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Diamond Industry Lacks Bankability, Not Liquidity
Q&A with Erik A. Jens, CEO of ABN Amro’s Diamond & Jewellery Clients
Mar 27, 2015 6:00 AM
By Avi Krawitz
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RAPAPORT... ABN Amro has been a major lender to the midstream diamond industry over the past century. More recently, the group has called on the diamond industry to improve its “bankability” as banks tighten their lending requirements. Rapaport News recently spoke with Erik Jens, CEO of ABN Amro’s Diamond & Jewellery Clients, about some of the issues governing diamond industry financing:
Rapaport News: How do you assess the diamond market at the start of 2015?
EJ: The first half of 2014 was decent but profit margins diminished in the third and fourth quarter. Therefore, much of the profit made in the first half was canceled out and today we see companies with flat earnings or losses. That will be reflected in annual reports and it will affect credit approvals and ratings. In that context, I'm not very optimistic to see the 2014 financial results.
I think diamantaires are responding to the situation. Rough prices have come down a bit and they’re taking care not to overstock their inventory. The second half of 2015 could be better.
The biggest challenge facing the industry relates to consumer demand. I’m not convinced that current levels of demand are sufficient. I'm concerned that the industry is being forced to cope with its own changes yet it also needs to have a stronger focus on the end consumer.
Rapaport News: What are those changes that are affecting the industry?
EJ: In the old days, there was basically one rough diamond supplier. Prices were high but everyone made money as there was a consistent flow of diamonds at a consistent price. That’s not the case anymore.
The industry also faces a lot of regulation and it doesn't seem to be able to take a clear position on issues because it’s polarized by many different organizations.
Furthermore, the older generation of diamantaires still operates by doing business on a handshake. That is not conducive to today’s regulatory requirements, but it will take years to change that mindset.
The industry acknowledges that it needs to improve its bankability and reputation because regulators still see the industry as high risk. We appreciate and support where possible the many initiatives taken to remedy this situation, for instance by the World Diamond Council, the World Federation of Diamond Bourses and other stakeholders.
Rapaport News: What is influencing the lack of liquidity in the middle of the pipeline?
EJ: I don't believe there is a lack of liquidity. I think there is a challenge in certain areas of the market and in certain locations. But there is liquidity available for good companies.
A lot of companies have moved into a specialized niche or reinvented themselves to be profitable. There are still too many companies that only think about top-line turnover, instead of bottom-line profits. The banks are expected to support them based on turnover but that's not the way it works anymore.
Rapaport News: The closure of Antwerp Diamond Bank (ADB) has affected liquidity. Is ABN Amro taking on some of that credit and ADB’s clients?
EJ: We’ve taken on new clients in the normal course of business but we cannot just open hundreds of new facilities. That doesn't fit our strategy and it’s also very costly. Given its high-risk classification, the diamond business requires a different kind of reporting, which is very expensive.
In addition, opening our books for that kind of inflow would not help the industry. We need more banks lending to the industry, especially in Antwerp. The industry should not be dependent on one player.
Rapaport News: Does the perceived lack of liquidity also stem from banks reducing their available credit to the industry?
EJ: The banks are willing to grow step by step so I don't think there's a liquidity crisis in Israel, Hong Kong, New York, Dubai or Africa.
The question arises why such a large portion of industry financing is concentrated on the middle of the distribution chain. The miners get paid in cash 10 days in advance, and don't give credit to their buyers. Retailers have a lot of inventory on consignment and they buy with 120 days credit. So the problem is not so much overall credit, but the way that financing is distributed throughout the pipeline.
The banks are willing to support the industry, but they are also short on capital and have to comply with new regulations. So the industry needs to think of other structures, like special purpose vehicles (SPVs), or bring in investors. There are solutions beyond the banks and there should be a shift toward more asset-based secured lending.
Rapaport News: ABN Amro was among the first to shrink its credit lines to finance 70 percent of rough purchases from 2014. What effect did that decision have on the market?
EJ: I don’t think it had an adverse impact. It may have even helped lower rough prices. Our clients reduced their purchases but they also put more of their own skin in the game and became more robust.
The policy is in place and we're absolutely not going to raise our advanced rates. If anything, we may further reduce our financing of rough purchases for trading purposes. We don’t have concrete plans but this has been discussed because trading is more speculative than manufacturing.
