RISK MANAGEMENT IN AIRLINES: FINANCIAL RISKS AT TURKISH AIRLINES

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RISK MANAGEMENT IN AIRLINES: FINANCIAL RISKS AT TURKISH AIRLINES

  1. 1. RISK MANAGEMENT IN AIRLINES: FINANCIAL RISKS AT TURKISH AIRLINES UNAL BATTAL ANADOLU UNIVERSITY TURKEY
  2. 2. RISK MANAGEMENT IN AIRLINES Introduction : <ul><li>Airlines are doing everything to reduce costs </li></ul><ul><li>Some of the risks stem from complex industry structure </li></ul><ul><li>Necessary to reduce the risk </li></ul><ul><li>Much of this risk, however, could be identified and managed </li></ul><ul><li>Effective strategies, adopted by other sectors </li></ul><ul><li>In general, the financial markets do not trust airlines </li></ul>
  3. 3. RISK MANAGEMENT IN AIRLINES Risk Management <ul><li>Aviation encompasses a full spectrum of risk factors : </li></ul><ul><ul><li>International airline is exposed </li></ul></ul><ul><ul><ul><li>general entrepreneurial risks and </li></ul></ul></ul><ul><ul><ul><li>industry-specific risks. </li></ul></ul></ul><ul><li>Key areas of exposure are </li></ul><ul><ul><li>capacity and utilization risks, </li></ul></ul><ul><ul><li>strategy-related risks, </li></ul></ul><ul><ul><li>political risks, </li></ul></ul><ul><ul><li>operational risks, </li></ul></ul><ul><ul><li>procurement risks, </li></ul></ul><ul><ul><li>labor agreement risks, </li></ul></ul><ul><ul><li>financial and treasury management risks. </li></ul></ul>
  4. 4. RISK MANAGEMENT IN AIRLINES Risk Management <ul><li>Mercer Management Consulting analyzed aviation industry risks ( 1991 - 2001 ): </li></ul><ul><ul><li>The primary risk facing the industry four categories </li></ul></ul><ul><ul><ul><li>hazard , </li></ul></ul></ul><ul><ul><ul><li>strategic , </li></ul></ul></ul><ul><ul><ul><li>financial and </li></ul></ul></ul><ul><ul><ul><li>operational . </li></ul></ul></ul><ul><ul><li>F ailure to manage the risks resulted in the evaporation of $46 billion in shareholder value </li></ul></ul>
  5. 5. RISK MANAGEMENT IN AIRLINES
  6. 6. RISK MANAGEMENT IN AIRLINES Risk Management <ul><li>Hazard events safety, liability, and war were the least </li></ul><ul><li>Strategic and financial risks were much more prevalent </li></ul>
  7. 7. RISK MANAGEMENT IN AIRLINES Key Risks for Airlines <ul><li>Strategic risks are defined by business design choices </li></ul><ul><ul><li>Challenges from a new form of competition shifts in </li></ul></ul><ul><ul><ul><li>customer preference and </li></ul></ul></ul><ul><ul><ul><li>industry consolidation </li></ul></ul></ul><ul><ul><li>These challenges may be mitigated through traditional responses </li></ul></ul><ul><ul><ul><li>creating a culture focused on the customer, </li></ul></ul></ul><ul><ul><ul><li>developing a rigorous strategic planning process or </li></ul></ul></ul><ul><ul><ul><li>maintaining an independent board of directors. </li></ul></ul></ul>
  8. 8. RISK MANAGEMENT IN AIRLINES Key Risks for Airlines <ul><li>M any risks can be lessened through the selection of the business design </li></ul><ul><ul><li>For example, Southwest has designed a business that </li></ul></ul><ul><ul><ul><li>attracts customers in good times and in bad </li></ul></ul></ul><ul><ul><ul><li>because it is simple operationally and, </li></ul></ul></ul><ul><ul><ul><li>therefore, cost effective </li></ul></ul></ul><ul><ul><ul><li>use of secondary airports insulates from competitive pressure </li></ul></ul></ul><ul><ul><ul><li>low debt levels make the company less vulnerable to interest rate fluctuations. </li></ul></ul></ul><ul><ul><ul><li>profit sharing and fun culture reduce the chance of labor difficulties. </li></ul></ul></ul>
