Jeff Judy

Jeff's Thoughts - May 2, 2018

Beware the Rare!

Recently, a public relations disaster in my own backyard reminded me of how often players in our industry (and their customers) fail to consider potentially catastrophic events when they think about “risk.” When analyzing credit requests and devising credit structure, there is a natural tendency to think of “risk management” as “preparing for what is likely to go wrong.”

In other words, we equate “risk” within “probability.” We identify the most likely problems and take steps to mitigate them, if possible.

And then we have to write off a credit when we get blindsided by a low-probability, high-impact event.

Back in my part of the world, a Minneapolis-based company has received horrible publicity, not only locally but nationally, because they didn’t think hard enough about what Minneapolis weather can be like in what we laughingly call “spring” here. Sun Country Airlines runs a winter-only schedule to several tropical locations. In the middle of April, a couple of the last flights of the season were intended to bring passengers home to Minneapolis from Mexico.

What could go wrong? Well, of course there could be mechanical problems with a flight, leading to delays, and you can probably think of some other likely issues.

But unless you live here – and more importantly in this case, even if you do – you might not expect April 14 to bring a foot-and-a-half of snow, whipped around by 35 mph winds to produce a full scale blizzard, shutting down the Minneapolis-Saint Paul airport (a very rare event).

Sun Country’s response was to cancel those last flights and tell their customers, waiting in Mexico, that since they had no other scheduled flights until the next winter season, they would have to find their own ways home! A few days after being embarrassed by all kinds of interviews with stranded families looking at huge costs to book one-way, last-minute flights for entire families, Sun Country announced that they would pay for these additional expenses.

This is a classic case of a low-probability, high-impact event, and we need to think about such events when we do analysis. As commercial creditors, one of the most common examples of these rare but devastating events is the loss, within a borrower, of a key player, whether that’s the CEO, an exceptional salesperson, or a crucial role player in product development.

We used to talk about the “three D’s” – death, drugs, and divorce -- that could suddenly displace key personnel. Nowadays, especially with the 24-hour news cycle and social media, scandal or the perception of same can make a manager, or even a board, disappear overnight. How will that affect the creditworthiness of your borrower?

Keep in mind that Sun Country’s PR disaster was not created so much by the event as by management's response to the event. They now say they should have arranged unscheduled flights to rescue those travelers. Isn’t hindsight wonderful?

How would the management of your borrowers respond to a surprising and hugely negative event? Do they have the skills, the vision, the values to make the best of a sudden potential disaster?

You cannot prepare for every possible event. But you probably can do more to identify high-impact events that, though rare, could have major consequences for both you and your borrower.

After all, hindsight, knowing what should have been done, does not repay credits.