RAPAPORT... As if the subprime mortgage crisis in the U.S. is not enough to heighten people’s concerns about economic instability, another example of financial mismanagement has just been revealed — this time in the U.K.
Shashin Choksi of Swati Gems explained that “The events that just took place with Northern Rock are the best example of what could be waiting for us should our industry bankers not be careful enough.” As a leading mortgage company in the U.K. — and a fast-growing one at that — Northern Rock has had to borrow substantial amounts of money from other banks. The problem is that in its efforts to grow its own loan portfolio, the company didn’t pay enough attention to the quality of its borrowers.
Eventually, Northern Rock saw its “confidence capital” eroding in the eyes of the major banks. Most Northern Rock loans provided fixed interest rates during the first five years of the loan. But once that contractual period ended, adjustable interest rates kicked in. As a result, many clients saw their monthly repayment rise above the limit they could afford. This resulted in a sudden increase in real estate listings as homeowners tried to get out from under their debt burden and that in turn caused a setback in sales prices and values in the overall housing market. The collateral Northern Rock owned to secure its loans followed the same pattern — declining in value — while the company continued to repay on its loans. Eventually, the gap between outstanding loans and loan collateral became huge, with company assets of $33 billion balanced precariously against debt of about $156 billion.
“For a long time now, Indian diamond companies have enjoyed very cheap loans from their banks,” Choksi said. “Diamantaires could borrow money at rates as low as 5 percent yearly. They used that money to buy diamonds and manufacture them, after which the sales process could begin. That is where things became interesting. With an interest rate of, let’s say, 5 percent, they could afford to offer their customers unbeatable terms. In exchange for a 10 percent margin, customers got a whole year of credit. This system used to give those diamantaires a serious edge over their competitors.” When you think that money on the open market would cost at least double that interest rate or even three times — up to 15 percent — no manufacturer could ever dream of making on a consistent basis a two-digit return on capital.
Responsibility
In the past year and a half, the interest rates in India have been rising steadily. Very, very soon the Indian companies that have been benefiting from such credit largesse will see their profit margin melting. Some are already seeing negative margins. It’s becoming more and more real. Let’s bear in mind that if, in fact, the global diamond industry debt has rocketed to $13 billion in the past 48 months, it hasn’t been happening in Antwerp or in New York but in India, where loans virtually exploded.
Dilip Mehta of Rosy Blue elaborated: “Indian diamantaires, and diamantaires in general, should be more cautious when doing business. The turnover is not what they want to work for, but the profit margins are. If the margin of a given deal is not high enough, one might be better off not closing the deal.”
Choksi insisted that “The banks of our industry and of India should act with the most extreme caution, as we all — and they in particular — have a huge responsibility to not transform our trade into a virtual bubble by risking the same kind of damage as the Northern Rock bank caused to real estate in the U.K.”
Responsibility has become the key word today, not in terms of propaganda or window dressing, but in real terms. Banks are wise and will become even wiser in order to make sure they do all that’s necessary to avoid inflating the bubble further.
Is it too late? Apparently, the measures taken by some of the Western diamond banks to close the credit taps until real money starts coming in again were a clever move.
Now that money’s raining on the Indian economy, let’s hope that Indian banks will have the courage and the strength to refrain from continuing to lend money to everyone and anyone without discernment. That hasn’t been the case so far. Hopefully, the events that are shaking the world finance markets and stock exchanges will shape their strategies for the future. Mehta concluded that “Hopefully, it’s going to be all right, but it just might take a few bankruptcies for the diamond industry to face reality.”
The Marketplace• 1 to 7 points: Everything’s moving. Rough goods in this category went up too much and polished did not keep pace with it. As typical U.S. market goods, piqués don’t follow the same trend.
• 20 to 50 points and 3-grainers: K-M colors are a little soft across the board. • 1 carat is pretty strong across the board. No availability in clean goods. Moving faster than 2-caraters in SI+, H+ goods.
• Fancy shapes: SI+ are strong, as is demand for 50-pointers+ in pears and hearts, but not so much in princess.
• Rough: The sky’s the limit!
Article from the Rapaport Magazine - October 2007. To subscribe click here.