  9. 9. RISK MANAGEMENT IN AIRLINES Key Risks for Airlines <ul><li>Financial risks involve </li></ul><ul><ul><ul><li>the management of capital and cash, </li></ul></ul></ul><ul><ul><ul><li>including exogenous factors </li></ul></ul></ul><ul><ul><ul><li>affect the predictability of revenue and cash </li></ul></ul></ul><ul><li>Financial solutions may include the design of financial transactions </li></ul><ul><ul><ul><li>structured finance, </li></ul></ul></ul><ul><ul><ul><li>derivatives, </li></ul></ul></ul><ul><ul><ul><li>insurance, </li></ul></ul></ul><ul><ul><ul><li>contingent financing and </li></ul></ul></ul><ul><ul><ul><li>debt equity offerings. </li></ul></ul></ul>
  10. 10. RISK MANAGEMENT IN AIRLINES Key Risks for Airlines <ul><li>Operational risks arise from the more tactical aspects </li></ul><ul><ul><ul><li>crew scheduling, </li></ul></ul></ul><ul><ul><ul><li>accounting and information systems , </li></ul></ul></ul><ul><ul><ul><li>e-commerce activities. </li></ul></ul></ul><ul><li>Operational risks can be mitigated through organizational solutions, </li></ul><ul><ul><ul><li>process redesign, </li></ul></ul></ul><ul><ul><ul><li>organization structural changes, </li></ul></ul></ul><ul><ul><ul><li>improved communication, </li></ul></ul></ul><ul><ul><ul><li>contingency planning, </li></ul></ul></ul><ul><ul><ul><li>performance measurement and reward systems , </li></ul></ul></ul><ul><ul><ul><li>capital allocation and pricing. </li></ul></ul></ul>
  11. 11. RISK MANAGEMENT IN AIRLINES Risk Mitigation <ul><li>Mitigating strategic risk : </li></ul><ul><ul><li>Lufthansa’s diversification into non-flying businesses was designed </li></ul></ul><ul><ul><ul><li>I n 1994 four companies being created: </li></ul></ul></ul><ul><ul><ul><ul><li>Lufthansa Technique, Lufthansa Cargo, Lufthansa Service, and Lufthansa Systems. </li></ul></ul></ul></ul><ul><ul><ul><li>Revenue growth has been highest 70 percent in 1995. </li></ul></ul></ul><ul><ul><li>Not all of the divisions have been successful. </li></ul></ul><ul><ul><ul><li>Swissair pursued a similar strategy but they couldn't succeed </li></ul></ul></ul>
  12. 12. RISK MANAGEMENT IN AIRLINES Risk Mitigation <ul><li>Some airlines have contained strategic risk through aggressive cash management. </li></ul><ul><ul><li>During the 2001 crisis, </li></ul></ul><ul><ul><ul><li>low-cost airline Ryanair an order for 100 Boeing 737s with 50 options, </li></ul></ul></ul><ul><ul><ul><li>during a time when most airlines are deferring orders </li></ul></ul></ul><ul><ul><ul><li>They were able to negotiate a low unit price . </li></ul></ul></ul><ul><ul><li>During the Asian financial crisis, </li></ul></ul><ul><ul><ul><li>Singapore Airlines upgrades to their onboard product, </li></ul></ul></ul><ul><ul><ul><li>for entrenching their leadership position during the later economic upturn. </li></ul></ul></ul>
  13. 13. RISK MANAGEMENT IN AIRLINES Risk Mitigation <ul><li>Mitigating financial risk : </li></ul><ul><li>Techniques to mitigate financial risks are the most advanced </li></ul><ul><ul><li>T here is a large third-party market dedicated to the effort, </li></ul></ul><ul><ul><ul><li>including banks, </li></ul></ul></ul><ul><ul><ul><li>credit specialists, </li></ul></ul></ul><ul><ul><ul><li>derivative markets and others. </li></ul></ul></ul><ul><ul><li>Hedging is a common way to manage the financial risk </li></ul></ul><ul><ul><ul><li>no airline input is more volatile than fuel </li></ul></ul></ul><ul><ul><ul><li>hedging is not a core competency, and </li></ul></ul></ul><ul><ul><ul><li>as long as competitors are not hedged, it will be a level playing field. </li></ul></ul></ul><ul><ul><li>W hen fuel prices rise dramatically, airlines cannot pass all of the cost on to their customers. </li></ul></ul>
