RAPAPORT... There’s apparently a shortage of cash in the pipeline that’s been developing for more than a year —“apparently” because, while liquidity problems are regularly encountered by some players, others don’t feel them at all. Alain Sternberg of Antwerp Gem Co. explains that “From our point of view, as specialists in larger stones, there’s no such thing as a liquidity issue. Furthermore, this is not just a niche perception. Take the example of the sales of polished by Sierra Gems that took place in Antwerp a couple of weeks ago. It’s been reported that stones starting from 2 carats up were sold for cash for a total of about $29 million — that indicates that there’s money available.”
It appears that those who sell lower-quality polished are facing liquidity problems originating from the retail end, where sales are off and payments are slow. But those active on the higher end, where supplies are short and demand is strong — provided they’re sufficiently capitalized — are less affected, if at all.
ARE BANKS GUILTY?One thing is for sure. Whether the lack of liquidity is real or just perceived, banks are not responsible for it as they were about two years ago when they deliberately decided to close the credit tap. But they are not helping either because they are miles away from considering a reopening of the credit pipeline.
On the contrary, says Loet Kniphorst of ABN AMRO, “There’s still a too-high debt burden in the trade and this trend must reverse. Even before the subprime crisis, we were monitoring very closely the invoices and the buyers who are behind them. We’re looking at payment delays, and we’ve implemented all the necessary checks and balances in order to avoid round-tripping and other such bogus tricks.”
Round-tripping is a discredited practice used by companies to artificially inflate revenues by negotiating “sham” transactions in which they sell an unused asset to another company and buy back the same or similar asset at about the same price. The practice was used by such energy traders as Enron to temporarily — and falsely — inflate their market capitalization.
“People must understand that we bankers will be even more stringent in the future as far as credit is concerned,” says Kniphorst.
REINVESTING IN THE TRADESeveral major diamond industry players suggest that the moment has come for diamantaires to reinject some money into the industry. According to the major pipeline figures, the diamond share of sales in 2007 was about $20 billion, compared to $13 billion to $14 billion of bank debt. This indicates that about 70 percent of the sales were credit-financed. This is far higher than in other trading businesses. If the industry could raise that 30 percent of self-financed sales to 40 percent, bank debt should come down to $11 billion to $12 billion. The only way to do that is if there is more investing in the trade.
“We must convince people to reinject monies in the pipeline,” says Kniphorst, “either by making diamond trading more profitable or by the banks requiring higher levels of capital to maintain the same credit levels. The current credit crisis is expected to have its effect on the interest that is charged to diamond companies and, in general, for this type of asset, banks will require a higher return.”
Paul Goris of Antwerp Diamond Bank says it is not possible “to confirm that there’s a problem with liquidity because it just doesn’t reflect in our records. Turnovers didn’t go down. But bank debt did go up, which could be explained by several factors. Five years ago, the average global bank debt was approximately $5 billion to $6 billion. Today, it’s double that. But the average turnover didn’t increase. This can be explained by a rise of prices, by the lengthening of payment terms, by all kinds of investments made in exploring new markets and marketing and, of course, by the opening of factories in the South African countries. But even all those forces don’t quite explain everything. Bank debt could have been increasing because people were removing money from their companies.”
“Bank debt also could have been encouraged by the revaluations of stocks for Antwerp-based companies that took place about two years ago,” continues Goris. “That revaluation overnight granted companies bigger and stronger solvency ratios because their stock was being valued at higher prices. That, in turn, enabled diamantaires to ask their bankers to allow them to pull back the shareholders subordinated loans — loans that were made precisely in order to strengthen the companies’ capitalization. Let’s not forget that this sudden increase of capital just happened on paper and that there’s no increase in collateral resulting from that operation.”
Before revaluation, one method diamantaires used to expand their access to capital was to invest more cash in their companies. The additional cash infusion expanded the companies’ equity base — and the banks’ collateral for loans. But now that the stock has been reevaluated, diamantaires figure they might as well pull their money out of their companies because the revalued stock has automatically increased the value of the stock as collateral for the bankers.
In addition, it’s likely that the presence of two new banks, ICICI and the State Bank of India, with an additional $400 million in capital made available to the diamond trade, has helped ease liquidity concerns because it has pumped more capital into the lending pool.
PROFITABILITY OR NOTHING
If Antwerp’s diamond industry needs more private investment, there’s no easy solution. Dilip Mehta of Rosy Blue says that “If diamantaires are to invest more in the trade, profitability margins must be restored. That’s the key issue. Simply increasing interest rates would only reduce profit further, which would discourage investment.” Goris agrees that “Roughly speaking, the question remains that of profitability. Why would you invest in the diamond business for a 3 percent to 5 percent profit, when you can get 20 percent from real estate investments in Hong Kong? If bankers want to see money plowed back into the business, increasing interest rates is certainly not the right move as it brings profitability down even further.”
The message appears to have gotten through to diamantaires. Increasingly, they aren’t doing business just for the sake of business, just to move merchandise. They want to make money, or they’ll pull back from doing the deal at all.
Goris concludes that “Bankers will have to be assured that diamantaires do trust and have faith in their business. If diamantaires don’t, why should bankers? Maybe the time has come to organize a conference that would have as theme ‘how to keep diamond business profitable.’”
Last but not least, what would happen to the capital markets for the diamond industry if bankers start really pulling back to the same extent as diamantaires have?
Article from the Rapaport Magazine - June 2008. To subscribe click here.