top of page
  • Writer's pictureHarmony Oswald, Esq.

Titan Submersible Crash Course on Risk Management and Industry Standards in Finance

Updated: Jul 25, 2023



Like a deal gone bad, the world watched as Titan sank 13,000 feet under the sea to a tragic implosion. We later learned that this horrific event was the natural consequence of poor risk prevention. This wasn't the first time that carelessness led to severe repercussions. Throughout history, the failure to devote proper attention to risk has led to disaster.

To steer clear of rough waters and stay ahead of the curve, lenders should embrace the moment and reflect upon what can be learned from humanity’s mistakes. Risk analysis is vital in understanding and mitigating potential dangers in various industries. Financiers must be ever-vigilant when making key financial decisions. Events like the Titan implosion, the collapse of Silicon Valley Bank, and the 2008 housing crisis highlight the importance of financiers remaining consistently attentive when evaluating important deals. In this article, we'll reflect upon historic risk assessment failures and break down lessons learned to set up lenders for successful dealmaking processes into the future.


What Happened: Titan Submersible Risk Assessment Failures

The Titan submersible incident provides insights into risk analysis for banks and lenders. This tragic event occurred during a deep-sea expedition. In the Titan’s journey, the submersible experienced a catastrophic failure, leading to the loss of valuable human lives and equipment. It has recently become public information that Oceangate may have cut corners when manufacturing the submersible, which resulted in the implosion of the vessel. Reportedly, the Titan used a carbon fiber composite for the cabin, departing from the traditional and tested method of using a cabin made exclusively of titanium, as is seen in most other submersibles. In addition, the cylindrical design of the cabin subjected it to more external pressure than the typical spherical shape. Despite the unconventional design, against the recommendation of several leaders involved in the project, and in opposition to industry standards, CEO Stockton Rush declined to have the submarine certified or classed. Rush’s blatant disregard for the risks involved with the vessel led to the disastrous events on June 18, 2023.

Lessons Learned:

  1. Honoring industry guidelines: This mishap emphasized the importance of honoring industry rules and guidelines. Industry standards are typically developed over many years of trial and error. Merely trusting the views of a single influential executive is problematic and heightens safety concerns. Instead, leading lenders should implement peer-reviewed, data-driven strategies to develop industry standards, such as committee-based, market-based, and government-based methodologies. These practical solutions utilize multiple levels of review to develop effective guidelines that can be put in place now, updated periodically to promote industry-wide innovation, and are more likely to produce optimal results than individual opinions. As we have seen in Titan, a failure to implement adequate standards can lead to disastrous consequences. Here, Rush’s deviation and outright rejection of collaborative industry practices played a significant part in the tragic events that occurred on June 18.

  2. Conducting risk assessments and monitoring risk exposure: Frequent risk assessments and continuous monitoring of risk exposure are essential practices for lenders. The Titan crisis highlighted the potentially devastating consequences of inadequate risk management in any industry. Financiers should consistently follow risk assessment policies and procedures, including identifying risk categories such as income, debt, and repayment history, rating their importance, and implementing strategic mitigation policies. As Titan has illustrated, cutting corners can lead to harmful results. Additionally, lenders should establish and maintain effective procedures to monitor risk exposure across time. By closely monitoring key performance indicators, market trends, and industry-specific risks, lenders can proactively identify vulnerabilities and take timely actions to mitigate losses. Conducting regular risk assessments and implementing robust risk monitoring systems will help lenders to ensure the stability and resilience of their loan portfolios in the face of evolving market conditions and potential economic downturns.