  14. 14. RISK MANAGEMENT IN AIRLINES Risk Mitigation <ul><li>Mercer analyzed the effect of year 2000 hedging strategies : </li></ul><ul><ul><li>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. </li></ul></ul><ul><ul><li>If such tools are not further leveraged, earnings will continue to be vulnerable . </li></ul></ul>
  15. 15. RISK MANAGEMENT IN AIRLINES Risk Mitigation <ul><li>A new technique for financial risk management involves guarantees for credit card transactions </li></ul><ul><ul><li>In the new arrangement, a guarantor “insures” the refunds to the bank, which then releases the cash in the escrow account. </li></ul></ul>
  16. 16. RISK MANAGEMENT IN AIRLINES Risk Mitigation <ul><li>Of the 45 risk events analyzed by Mercer, </li></ul><ul><ul><li>T wo-thirds could have been avoided using the types of approaches discussed above. </li></ul></ul><ul><ul><li>Ten could have been mitigated through traditional means such as insurance or financial derivatives. </li></ul></ul><ul><ul><li>Fourteen events could have been mitigated by more consistent and in-depth customer analysis, combined with scenario planning and game theory exercises. </li></ul></ul><ul><ul><li>Finally, eight events could have been mitigated through improved merger integration planning and improved execution. </li></ul></ul>
  17. 17. FINANCIAL RISKS AT TURKISH AIRLINES Current Status of Turkish Airlines <ul><li>Air transportation is a fast growing sector of the Turkey economy. </li></ul><ul><ul><li>According to IATA report, Turkey will be one of the fastest growing markets between 2005 - 2009. </li></ul></ul><ul><ul><li>An approximate of 8.9% growth in passenger numbers is estimated for Turkey for the next 5 years. </li></ul></ul><ul><li>Turkish Airlines (THY), founded in the year 1933, </li></ul><ul><ul><li>THY, remains the national flag carrier. </li></ul></ul><ul><ul><li>However with competition in the market, T HY has improved its standards </li></ul></ul><ul><ul><li>T he private sector has steadily increased its share in the international market. </li></ul></ul>
  18. 18. FINANCIAL RISKS AT TURKISH AIRLINES Current Status of Turkish Airlines <ul><li>During the year 2007, </li></ul><ul><ul><li>THY carried 19,6 million passengers, </li></ul></ul><ul><ul><li>flies to 69 countries, 138 cities and 140points, </li></ul></ul><ul><ul><li>fleet of 102 aircraft and </li></ul></ul><ul><ul><li>seat capacity of 17,594. </li></ul></ul><ul><li>In Jan-Mar 2008, </li></ul><ul><ul><li>O n domestic routes On international routes; </li></ul></ul><ul><ul><ul><li>capacity increased by 9,4%, capacity increased by 10%, </li></ul></ul></ul><ul><ul><ul><li>traffic increased by 9,7%, traffic increased by 16,5%, </li></ul></ul></ul><ul><ul><ul><li>load factor decreased by 71,4%. load factor increased by 70,2%. </li></ul></ul></ul>
  19. 19. FINANCIAL RISKS AT TURKISH AIRLINES Current Status of Turkish Airlines <ul><li>Out of 59 aircraft, 43 of them joined the fleet as of 2008. </li></ul><ul><ul><li>As of 2008 average age of the fleet will be around 6 yrs. </li></ul></ul><ul><ul><li>Total of 2.7 billion dollars financing were completed for the aircraft delivered </li></ul></ul><ul><ul><li>Annual lease expenses will be approximately around $545 million; </li></ul></ul><ul><ul><ul><li>77% Financial leases and </li></ul></ul></ul><ul><ul><ul><li>23% Operational l eases </li></ul></ul></ul>
