Capital Markets

Yen Effects

By intervening to stop a strengthening yen, Japan's central bank throws uncertainty into the forex strategies of U.S. companies.
Vincent RyanSeptember 20, 2010

To all the headaches that finance chiefs have to worry about, add one more: Japan’s intervention in the currency markets last week to weaken the yen. While big Japanese exporters such as Sony and Honda cheered the Japanese central bank’s efforts to halt the yen’s five-month climb against the dollar, the intervention presents quite a different set of issues for U.S. CFOs.

The yen stood at 85.70 to the dollar Monday morning, and another round of intervention is possible. An executive at Nissan Motor said Thursday that many companies in Japan are not profitable even at the rate of 90 yen to the dollar, and a continued strong yen could mean domestic job losses.

U.S. automakers, of course, welcomed a strong yen, because it makes Japanese cars less price-competitive in the United States. But it also means higher costs for U.S. manufacturers importing large machinery or parts from Japan.

Ryan Gibbons, managing director of GPS Capital Markets, says the Japanese central bank’s move to flood the markets with yen is a wake-up call to U.S. CFOs who have been riding the profits from the currency’s appreciation the past few months. “Take a more conservative approach now,” counsels Gibbons. “If you’re in the money on hedges, you should lock into those.”

The important thing is to recognize that it’s no longer only traders and other private-enterprise players in the market who are making the yen move, says Gibbons, adding, “If you bet against central banks, you lose.”

For many U.S. companies, though, the situation is more complex. Consider Columbus, Georgia-based health insurer Aflac. Its Aflac Japan unit accounted for 76% of the company’s revenue in the first half of 2010 and roughly 80% of its assets. Aflac Japan does little converting of yen into dollars: the unit operates in yen, pays claims in yen, and collects premiums in yen, and most of its expenses are yen denominated, as are the bulk of its investments. So yen movements against the dollar have little economic effect, says Aflac CFO Kriss Cloninger. But when the Japanese unit’s results have to be translated into U.S. dollars for GAAP reporting, a large, sustained movement in the yen can “distort” the apparent growth rates of Aflac’s operations, he says.

Before the effect of foreign exchange, for example, Aflac is projecting earnings-per-share growth of 9% to 12% year-on-year, Cloninger says. But the yen’s movements can affect the as-reported figures substantially, according to a table in Aflac’s second-quarter 10-Q. If the weighted average yen-to-dollar exchange rate for all of 2010 is 85, for example, Aflac’s net EPS will grow between 16% and 18% over 2009. But if the currency weakens to 100 yen to the dollar, Aflac’s posted earnings will grow only 5% to 7%. “Within a range we are fairly neutral on what happens to the yen,” says Cloninger.

For Aflac, the nuance occurs in the risk capital that Aflac Japan has to hold to comply with regulators. Because Aflac Japan hedges a portion of its capital account by investing in U.S. dollar securities, the dollar-denominated investments have to be converted back into yen for reporting of the company’s risk-based capital ratios. So a strong yen can slightly reduce the solvency ratios that Aflac Japan reports to regulators. “We have to be cognizant of the effect of that,” says Cloninger.

Any positive effect of the previous yen strengthening on U.S. businesses, economically or accounting-wise, has been partly muted by the worldwide economic downturn. A strong yen is usually good news for U.S. luxury-goods makers, for example. Tiffany reported a 4% increase in sales in Japan in the second quarter, which it attributed to a rise in the average price per unit sold. But the boost was partly offset by a decline in units sold. Comparable store sales in the quarter actually fell 1%.

The globalization of U.S. businesses is another reason why a stronger yen hasn’t had huge effects. Rarely now is the value of a company purely tied to one currency pair, says Wolfgang Koester, chief executive of FireApps, a developer of forex exposure management software. The average company has exposure to between 40 and 300 currency pairs, he says. “I don’t know any company with more than $500 million in revenue that has less than 20 currency pairs,” says Koester. “If you looked at [the yen’s rise] in a closed [dollar-yen] system, it’s a positive for many U.S. companies, but that’s an impossible assumption.”

Despite Japan’s intervention in the yen-dollar exchange rate, there’s skepticism this time around about how effective it will be. With the U.S. economy still ailing, the Obama Administration is unlikely to assist Japan in managing the yen-dollar rate — at least in the near term. In addition, low interest rates in the United States have helped strengthen the yen as investors move money out of dollars. So any quantitative easing by the Federal Reserve could counteract the intervention.

Still, the yen is more likely to weaken than return to pre-intervention levels, Gibbons says. CFOs have some time to let the situation play out before final budgets for 2011 are due, but for those starting the budgeting process now, Gibbons recommends being at least 5% more conservative with yen-dollar exchange-rate projections. “I would set my budgets closer to 90 [yen to the dollar],” he says.

China’s yuan, of course, also needs to be on the radar screen for CFOs, but for the opposite reason. Koester points out that the larger exposure for many U.S. companies is with the yuan. “Quite a few CFOs are not looking at China as an exposure,” he says. “If they do their [value at risk] calculations and look at historical volatility, it will tell them they have no risk.” But companies have to consider how much the Chinese currency could appreciate overnight if the government suddenly lets it float freely against the dollar. “A lot of research puts the appreciation at north of 10%,” Koester says.