  3. Planning a response to emergencies: The Titan failure underscored the need for comprehensive emergency response plans. One way to implement this is through contingency measures, or plans made in anticipation of negative events at scale. In addition, lenders should establish smart and sound policies and procedures for unexpected default accounts. Prompt and coordinated actions, such as communicating with the necessary parties and implementing recovery strategies, are crucial in mitigating the impact of deals gone bad. Furthermore, operational reviews can help lenders identify potential vulnerabilities or inefficiencies in their recovery plans and make systemic improvements accordingly. Familiarity with both a recovery plan and a deal’s potential vulnerabilities can enable a financier to act fast and respond to issues efficiently. To ensure they are always ready, it can also be helpful to have a lawyer on speed dial. Strong legal counsel can help to efficiently resolve matters outside the court, recover collateral, file lawsuits, and enforce judgments.


What Happened: Silicon Valley Bank Risk Assessment Failures

The collapse of Silicon Valley Bank (SVB) in early 2023 offered in-depth insights into risk assessment and management within the technology and banking sectors. SVB, which catered to technology startups, faced significant challenges after making some questionable business decisions. Specifically, a large amount of their funds were invested in U.S. Treasury securities during a period of time when interest rates were very low. When the FED raised interest rates in an attempt to combat inflation, the securities lost their value. After taking a $1.8 billion hit upon the sale of some of these securities, SVB unsuccessfully tried to raise $2 billion to offset the loss. When they were unsuccessful, many prominent venture capital firms advised businesses to pull out of the bank. This created a snowball effect, and individual depositors began withdrawing their funds as well. Ultimately, the large amounts of loss incurred and funds withdrawn forced the bank to shut down to protect the few depositors left. SVB’s deposits were only FDIC insured for up to $250,000, and it is estimated that around 94% of their deposits were uninsured. This lack of security contributed to the mass panic that occurred when SVB reported a significant loss. In the end, the bank's heavy exposure to high-risk loans and insufficient risk management practices led to its collapse. A nationwide panic ensued that resulted in the dissolution of other banks such as First Republic and Signature Bank as well.


Lessons learned:

  1. Risk monitoring /early warning systems: Inadequate risk management contributed to SVB's downfall. The bank failed to conduct proper due diligence, monitor loan quality, assess the long-term sustainability of its lending practices, and conduct stress tests to examine how it would navigate difficult times. The collapse of SVB highlighted the need for lenders to have effective risk monitoring systems and early warning mechanisms in place. Lenders should regularly monitor their loan portfolios to identify any signs of deteriorating financial health or increased default risks. This involves closely monitoring key performance indicators, financial statements, market trends, and any potential industry-specific risks. By implementing robust risk monitoring practices, lenders can detect early warning signs and take timely actions to prevent and stay ahead of default accounts.

  2. Industry dynamics: The collapse of SVB emphasized the importance of understanding industry dynamics and adjusting risk management strategies accordingly. Rapid changes in the technology sector, for example, can significantly impact the financial health of institutions serving that industry. Lenders should deeply understand the industries they invest in, and make conscious efforts to stay up to date with news/current events that could impact the industry.

  3. Diversification/risk mitigation: The collapse of SVB highlighted the dangers of overexposure to a specific industry or market segment. The bank's heavy reliance on the technology sector made it vulnerable to economic downturns and disruptions in that industry. Financiers should avoid the temptation, especially during particularly good times or when exciting new opportunities arise, of excessively concentrating loans in specific industries, regions, or borrowers. By diversifying their loan portfolios, lenders can spread the risk and minimize the impact of potential defaults or adverse events in a particular sector. Additionally, lenders should proactively adopt risk mitigation strategies, such as collateral requirements, loan covenants, personal guarantors, or risk-sharing arrangements, to further distance themselves from negative outcomes.


What Happened: 2008 Housing Market Crash Risk Assessment Failures

The 2008 housing market crash, also known as the subprime mortgage crisis, was a severe downturn that served as a teachable moment regarding risk assessment for banks and lenders. It was triggered by a combination of factors, including risky lending practices, inflated housing prices, and the subsequent collapse of the housing bubble. As a result, many homeowners defaulted on their mortgage payments, leading to a wave of foreclosures and financial losses for lenders. This crisis highlighted the importance of responsible lending practices, thorough risk assessment, and vigilant monitoring of loan portfolios to mitigate potential risks. While times of crisis can be nerve-wracking, with strong, preventative risk management practices in place, financiers can feel confident knowing that they will successfully navigate the storm.