  20. 20. FINANCIAL RISKS AT TURKISH AIRLINES Financial Risk Management <ul><li>A formally specified risk management model are not available within the THY. </li></ul><ul><li>Important risks of the THY are </li></ul><ul><ul><li>Currency risk, </li></ul></ul><ul><ul><li>Interest rate risk and </li></ul></ul><ul><ul><li>Liquidity risk </li></ul></ul><ul><li>Financial risks related to the changes in the exchange rate and interest rate due to its operations. </li></ul>
  21. 21. FINANCIAL RISKS AT TURKISH AIRLINES Financial Risk Management <ul><li>Foreign currency risk management : </li></ul><ul><li>THY’s income is diversified among the major currencies. </li></ul><ul><ul><li>Due to its currency basket THY is very flexible on position. </li></ul></ul><ul><ul><li>USD income is lower then USD expenses, </li></ul></ul><ul><ul><li>THY is able to cover its USD expenses from Euro income </li></ul></ul><ul><ul><li>Same concept on USD/Euro is applicable to cover Turkish Lira expenses </li></ul></ul>
  22. 22. FINANCIAL RISKS AT TURKISH AIRLINES Financial Risk Management <ul><li>There is a natural balance in the foreign currency risk </li></ul><ul><li>Foreign currency sensitivity: </li></ul><ul><ul><li>T he sensitivity of the THY against 10 % change in US D and E UR exchange rates. </li></ul></ul><ul><ul><li>Negative amount demonstrates the decrease effect of the 10 % increase in the value of US D and EUR against YTL in the net profit for the year. </li></ul></ul><ul><ul><li>If US D and E UR is devaluated against YTL by 10 %, the amounts are the same as the figures in the table below </li></ul></ul>
  23. 23. FINANCIAL RISKS AT TURKISH AIRLINES Financial Risk Management <ul><li>Interest rate risk management: </li></ul><ul><li>THY’s liabilities are on fixed and variable interest rates. </li></ul><ul><li>When the existing debts are being considered it is seen that the variable interests compose the majority. </li></ul><ul><li>THY’s debts with variable interest rate are dependent to Libor and Euribor, dependency to local risks is low. </li></ul><ul><li>When there is an increase by 0,5 % in Libor and Euribor interest rates </li></ul><ul><ul><li>THY’s interest expense for the twelve months period increases by 4.616.168 YTL. </li></ul></ul><ul><li>When the Libor and Euribor interest rates decrease by 0,5 %, twelve months interest expense decrease as the same amount. </li></ul><ul><li>THY signed interest swap contracts in order to change its financial leasing debts from fixed interest rate to floating interest rate. </li></ul><ul><li>THY signed exchange contracts in order to change financial leasing debts from Euro to US dollar. </li></ul>
  24. 24. FINANCIAL RISKS AT TURKISH AIRLINES Financial Risk Management <ul><li>Credit risk management : </li></ul><ul><ul><li>THY’s credit risk is basically related to its receivables. </li></ul></ul><ul><ul><li>THY’s credit risk is dispersed and there is not important credit risk concentration. </li></ul></ul><ul><ul><li>THY manages the risk through obtaining guarantees for its receivables. </li></ul></ul><ul><li>Liquidity management : </li></ul><ul><ul><li>THY manages liquidity risk by maintaining adequate reserves, banking facilities and reserve borrowing facilities </li></ul></ul><ul><li>Capital risk management : </li></ul><ul><ul><li>The capital structure of the THY consists of debt, which includes the borrowings and equity comprising issued capital, reserves and retained earnings. </li></ul></ul><ul><ul><li>The top management of the THY assesses the cost of capital and the risks associated with each class of capital. </li></ul></ul><ul><ul><li>T he Group provides the optimization of the capital diversification through obtaining new debts, repayment of the existing debts and/or capital increase. </li></ul></ul>
