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Aer Lingus' treasury function: in it for the long haul Back  
As a pioneer of corporate treasury in Ireland it is hardly surprising that Aer Lingus is flying high in funding and risk management. Brian Dunne writes.
Aer Lingus was one of the first Irish corporates to set up a specialist treasury operation. The treasury function initially managed the financial exposures and risks of a diverse international group. Following the recent completion of the company’s asset disposal programme and the focus on the core airline business the role of the treasury team is now focussed 100 per cent on managing the airline financial exposures and risks.

Recent business developments in Aer Lingus are well documented. Following the tragic events of 11 September 2001, the airline promptly developed and implemented a Survival Plan. This involved cutting back on capacity by about 17 per cent, reducing staff numbers by 33 per cent - 2000 people, absolute control over all costs and ultra tight cash management. The airline has gone significantly beyond the survival plan and has identified further savings of E130 million of which E90 million has now been achieved. This together with new routes supported by low fares and its efficient user-friendly internet site www.aerlingus.com has resulted in a projected loss of E27 million for 2002 being turned into a significant operating profit.

Business rationale and treasury

The objective of the treasury operation is to execute the key treasury responsibilities of funding and risk management in a secure and cost-effective manner. The Aer Lingus attitude to risk is a strategic risk management approach. It involves maintaining appropriate levels of cover and implementing strategies to manage exposures based on business risks and assessment of possible market movements. This requires a close interface with the ever-changing business and a comprehensive understanding of the economic exposures created by the business. Today an international airline is faced with many financial exposures relating to currency, interest rates, commodity price risk (fuel) and high value foreign currency denominated assets (aircraft) together with major operating risks, which must be insured against.

At Aer Lingus, treasury management is governed by the board approved treasury policy. This policy determines the parameters within which treasury management must operate. All transactions relate strictly to business exposures. The effectiveness of the policy is regularly reviewed to ensure that it meets the requirements of the business and best practice.

Key responsibilities

The key responsibilities of the treasury team in Aer Lingus are:

• Liquidity Management: This involves ensuring that working capital and cash resources are managed in a manner to optimise the returns whilst ensuring that funding is available to meet the operating and capital asset requirements of the business. Aer Lingus has a turnover of the order of E1 billion p.a. resulting in operating cash flows of approximately E2 billion p.a. In addition asset acquisitions, primarily aircraft (- a transatlantic aircraft, Airbus A330, costs approximately US$90million and a short haul aircraft, Airbus A320, costs around US$40million) must be funded.

In 2002 the airline took a number of actions to improve its cash position. These included the sale of surplus assets, the curtailment and deferral of capital expenditure, the review of financing structures and raising new finance. The airline sold interests in three remaining non-core businesses, Aviation Services Ireland, Timas Limited and FUTURA, the Spanish charter airline. It negotiated a $20million working capital facility with Anglo Irish Bank and, as detailed below, completed an aircraft financing generating approximately $70 million. These actions together with the improved trading resulted in its available cash balance increasing from E169 million at 31 December 2001 to approximately E360 million at the end of 2002.

• Currency exposure management: The primary operating currencies of the airline are euro, dollar and sterling. The airlines base currency is euro. The airline is short dollar and long sterling. The dollar deficiency results from dollar operating costs (aircraft lease rentals, fuel etc.) exceeding dollar income. The airline also has requirements for dollar to fund aircraft acquisitions.

The exposures are proactively managed to minimise the impact on the trading result and balance sheet of the company from currency rate fluctuations. Exposures are managed on a ‘net’ basis using a range of financial instruments. The main derivative instruments used to manage currency exposures are FX forwards, FX options, FX swaps and FX interest rate swaps.

• Commodity (fuel) price exposure management: The volatility of aviation fuel prices is such that it can have a significant impact on the profitability of the airline. During the period 1999 to 2001 the price of aviation jet fuel fluctuated in the range $100 to $400 per tonne. As the airline uses about 400,000 tonnes of fuel annually, a movement of $1 per tonne in the price impacts the bottom line by $400,000. The airline is very active in fuel price hedging, covering positions up to 18 months out. The risk management policy sets predetermined cover levels to be in place within predetermined time parameters (e.g. the policy is to maintain a minimum hedging level of 60 per cent of Q1 and 30 per cent of Quarters 2, 3, 4 by the start of each year with overall minimum cover of 40 per cent of annual volumes). Currently the airline is fully hedged well into 2003. This provides it with major protection against potential fuel price rises from e.g. conflict in the Middle East, OPEC supply issues and labour disputes in Venezuela.

Derivative instruments used to manage fuel price exposures include swaps, futures, options, forwards, caps, floors, collars and cylinders.

• Accounting and balance sheet exposure management: Exposures resulting from the accounting treatment of foreign currency denominated assets and liabilities also require management. The main exposure categories are FX debtors and FX creditors, FX deposits and FX borrowings and FX provisions. The disclosure requirements relating to the use of and accounting for derivatives also have to be addressed.

• Aircraft financing: When the airline decides to acquire aircraft it must also decide the optimal financing arrangements for such assets. Aer Lingus has utilised many innovative financing structures since the mid 1980s including conventional operating leases, Japanese, German and French leveraged leases and Japanese operating leases. Conventional operating leases provide fleet flexibility - a very important factor post 11 September 2001 whilst the other structures provide financing significantly below conventional debt financing costs. The airline recently completed the financing of two Airbus aircraft raising approximately $70 million at a cost significantly below market cost of funds. The financing was provided by Bank of Ireland and Lombard Aviation Capital and was arranged by Macquarie Bank, an Australian investment bank.

• Insurance: Because of aircraft financing undertakings and the many countries and jurisdictions that it operates into and over-flies the airline must insure against specific risks in order to comply with regulatory, operating and financing undertakings. The airline must also protect itself against the destruction of assets or claims by third parties where such losses could undermine the financial integrity, stability and profitability of the airline. Since 11 September 2001, the cost of aviation insurance has increased by between 400 per cent and 500 per cent. Immediately following these tragic events the aviation insurance market effectively withdrew third party war risk cover and airlines worked with their national governments in order to maintain services. Aer Lingus and other Irish airlines sourced this cover from the aviation insurance market when it re-opened late in 2002. Consistent with its risk management philosophy Aer Lingus will self-insure risks where the premiums chargeable by the insurance market are out of line with the risk being covered.

The team

Treasurer Brian Wheatley heads up the treasury team, with operational management and technical expertise provided by Sean Grace. Dermot Byrne specialises in aircraft financing and together with Frank Rogers looks after the daily cash management and dealing etc. Dawn Evans and Sean Gilmartin attend to insurance matters.
The market in which Aer Lingus operates presents significant financial, economic and commodity price risks. The proactive and skilled management of these exposures in a manner consistent with the corporate objectives of Aer Lingus is an integral and key aspect of the overall management of the business.

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