RISK MANAGEMENT IN AIRLINES: FINANCIAL RISKS AT TURKISH AIRLINES

1. RISK MANAGEMENT IN AIRLINES: FINANCIAL RISKS AT TURKISH AIRLINES UNAL BATTAL ANADOLU UNIVERSITY TURKEY

2. 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

3. 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.

4. 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

5. RISK MANAGEMENT IN AIRLINES

6. RISK MANAGEMENT IN AIRLINESRisk Management • Hazard eventssafety,liability, andwar were the least • Strategic and financial risks were much more prevalent

7. 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.

8. 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.

9. 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.

10. 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.

11. RISK MANAGEMENT IN AIRLINESRisk 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

12. RISK MANAGEMENT IN AIRLINESRisk Mitigation • Some airlines have contained strategicrisk 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.

13. RISK MANAGEMENT IN AIRLINESRisk Mitigation Mitigating financialrisk: • 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.

14. 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.

15. 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.

16. 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.

17. 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.

18. 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%.

19. 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

20. 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.

21. FINANCIAL RISKS AT TURKISH AIRLINESFinancial 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

22. 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

23. FINANCIAL RISKS AT TURKISH AIRLINESFinancial 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.

24. FINANCIAL RISKS AT TURKISH AIRLINESFinancial 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.

25. CONCLUSION • THY start a expansion plan turn into global airlines: • THYbought 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(-).

26. CONCLUSION • THY makes decisions by researching all alternatives as • ECA, • Guaranteed Financial leasing, • Operational leasing, • Japanese Operating Lease(JOL) • Tax Shielded Financial Leasingand • 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 useUS Eximbank guarantied Boeing aircrafts which will be delivered in 2008

27. 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,

28. 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.

29. 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.