The Corporate Finance Department is responsible for managing the Company’s Financial Policy. This policy enables responding effectively to changes in conditions other than the normal business operating conditions and, thus, maintaining and anticipating a continuous flow of funds toward ensuring operational continuity.
Additionally, the Finance Committee, integrated by the Executive Vice-president’s Office and LATAM Board Members, meet periodically to review and propose to the Board of Directors the consideration and approval of topics not heretofore regulated by such Financial Policy.
The Financial Policy of the LATAM Airlines Group seeks to achieve the following objectives:
- To ensure a minimum level of operational liquidity. To preserve and maintain adequate cash flows in order to ensure operational requirements and growth. To maintain an adequate level of lines of credit with local and foreign banks in order to react before contingencies.
- To maintain an optimum level and profile of indebtedness in a proportion considered reasonable as a function of operational growth, while bearing in mind the objective of minimizing financing costs.
- To make cash surpluses yield profits, through financial investments that guarantee a risk and liquidity consistent with the Financial Investment Policy.
- To diminish impacts implying market risks such as fuel price changes, foreign exchange and interest rate fluctuations over the Company’s net margin.
- To reduce Counterpart Risks, by diversifying and limiting investments in counterpart operations.
- To maintain visibility at all times of the Company’s long-term financial projections, in order to anticipate situations of eventual breach of covenants (agreements), low liquidity, deterioration of financial ratios committed with rating agencies, etc.
The Company’s Financial Policy issues guidelines and restrictions for the handling of Liquidity and Financial Investment Operations, Financing Activities, and Market Risk Management.
LIQUIDITY AND FINANCIAL INVESTMENT POLICY
During 2016, the LATAM Airlines Group maintained adequate liquidity levels in order to hedge against eventual external shocks and the volatility and cycles inherent to the industry, closing as of December 2016 with a liquidity ratio of approximately 19 % over total sales of the last twelve months, which includes a committed revolving line of credit for a total amount of US$ 325 million with nine both local as well as foreign financial institutions; which, by the year’s end was fully available.
Additionally, during this year 2016, the Company continued to finance with its own corporate equity an important part of the advance payments associated to aircraft manufacturing (pre-delivery payments) linked to the aircraft that LATA has ordered and will receive in the future, from both Boeing as Airbus; whose balance as of December 31, 2016 amounted to US$170 million in pre-delivery payments financed with corporate equity.
During 2016, the Company managed to reduce its gross debt balance by approximately US$ 412 million, which is explained by the pre-payment of debt maturities totaling approximately US$ 1,816 million and the drawing new debt totaling US$ 1,404 million. Among the main financing activities carried out during the year 2016 is the issue of debt linked to the acquisition of aircraft and engines for approximately US$ 903 million, and US$ 501 million of bank debt for general purposes.
With respect to the Company’s Financial Investment Policy, the objective is to centralize investment decisions so as to optimize profitability, corrected by currency risk and subject to maintaining an adequate level of safety and liquidity.
Additionally, such policy seeks to manage risk through the diversification of counterparts, deadlines, currencies and instruments (securities).
The scope of LATAM’s Financing Policy is to centralize financing activities and offset the useful life of assets with the maturity of the debt.
Most of the investments materialized by the LATAM Airlines Group correspond to fleet acquisition programs, which are generally financed through a combination of corporate equity and long-term structured financial debt. Normally, LATAM finances between 80-85% of the asset value of such programs with bank loans, bonds secured by export promotion agencies or also unsecured bonds from export promotion agencies such as the EETC, while the remaining portion is usually financed with commercial loans and corporate equity.
The payment terms of the different financing structures are mostly at 12 years. Additionally, LATAM hires a significant percentage of its fleet acquisition commitments through operational leases as an additional financial source.
With the objective of diversifying aircraft financing alternatives, on May 29, 2015 LATAM issued and placed private debt securities denominated Enhanced Equipment Trust Certificates (“EETC”) for an aggregate amount of US$ 1,020.8 million. The execution of this operation allowed financing the acquisition of eleven new Airbus A321-200, two Airbus A350-900 and four Boeing 787-9 that were delivered during 2015 and the first half of 2016. The total amount of debt securities issued during 2016 amounted to US$ 345 million.
In addition, on May 18, 2016, the company executed commercial financing in the Senior and Junior formats for a total amount of US $ 456 million to finance the acquisition of three Airbus A350-900s and one Airbus A320neo.
With respect to short-term financing, as of December 31, 2016, LATAM kept about 3% of its total debt in exporter and importer loans aimed at financing working capital requirements.
Another objective of the Company’s Financial Policy consists in ensuring a stable profile of debt and lease commitment maturities, including servicing the debt and paying fleet leases, which would be consistent with LATAM’s operating cash flow.
