RISK MANAGEMENT IN AIRLINES: FINANCIAL RISKS AT TURKISH AIRLINES

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RISK MANAGEMENT IN AIRLINES FINANCIAL RISKS AT
TURKISH AIRLINES

• UNAL BATTAL
• ANADOLU UNIVERSITY
• TURKEY

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RISK MANAGEMENT IN AIRLINESIntroduction

• Airlines are doing everything to reduce costs
• Some of the risks stem from complex industry
  structure
• Necessary to reduce the risk
• Much of this risk, however, could be identified
  and managed
• Effective strategies, adopted by other sectors
• In general, the financial markets do not trust
  airlines

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RISK MANAGEMENT IN AIRLINESRisk Management

• Aviation encompasses a full spectrum of risk
  factors
• International airline is exposed
• general entrepreneurial risks and
• industry-specific risks.
• Key areas of exposure are
• capacity and utilization risks,
• strategy-related risks,
• political risks,
• operational risks,
• procurement risks,
• labor agreement risks,
• financial and treasury management risks.

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RISK MANAGEMENT IN AIRLINESRisk Management

• Mercer Management Consulting analyzed aviation
  industry risks (1991-2001)
• The primary risk facing the industry four
  categories
• hazard,
• strategic,
• financial and
• operational.
• Failure to manage the risks resulted in the
  evaporation of 46 billion in shareholder value

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RISK MANAGEMENT IN AIRLINES
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RISK MANAGEMENT IN AIRLINESRisk Management

• Hazard events safety, liability, and war were the
  least
• Strategic and financial risks were much more
  prevalent

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RISK MANAGEMENT IN AIRLINESKey Risks for Airlines

• Strategic risks are defined by business design
  choices
• Challenges from a new form of competition shifts
  in
• customer preference and
• industry consolidation
• These challenges may be mitigated through
  traditional responses
• creating a culture focused on the customer,
• developing a rigorous strategic planning process
  or
• maintaining an independent board of directors.

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RISK MANAGEMENT IN AIRLINESKey Risks for Airlines

• Many risks can be lessened through the selection
  of the business design
• For example, Southwest has designed a business
  that
• attracts customers in good times and in bad
• because it is simple operationally and,
• therefore, cost effective
• use of secondary airports insulates from
  competitive pressure
• low debt levels make the company less vulnerable
  to interest rate fluctuations.
• profit sharing and fun culture reduce the chance
  of labor difficulties.

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RISK MANAGEMENT IN AIRLINESKey Risks for Airlines

• Financial risks involve
• the management of capital and cash,
• including exogenous factors
• affect the predictability of revenue and cash
• Financial solutions may include the design of
  financial transactions
• structured finance,
• derivatives,
• insurance,
• contingent financing and
• debt equity offerings.

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RISK MANAGEMENT IN AIRLINESKey Risks for Airlines

• Operational risks arise from the more tactical
  aspects
• crew scheduling,
• accounting and information systems,
• e-commerce activities.
• Operational risks can be mitigated through
  organizational solutions,
• process redesign,
• organization structural changes,
• improved communication,
• contingency planning,
• performance measurement and reward systems,
• capital allocation and pricing.

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RISK MANAGEMENT IN AIRLINESRisk Mitigation

• Mitigating strategic risk
• Lufthansas diversification into non-flying
  businesses was designed
• In 1994 four companies being created
• Lufthansa Technique, Lufthansa Cargo, Lufthansa
  Service, and Lufthansa Systems.
• Revenue growth has been highest 70 percent in
  1995.
• Not all of the divisions have been successful.
• Swissair pursued a similar strategy but they
  couldn't succeed

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RISK MANAGEMENT IN AIRLINESRisk Mitigation

• Some airlines have contained strategic risk
  through aggressive cash management.
• During the 2001 crisis,
• low-cost airline Ryanair an order for 100 Boeing
  737s with 50 options,
• during a time when most airlines are deferring
  orders
• They were able to negotiate a low unit price.
• During the Asian financial crisis,
• Singapore Airlines upgrades to their onboard
  product,
• for entrenching their leadership position during
  the later economic upturn.

