Photo of Nicholas Ro, Toyota Financial Services.
In addition to global macroeconomic issues, Toyota Financial Services (TFS) was experiencing its own unique challenges due to the automobile production disruptions from the earthquake in Japan and flooding in Thailand. In turn, this impacted TFS’ short-term investment portfolio (STIP) because the investment strategy centres its decisions on the cash flows required to fund future liquidity needs within a 12 month period. With greater uncertainty regarding TFS’ future liquidity needs, the key issue for the investment team was how to improve the company’s cash flow forecasts.
Nicholas Ro
National Manager – Sales and Trading
Toyota Financial Services (TFS) is the finance and insurance brand for Toyota in the US, offering retail auto financing and leasing through Toyota Motor Credit Corporation (TMCC). TFS currently employs over 3,300 associates throughout the US, and has managed assets totaling nearly $89 billion.
After analysing which area would have the most impact, TFS’ investment team focused on the bilateral collateral exchange process with its swap counterparties (23 in total). “We decided to move from a monthly to a daily exchange of collateral with zero credit thresholds and same-day settlement,” says Ro. While this reduced counterparty risk exposure, it increased the uncertainty of how much daily liquidity was necessary in the STIP. Since the $100 billion derivative portfolio has over $20 billion in cross-currency exposure, TFS’ objective was to estimate future collateral movements based on changes in foreign exchange rate forecasts.
By further analysing the company’s liquidity needs, TFS’ investment team segmented the STIP into categories based on specific functions, time horizons, and liquidity requirements. “We partnered with experts at Bloomberg and Wall Street Systems to identify FX rate movements as key factors influencing the daily collateral movement,” explains Ro. “We created scenarios to understand the derivative portfolio’s market value sensitivity to changes in FX rates.” This enabled the company to estimate the potential collateral movements.
By understanding the derivative portfolio’s sensitivity to foreign exchange rate movements and creating various scenarios for projected future currency values, TFS was able to estimate future collateral movements and make sound investment decisions. “Adding FX rate forecasts into TFS cash flow models created a clearer understanding of how much operating cash was needed to meet potential daily collateral movements. By increasing the reliability of cash flow estimates, we could then use the excess liquidity for core cash investments,” summarises Ro. The yield of the STIP was increased by lengthening the investment maturities beyond the same-day horizon of bank accounts and money market funds. “For example, by allocating a portion of the cash to longer-dated US Treasuries, US Agencies, and A1+/P1 Certificates of Deposit, we have managed to improve the yield by 25 basis points. This increase has generated an additional $10m in annual income without sacrificing safety of principal.” says Ro.
Technology infrastructure was a critical component for the success of this initiative. In addition, TFS used Toyota’s Kaizen approach (Toyota’s methodology of process improvement) to improve existing infrastructure and operational processes.
As a result of this innovation, TFS now has a STIP strategy which can be applied to additional currencies from future currency swap transactions. This transformation resulted in TFS becoming the first corporate treasury to perform daily collateral exchanges with zero credit thresholds and same-day settlement. There were softer benefits to the solution too. “Throughout this process, TFS was able to create a ‘people development’ opportunity which enabled associates to ‘grow, perform and succeed’,” says Ro. Since this project involved analysing the impact of foreign exchange movements on its derivative portfolio, the TFS Treasury team hosted ‘knowledge sharing’ sessions with FX strategists from major investment banks which increased TFS associates’ understanding of the macroeconomic themes and events influencing FX forward rates.
“Focusing on continuous process improvements while having a respect for people is part of Toyota’s core values. Being able to combine these important foundations of the Toyota culture created a higher performing organisation,” Ro adds.
