle. A key competitive advantage over other captives has been the implemented daily valuation and collateral exchange arrangements TFS has with all derivative counterparties. Collateral arrangements with all, but one, counterparty include a zero threshold, full collateralisation requirement which significantly reduced counterparty credit risk exposure as of 31^st March 2013. Without a daily collateral exchange, the cost savings on the structured notes would not have been as substantial as counterparties would charge more for dealing with longer collateral exchange horizons. This competitive advantage allowed TFS to climb the league table from 13^th in 2012 to 1^st in 2013 year-to-date.

TFS issues where investor demand is present and the cheapest funding is attained without compromising the company’s liquidity position. The latest deals provided an equivalent option adjusted duration of seven years.

Baharet explains, “we were able to substitute a seven-year benchmark deal with an equivalent maturity profile in the structured notes, realising cost savings of $29m.”