RISK MANAGEMENT IN AIRLINES: FINANCIAL RISKS AT TURKISH AIRLINES UNAL BATTAL ANADOLU UNIVERSITY TURKEY RISK MANAGEMENT IN AIRLINES Introduction: 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 RISK MANAGEMENT IN AIRLINES Risk 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. RISK MANAGEMENT IN AIRLINES Risk 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 RISK MANAGEMENT IN AIRLINES RISK MANAGEMENT IN AIRLINES Risk Management Hazard events safety, liability, and war were the least Strategic and financial risks were much more prevalent RISK MANAGEMENT IN AIRLINES Key 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. RISK MANAGEMENT IN AIRLINES Key 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. RISK MANAGEMENT IN AIRLINES Key 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. RISK MANAGEMENT IN AIRLINES Key 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. RISK MANAGEMENT IN AIRLINES Risk Mitigation Mitigating strategic risk: Lufthansa’s 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 RISK MANAGEMENT IN AIRLINES Risk 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. RISK MANAGEMENT IN AIRLINES Risk 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. RISK MANAGEMENT IN AIRLINES Risk 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. RISK MANAGEMENT IN AIRLINES Risk 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. RISK MANAGEMENT IN AIRLINES Risk 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. FINANCIAL RISKS AT TURKISH AIRLINES Current 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. FINANCIAL RISKS AT TURKISH AIRLINES Current 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%. FINANCIAL RISKS AT TURKISH AIRLINES Current 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 FINANCIAL RISKS AT TURKISH AIRLINES Financial 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. FINANCIAL RISKS AT TURKISH AIRLINES Financial Risk Management Foreign currency risk management: THY’s 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 FINANCIAL RISKS AT TURKISH AIRLINES Financial 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 FINANCIAL RISKS AT TURKISH AIRLINES Financial Risk Management Interest rate risk management: THY’s 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. THY’s 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 THY’s 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. FINANCIAL RISKS AT TURKISH AIRLINES Financial Risk Management Credit risk management: THY’s credit risk is basically related to its receivables. THY’s 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. 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 isn’t taken and The lowest interest rate credit accepted on libor(-). 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 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, 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 it’s 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. 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.