  25. 25. CONCLUSION <ul><li>THY start a expansion plan turn into global airlines : </li></ul><ul><ul><li>THY bought 61 new airplanes </li></ul></ul><ul><ul><li>41 airplanes financing has completed and delivered to THY </li></ul></ul><ul><ul><li>18 airplanes financing has been decided </li></ul></ul><ul><ul><li>A pproximately 2,7 billion dollars financing has provided </li></ul></ul><ul><ul><li>T reasure guaranty isn’t taken and </li></ul></ul><ul><ul><li>T he lowest interest rate credit accepted on libor(-). </li></ul></ul>
  26. 26. CONCLUSION <ul><li>THY makes decisions by researching all alternatives as </li></ul><ul><ul><li>ECA, </li></ul></ul><ul><ul><li>Guaranteed Financial leasing, </li></ul></ul><ul><ul><li>Operational leasing, </li></ul></ul><ul><ul><li>Japanese Operating Lease (JOL) </li></ul></ul><ul><ul><li>Tax Shielded Financial Leasing and </li></ul></ul><ul><ul><li>Securitization. </li></ul></ul><ul><li>J OL method has first time used on aircraft financing. </li></ul><ul><ul><li>Supplied the possibility of low interest to THY like in US Eximbank </li></ul></ul><ul><li>French Tax Shielded Financial Leasing system which one of first in international market </li></ul><ul><ul><li>This method was used financing Airbus aircraft in 2006 </li></ul></ul><ul><ul><li>will be use US Eximbank guarantied Boeing aircrafts which will be delivered in 2008 </li></ul></ul>
  27. 27. CONCLUSION <ul><li>The risk of interest of companies has two sources: </li></ul><ul><ul><li>the sensitiveness of assets and the sensitiveness of debts to the interests. </li></ul></ul><ul><ul><li>If the companies want to protect themselves on natural ways from the risk of interests, </li></ul></ul><ul><ul><ul><li>positive correlation with the changes of interest should prefer the floating interest debt and </li></ul></ul></ul><ul><ul><ul><li>negative correlation with the changes of interests should prefer the fixed interest debt. </li></ul></ul></ul><ul><li>Distribution of foreign money on the revenues and the expenses are care about. </li></ul><ul><ul><li>If the cost is low, a part of financing can be done on Euro beside dominant money US Dollar in aircraft market. </li></ul></ul><ul><ul><li>THY provide positive contribution with the matching distribution of revenues and expenses in their future cash flows, </li></ul></ul>
  28. 28. CONCLUSION <ul><li>THY management manages the risks through its decisions and applications. </li></ul><ul><ul><li>A formally specified risk management model is not available in THY </li></ul></ul><ul><ul><li>Corporate risk management model has been aimed </li></ul></ul><ul><li>Enterprise Risk Management (ERM) also comprise financial, strategic risks which will give many advantage to THY </li></ul><ul><ul><li>With formation of ERM it’s planning to </li></ul></ul><ul><ul><ul><li>identify risk appetite, </li></ul></ul></ul><ul><ul><ul><li>risk strategy and </li></ul></ul></ul><ul><ul><ul><li>create risk transparency </li></ul></ul></ul><ul><ul><ul><li>to create a strong risk organization, to inculcate sharing risk culture and effective risk processes . </li></ul></ul></ul>
  29. 29. CONCLUSION <ul><li>Risk management is an ongoing process, not a one-time event. </li></ul><ul><li>If economy is a chain and every sector is its ring, every sector has to keep its ring strong. </li></ul><ul><li>Over the long-term, the only alternative to risk management is crisis management. </li></ul>

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