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RISK MANAGEMENT IN AIRLINESRisk Mitigation

• Mitigating financial risk
• Techniques to mitigate financial risks are the
  most advanced
• There is a large third-party market dedicated to
  the effort,
• including banks,
• credit specialists,
• derivative markets and others.
• Hedging is a common way to manage the financial
  risk
• no airline input is more volatile than fuel
• hedging is not a core competency, and
• as long as competitors are not hedged, it will be
  a level playing field.
• When fuel prices rise dramatically, airlines
  cannot pass all of the cost on to their
  customers.

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RISK MANAGEMENT IN AIRLINESRisk Mitigation

• Mercer analyzed the effect of year 2000 hedging
  strategies
• While many airlines were able to maintain profits
  in the face of price increases, more aggressive
  strategies could have been used to further
  improve results.
• If such tools are not further leveraged, earnings
  will continue to be vulnerable.

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RISK MANAGEMENT IN AIRLINESRisk Mitigation

• A new technique for financial risk management
  involves guarantees for credit card transactions
• In the new arrangement, a guarantor insures the
  refunds to the bank, which then releases the cash
  in the escrow account.

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RISK MANAGEMENT IN AIRLINESRisk Mitigation

• Of the 45 risk events analyzed by Mercer,
• Two-thirds could have been avoided using the
  types of approaches discussed above.
• Ten could have been mitigated through traditional
  means such as insurance or financial derivatives.
  
• Fourteen events could have been mitigated by more
  consistent and in-depth customer analysis,
  combined with scenario planning and game theory
  exercises.
• Finally, eight events could have been mitigated
  through improved merger integration planning and
  improved execution.

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FINANCIAL RISKS AT TURKISH AIRLINESCurrent
Status of Turkish Airlines

• Air transportation is a fast growing sector of
  the Turkey economy.
• According to IATA report, Turkey will be one of
  the fastest growing markets between 2005-2009.
• An approximate of 8.9 growth in passenger
  numbers is estimated for Turkey for the next 5
  years.
• Turkish Airlines (THY), founded in the year 1933,
  
• THY, remains the national flag carrier.
• However with competition in the market, THY has
  improved its standards
• The private sector has steadily increased its
  share in the international market.

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FINANCIAL RISKS AT TURKISH AIRLINESCurrent
Status of Turkish Airlines

• During the year 2007,
• THY carried 19,6 million passengers,
• flies to 69 countries, 138 cities and 140points,
• fleet of 102 aircraft and
• seat capacity of 17,594.
• In Jan-Mar 2008,
• On domestic routes On
  international routes
• capacity increased by 9,4, capacity
  increased by 10,
• traffic increased by 9,7, traffic
  increased by 16,5,
• load factor decreased by 71,4. load factor
  increased by 70,2.

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FINANCIAL RISKS AT TURKISH AIRLINESCurrent
Status of Turkish Airlines

• Out of 59 aircraft, 43 of them joined the fleet
  as of 2008.
• As of 2008 average age of the fleet will be
  around 6 yrs.
• Total of 2.7 billion dollars financing were
  completed for the aircraft delivered
• Annual lease expenses will be approximately
  around 545 million
• 77 Financial leases and
• 23 Operational leases

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FINANCIAL RISKS AT TURKISH AIRLINESFinancial
Risk Management

• A formally specified risk management model are
  not available within the THY.
• Important risks of the THY are
• Currency risk,
• Interest rate risk and
• Liquidity risk
• Financial risks related to the changes in the
  exchange rate and interest rate due to its
  operations.

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FINANCIAL RISKS AT TURKISH AIRLINESFinancial
Risk Management

• Foreign currency risk management
• THYs income is diversified among the major
  currencies.
• Due to its currency basket THY is very flexible
  on position.
• USD income is lower then USD expenses,
• THY is able to cover its USD expenses from Euro
  income
• Same concept on USD/Euro is applicable to cover
  Turkish Lira expenses

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FINANCIAL RISKS AT TURKISH AIRLINESFinancial
Risk Management