We also need to diversify the way financing is made available to different clients. We want to reward the more corporate clients that have the right structure and transparency, good governance, and that meet International Financial Reporting Standards (IFRS). We want to motivate clients to be more corporate-like or leave the bank.
We also recently wrote a letter to all the clients of our clients, which is something that hasn’t been done before. I'm sure other banks will follow our example.
We found that businesses sometimes manipulate their invoices. So we wrote a letter to ask the customers of our clients to acknowledge that they owe a certain amount to our client and to confirm that they will pay the outstanding balance. Our view is that if they don’t sign the document, we will reconsider our borrowing base.
Some felt that it was a bit harsh, but most of our clients were very happy with that action because it challenged their customers to pay up.
Rapaport News: What are the banks looking for when assessing their diamond clients?
EJ: Firstly, we want to gain a good understanding of the company’s goals, mission and strategy. We also want to understand its ethics in terms of corporate and social responsibility.
Then we go a bit deeper to understand how the company is structured and financed. We look at aspects such as who are the ultimate identified beneficial owners.
We look at the financials, the makeup of its equity and the company’s ratios. Cash flows are important because businesses with cash flow problems tend to face discontinuity. Profitability is very important to our assessment but we also understand that there are periods that are less profitable or non-profitable. We pay strong attention to inventory levels and valuations.
We also look at the people involved in the company. It’s okay if the business is made up of family members but we like to see, for example, an independent finance department and CFO, and we also take into account who are the auditors.
The more transparent the company, the better credit rating it will have.
Rapaport News: Are these measures a result of new regulations governing the banking sector in general?
EJ: Our de-risking exercise was initially an attempt to find out if we are in control of our diamond portfolio. It was also a matter of regaining trust and understanding the reputation of the industry.
However, we were also faced with other constraints. There are new ways for banks to allocate capital as a result of tougher restrictions. The cost of banking has gone up dramatically, especially when you consider the regulations and standards required of the banks. The banks and the regulators need to know more from their diamond clients than they do from clients in most other sectors because diamond clients are ranked as ‘increased risk.’ The industry needs to rebrand and reposition itself in that context.
Rapaport News: How do you assess risk and what affect does risk have on your book?
EJ: There are different types of risk that a bank faces regarding a client: operational risk, credit risk, market risk and reputational risk, and there are different models which calculate those risks. Risk is applied as a percentage of a bank’s outstanding credit and it is then assessed how well a bank is capitalized.
For example, if you have $1 billion outstanding from the industry, a bank will look at all those risks. It will calculate that for $1 billion you need to carry $500 million in capital to fulfill capital ratios. To maintain regulatory and healthy ratios, capital management and allocation is key.
So if a bank’s capital ratio rises, it would have to attract more capital to maintain its book, or reduce its exposure.
Rapaport News: What is your estimate of global bank credit to the diamond industry?
EJ: Financing rough diamond purchases has probably slowed to about $13 billion. I expect that about $4 billion to $5 billion is provided to India and the rest is spread across other centers.
Rapaport News: Has there been a similar tightening of lending in India?
EJ: India is a very diverse market with about 60 banks active in the diamond industry. Indian regulators have expressed concern about the high level of non-performing assets in the diamond and jewelry sector and we are concerned about the behavior of some industry partners there. I believe there is a concerted effort by the Reserve Bank of India and support from the Gem and Jewellery Export Promotion Council to improve the situation.
Rapaport News: What are your expectations for the industry in 2015?
EJ: Hopefully demand will pick up. We don’t expect double-digit growth, but there will be some improvement and that will help reduce polished inventory levels. I think people will have to create more of their own niches and specialties to be profitable. I hope that rough prices will come down, but not too fast, so that manufacturers will gain better profits on rough.
In the lending environment, I think we will see some players reducing their lending and new players coming in. Bank credit is not going to grow fast, but I don't think there's a need for credit to increase. I have a relatively good feeling about the banking environment but if you don't know what you're doing, you’ll get your fingers burnt.
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Tags:
ABN Amro, Antwerp Diamond Bank, Avi Krawitz, diamonds, Erik Jens, Jewelry
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Mar 27, 2015 11:30AM
By David Selove
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Well done - I hope that the diamantaires AND the accountants that should read this do so.
Things certainly change but as Darwin said, one must adapt. D.S.
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