MARKET RISKS POLICY
Given the nature of its operations, the LATAM Airlines Group is exposed to market risks, such as: (i) fuel price risks; (ii) rate of interest risks; and, (iii) foreign exchange rate risks. With the objective of hedging against these risks, either totally or partially, LATA operates with derivative instruments to fix or limit hikes in underlying assets. Market Risk Management is performed in an integral manner and considers the existing correlation of each exposure. In order to operate with each counterpart, the Company must have an approved line and a specific contract executed with the chosen counterpart. Such counterpart must have a Risk Classification, issued by an International Risk Classification Agency, equal or greater than an equivalent “A-“rating.
I. Fuel price risks:
Fuel price fluctuations significantly depend on: fuel supply and demand worldwide; the decisions adopted by the Organization of Petroleum Exporting Countries (OPEP); refining capacity worldwide; maintained inventory levels; the occurrence or lack of climactic phenomena; and, on geopolitical factors. LATAM purchases jet fuel denominated Grade 54 Jet Fuel. There is a reference index in the international market for this underlying asset; namely, the US Gulf Coast Jet 54, which was used by the LATAM Airlines Group for its 2016 hedging operations.
Our Fuel Hedging Policy restricts the minimum and maximum fuel range to hedge against, as a function of the capacity to pass these cost fluctuations onto prices and on the market scenario reflected in fuel prices. Additionally, it restricts the maximum hedging period and allows portfolio restructuring.
With respect to fuel hedging instruments, our Policy allows contracting Swaps and Options combined.
II. Interest rate risks to the cash flow:
Interest rate fluctuations depend heavily on the state of the world economy. An upward movement of long-term economic prospects pushes long-term rates upward, while an economic slowdown causes them to drop driven by market forces. However, if governmental intervention is considered, during economic contraction periods referential rates often drop in order to boost aggregate demand upon making credit more available and, in turn, expanding production (in the same manner that such referential rates increase during economic expansion periods).
The existing uncertainty as to how the market and governments will behave and, consequently, as to how the rate of interest will fluctuate, represents a risk associated to LATAM’s variable interest rate debt and its investments. The rate of interest risk on the debt is equivalent to the risk of the future cash flows of the financial instruments, given the fluctuation of market interest rates.
LATAM’s exposure to market interest rate fluctuation risks is mostly related to variable-rate long-term debt.
In order to diminish the risk before eventual interest rate hikes, the LATAM Airlines Group maintains interest rate at fixed rates and Swaps contracts in effect.
The instruments approved by the Company’s Rate of Interest Hedging Policy are: interest rate Swaps and Call Options.
III. Foreign exchange rate fluctuation risks:
The functional currency used by the Parent Company is the United States Dollar (USD), in terms of the pricing of its services, the composition of its financial statement, and the effects on its operating results. There are two types of foreign exchange rate risks: cash flow risks and balance sheet risks. The cash flow risk is generated as a consequence of the net position of non-USD revenue and costs.
LATAM sells most of its services in USD, at prices equivalent to the USD and Brazilian Reals. Approximately 58% of the revenue is denominated in USD, while approximately 21% is denominated in Brazilian Reals. Most expenses are denominated in USD or USD equivalents, particularly fuel costs, aeronautic duties, aircraft leases, insurance, and aircraft parts and accessories. Payroll expenses are denominated in local currencies. The total percentage of USD-denominated costs is about 56%, while the approximate Brazilian-Real-denominated costs are 17%.
The LATAM Airlines Group rates the majority of its international passenger and cargo business in USD. A portion of the fares of the international passenger business depends significantly from the Euro. In the domestic businesses, most fares are stated in local currency without any type of USD indexation. In the case of Ecuador’s domestic business, both its tariffs as well as its sales are stated in USD. As a result of the foregoing, LATAM is indeed exposed to the fluctuation of various currencies, mainly the Brazilian Real and the Euro.
The LATAM Airlines Group has hedged against foreign exchange exposure risks mainly using currency forward and option contracts. Thus, as of December 31, 2016, LATAM is mainly hedged against the Brazilian Real for US$ 60 million for the January-March 2017 period.
On the other hand, the balance sheet risk presents itself when balance sheet entries are exposed to foreign exchange rate fluctuation risks, since such entries are stated in a monetary unit other than the functional currency. Although LATAM is entitled to execute derivative hedging contracts against the impact of the eventual appreciation or depreciation of currencies with respect to the functional currency used by the parent company, during the year 2016 LATAM did not execute any hedging contract against such eventual balance sheet risk.
The main mismatch factor here is generated in TAM S.A. since its functional currency is the Brazilian Real and a significant portion of its liabilities are stated in USD, although its assets are expressed in local currency. At the closing of 2016, TAM entered into a cross currency swap agreement to partially hedge this balance sheet mismatch, whose net value on TAM’s balance sheet amounted to approximately US$1,100 million