• There is a natural balance in the foreign
  currency risk
• Foreign currency sensitivity
• The sensitivity of the THY against 10 change in
  USD and EUR exchange rates.
• Negative amount demonstrates the decrease effect
  of the 10 increase in the value of USD and EUR
  against YTL in the net profit for the year.
• If USD and EUR is devaluated against YTL by 10 ,
  the amounts are the same as the figures in the
  table below

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FINANCIAL RISKS AT TURKISH AIRLINESFinancial
Risk Management

• Interest rate risk management
• THYs liabilities are on fixed and variable
  interest rates.
• When the existing debts are being considered it
  is seen that the variable interests compose the
  majority.
• THYs debts with variable interest rate are
  dependent to Libor and Euribor, dependency to
  local risks is low.
• When there is an increase by 0,5 in Libor and
  Euribor interest rates
• THYs interest expense for the twelve months
  period increases by 4.616.168 YTL.
• When the Libor and Euribor interest rates
  decrease by 0,5 , twelve months interest expense
  decrease as the same amount.
• THY signed interest swap contracts in order to
  change its financial leasing debts from fixed
  interest rate to floating interest rate.
• THY signed exchange contracts in order to change
  financial leasing debts from Euro to US dollar.

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FINANCIAL RISKS AT TURKISH AIRLINESFinancial
Risk Management

• Credit risk management
• THYs credit risk is basically related to its
  receivables.
• THYs credit risk is dispersed and there is not
  important credit risk concentration.
• THY manages the risk through obtaining guarantees
  for its receivables.
• Liquidity management
• THY manages liquidity risk by maintaining
  adequate reserves, banking facilities and reserve
  borrowing facilities
• Capital risk management
• The capital structure of the THY consists of
  debt, which includes the borrowings and equity
  comprising issued capital, reserves and retained
  earnings.
• The top management of the THY assesses the cost
  of capital and the risks associated with each
  class of capital.
• The Group provides the optimization of the
  capital diversification through obtaining new
  debts, repayment of the existing debts and/or
  capital increase.

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CONCLUSION

• THY start a expansion plan turn into global
  airlines
• THY bought 61 new airplanes
• 41 airplanes financing has completed and
  delivered to THY
• 18 airplanes financing has been decided
• Approximately 2,7 billion dollars financing has
  provided
• Treasure guaranty isnt taken and
• The lowest interest rate credit accepted on
  libor(-).

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CONCLUSION

• THY makes decisions by researching all
  alternatives as
• ECA,
• Guaranteed Financial leasing,
• Operational leasing,
• Japanese Operating Lease (JOL)
• Tax Shielded Financial Leasing and
• Securitization.
• JOL method has first time used on aircraft
  financing.
• Supplied the possibility of low interest to THY
  like in US Eximbank
• French Tax Shielded Financial Leasing system
  which one of first in international market
• This method was used financing Airbus aircraft in
  2006
• will be use US Eximbank guarantied Boeing
  aircrafts which will be delivered in 2008

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CONCLUSION

• The risk of interest of companies has two
  sources
• the sensitiveness of assets and the sensitiveness
  of debts to the interests.
• If the companies want to protect themselves on
  natural ways from the risk of interests,
• positive correlation with the changes of interest
  should prefer the floating interest debt and
• negative correlation with the changes of
  interests should prefer the fixed interest debt.
• Distribution of foreign money on the revenues and
  the expenses are care about.
• If the cost is low, a part of financing can be
  done on Euro beside dominant money US Dollar in
  aircraft market.
• THY provide positive contribution with the
  matching distribution of revenues and expenses in
  their future cash flows,

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CONCLUSION

• THY management manages the risks through its
  decisions and applications.
• A formally specified risk management model is not
  available in THY
• Corporate risk management model has been aimed
• Enterprise Risk Management (ERM) also comprise
  financial, strategic risks which will give many
  advantage to THY
• With formation of ERM its planning to
• identify risk appetite,
• risk strategy and
• create risk transparency
• to create a strong risk organization, to
  inculcate sharing risk culture and effective risk
  processes.

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CONCLUSION

• Risk management is an ongoing process, not a
  one-time event.
• If economy is a chain and every sector is its
  ring, every sector has to keep its ring strong.
• Over the long-term, the only alternative to risk
  management is crisis management.