Turkish Airlines Annual Report 2010

20%

Risk mitigation strategies are deployed to cover 20% of the company’s fuel consumption.

* Under a Board of Directors resolution dated 21 January 2011, this coverage is to be increased to 50%.

Turkish Airlines assesses its financial risks and successfully deploys strategies to protect itself against them.

In order both to reduce our exposure to the risks caused by price volatilities in the aviation industry’s costs and to achieve a sounder financial structure, financial risk management practices are continuously updated.

Financial Risk Management

 

Turkish Airlines continues to adhere to effective risk management practices.
The risks to which the company is exposed are defined as follows:

Risk mitigation strategies were developed to make use of derivative markets in line with decisions taken so as to lock in commodity prices and credit interest rates in order to protect the company against those risks.

In future, efforts will continue to be made to keep risk management strategies current on the basis of analyses of the experience gained in dealing with commodity market risk since the very beginning as well as market developments and strategy options in order to achieve results which are both in line with the company’s interests and which outperform sectoral averages.

The prices which the company might encounter in situations where movements in the market barrel price of Brent crude oil take place within the framework of different scenarios during the risk mitigation period and the fuel costs which the company might have to bear as a result of such changes are shown below.

Commodity Price Risk Management
In order to reduce the impact that changes in oil prices have on aviation fuel costs by ensuring that the cost of aviation fuel is locked into a single price (or price range) and minimizing the effects that adverse conditions in fuel market may have, since December 2010 the company has been progressively making use of derivative instruments to protect itself against such risks. Denominated in terms of barrels of crude oil and thousands of tons of aviation fuel, these derivatives are designed so as to cover approximately 20% of the monthly amount of jet fuel which the company plans to consume during the next month.

Turkish Airlines seeks to systematically minimize its risk exposure in line with its Risk Mitigation Strategy Implementation Plan.

Interest Rate Risk Management
Under the heading of interest rate risk management, the company engages in a consistent and ongoing effort to monitor and analyze interest rate markets, to manage the structure of its debt exposure, to lock in credit interest rate so as to balance risk and cost, to analyze its sensitivity to interest rate changes as well as its weighted-average term exposure, and to keep track of possible changes in costs arising from interest rates.

Cash Flow Risk Management
Cash flow risk is defined as the risk that movements in cash positions and investment portfolios, taking short-, medium-, and long-term cash flows into account, will prevent the company from achieving its business objectives.

In order to ensure that medium- and long-term liquidity and financial risks are managed effectively throughout the company, cash flow projections are regularly prepared for each coming month. These projections are denominated in EUR, USD, and TL. When preparing these projections, the company’s exchange rate and fuel cost estimates for each period are reviewed and updated in order to be certain that the current cash flow projection is based on up-to-date and valid information. Once prepared, every cash flow projection is submitted to the Treasury and Risk Management Committee so that it may serve as the basis for that body’s investment and financing decisions.

Exchange Rate Risk Management
The company defines exchange rate risk as the likelihood of changes in cash flows and revenues resulting from movements in foreign currency exchange rates. In particular, the company secures a large portion of its revenues in euros but makes a considerable volume of its expenditures in dollars and Turkish liras. These currencies’ parities have been subject to volatile movements in the past and this situation is expected to continue in the future. These volatilities pose a significant risk for the company.

For this reason, the company reduces its exchange rate risk exposure arising from having to maintain positions in different currencies by holding onto cash items on hand in relative proportion to its expenses. By employing derivatives, it makes use of specific exchange rate risk mitigation methods in addition to general ones in order to manage its overall currency risk exposure.

Credit Risk as an Adjunct of Bank Relationship Management
The company engages in dealings with national and international financial institutions. There are no problems with any of these entities at this time. However in view of the lessons learned from the international economic crisis of 2008-2009, various measures are being taken to deal with any credit risk which might in future arise as a result of deposit and derivative account dealings with financial institutions. Taking an approach which incorporates fair and objective criteria that will minimize long-term counterparty risks related to both deposit and derivative transactions, the company enters into agreements with financial institutions concerning the credit risks that might arise from its trading in derivatives.

In the case of bank deposits, the company’s working principles call for determining the maximum total of deposits that may be held with each financial institution. The company prefers not to do business with any financial institution whose credit rating (as determined for financial institutions by the world’s leading credit rating agencies) falls below the credit risk threshold that the company itself specifies. For those that are above the threshold, the company assigns limits based on risk levels determined in accordance with its own credit risk assessment methodology. The credit ratings and limits which the company does assign to such financial institutions are periodically reviewed and revised. If a financial institution’s credit rating should go down, all dealings with it are immediately placed under close watch. If its rating should fall below prescribed limits, the company may have recourse to its option of unilaterally suspending its dealings with that particular bank.

The company seeks to protect itself from financial risk by formulating methodologies for dealing with the principal financial risks to which it is exposed. For this reason, the company enters into various agreements with non-Turkish-resident counterparties to manage the credit risks arising from its use of derivatives. These agreements incorporate the standards published by the International Swaps and Derivatives Association (ISDA) as well as other matters that are deemed to be necessary. Issues pertaining to credit risk management are governed by the ISDA’s credit support annex (CSA), under which credit risk is reduced by engaging in offsets at specified intervals of time. In addition to such agreements, the company also determines specific derivative trading limits for each bank in light of current legal requirements and it monitors these limits as required.

Carbon Emissions Risk Management
Beginning on 1 January 2012, Aviation industry will become subject to the European Union Emission Trading Scheme (EU ETS). Because of this, all airlines that fly into Europe, Turkish Airlines being one of them, will be required to comply with the regulations of the EU’s carbon emissions trading system.

Under EU ETS, an airline that exceeds its assigned carbon emissions quota will have to compensate for this by purchasing carbon credits from the exchange or by earning them through environmental protection projects. To this end, the company is currently involved in efforts to have its carbon emissions verified prior to obtaining a voluntary carbon quota and it is also planning what it must do to protect itself against the carbon emission risks that will be associated with such a quota.