Lessons learned:

  1. Prudent underwriting practices: One of the critical lessons from the 2008 housing market crash is the importance of sound and consistent underwriting practices. During the time of the crisis, Community Reinvestment Act regulators gave banks higher ratings for loans made in “credit-deprived” areas. Lenders were essentially rewarded for disregarding conventional underwriting practices. In the long run, this led to financial detriment for banks/financiers who participated. Moving forward, lenders should ensure that they always thoroughly assess borrowers' creditworthiness and ability to repay loans. This involves conducting comprehensive due diligence, verifying income and assets, and carefully evaluating the borrower's financial history. Implementing stringent underwriting standards helps prevent the issuance of risky loans and reduces the likelihood of defaults.

  2. Regulatory compliance: The 2008 housing crisis resulted in increased regulatory scrutiny and the implementation of stricter lending regulations. Banks and lenders must remain vigilant and ensure strict compliance with applicable laws, regulations, and industry best practices. This includes adherence to, for example, state-specific disclosure laws, anti-money laundering (AML) and know-your-customer (KYC) requirements, and compliance with fair lending practices and consumer protection regulations (such as section 1071 of the Dodd-Frank Act.) While lenders could become discouraged with so many banking and finance regulations, they should take heart knowing that many rules are put into place to protect financiers. By staying abreast of regulatory changes and proactively adopting compliance measures, lenders can minimize legal, reputational, and financial risks.

  3. Transparency, communication, and culture: The 2008 housing market crash taught us that building trust and maintaining open lines of communication with borrowers is crucial. Financiers should prioritize transparent and clear communication throughout the lending process, thus ensuring that borrowers fully understand the terms, risks, and responsibilities associated with their loans. Additionally, fostering open communication helps to manage expectations, provide timely updates on loan performance, and address concerns or questions effectively. When the customer is informed and involved they are more likely to uphold their obligations, thus ensuring a strong deal and securing a potential future relationship. Furthermore, employing well-trained personnel with a deep understanding of the lending industry and proper procedural knowledge is crucial in minimizing the likelihood of risk and consequences. Lenders should prioritize investing in comprehensive training programs that equip their staff with the necessary skills, knowledge, and situational awareness to effectively navigate risks. Policies and procedures will help to create a culture of risk awareness and proactive risk management within lending institutions, ultimately leading to better outcomes and protecting stakeholders' interests.

Conclusion

In summary, the risk evaluation failures in the Titan incident, SVB failure, and 2008 housing market crash provide valuable learning opportunities for lenders to apply within their own industries. For example, lenders should create and honor industry standards, stay vigilant in conducting thorough risk assessments, develop and implement risk mitigation and monitoring strategies, and be aware of fluctuating industry dynamics. By implementing and maintaining effective policies and procedures, financiers will establish a culture of excellence in dealmaking and invite successful outcomes into the future.

—--------

The author, Tenor D. Ickes, was born in Wurzburg, Germany, to U.S. military parents serving abroad. He is a summer intern at Oswald Law Firm, where he enjoys writing on trending business, banking & finance law, and litigation topics. He earned a B.A. from San Jose State University while working as a law clerk at a Silicon Valley banking litigation firm. He is an incoming 2L student at UC College of the Law San Francisco where he is pursuing a Juris Doctor degree, and he is a student member of the San Francisco Bank Attorneys Bar Association and The Bar Association of San Francisco. In his free time, Tenor enjoys spending time with family, international travel, and writing music.

The above article provides information only and does not create an attorney client relationship. It should not and cannot be construed as legal advice. Need help with

CA commercial finance litigation or enforcement? Oswald Law Firm can help. Contact Harmony Oswald, Esq. at hno@oswaldfirm.com


Copyright 2023 Oswald Law Firm. All Rights Reserved.

Comments


bottom of page