Rapaport Magazine


By Marc Goldstein
Down to Zero

In September, the European Central Bank (ECB) lowered its interest rate to a record low of .05 percent, the lowest rate since the implementation of the euro in 2000. The U.S. dollar interest rate is similarly anemic. Any investor will tell you that such flat interest rates are the perfect time to borrow money to invest in a business and/or refinance company loans and credit lines. If so, is this the time for the diamond industry to refinance its debt?
   According to the bankers, there’s no point in renegotiating credit terms. Erik Jens, chief executive officer (CEO) of ABN Amro’s international diamond and jewelry group, is cautious on the subject. “That sounds interesting. However, banks lend on the basis of cost-of-funding plus a margin. Since the majority of the bank funding to the industry is U.S.–dollar based, the ECB and euro rate are less relevant to the industry. In fact, the U.S. cost-of-fund rate has been bottoming out for some time after historic lows. Also, for the U.S. dollar–based loans, the cost of funding is still relatively low.”
   On any loan, explained Jens, “the margin is related to the type of finance, overdraft facility or straight loan and varies with the maturity, type of collateral, quality of the company, credit rating, solvency and many other factors. Banks will look at risk/return and will price the facilities to get the best tradeoff versus other assets they can finance. It is known that for the diamond industry, the implicit risks are in general relatively high. So banks will charge a good margin to compensate for those risks, in order to keep the diamond sector bankable.”

Industry Already Benefiting
   Bruno Nelemans, executive vice president for strategy and communication at Antwerp Diamond Bank (ADB), agreed that because diamond financing is predominantly U.S. dollar based, “diamond companies have already benefited from the low interest rate policy by the U.S. Federal Reserve and do not need to renegotiate their credit conditions.”
   Nelemans said that a case exists for the cost of money to get higher in the diamond trade. “Recently, many leading diamond banks have increased their risk margins as a result of a the higher cost of credit, the higher default rate and lowered recoveries over the past five years. Margins are also impacted by the higher capital requirements under Basel III,” explained Nelemans. “The rates applied by diamond banks remain very much competitive compared to yields paid by listed companies such as ALROSA, which paid 8.85 percent on its bond issue and Nyrstar, an integrated mining and metal business that paid 9 percent on its recent bond issue.”
   Raj Mehta of Rosy Blue noted that in his opinion, since the quantity of money made available by the banks to the industry won’t change, there is no reason for the cost of capital to shift downward.

Be Wary of Speculation
   The availability of cheap credit can pose its own problems — and temptations. Nelemans cautioned that diamond companies should not be enticed into speculative transactions within or outside the diamond trade.
Neleman’s warnings of dangerous practices include: paying higher prices for rough with the intent of keeping longer stock positions in anticipation of price increases down the road, granting too-lenient payment terms to off-takers as a compensation for charging higher prices and diverting cheap financing to invest in such nondiamond speculative transactions as commodities and real estate.

Clean Up Balance Sheets
   Jens suggested that the lowered interest rates should encourage diamond companies to become financially healthier by incentivizing them “to improve their balance sheets, reduce leverage, increase profitability through efficiencies and be transparent,” he said, adding that such an approach “will be paid back by better conditions and access to capital.” The conclusion of Jens is that most likely there won’t be more cash available to the industry in the short term.
   “An environment of lower interest rates combined with the right risk/return on assets in the industry will attract investors and financiers other than banks,” Jens said. “That new money should not be treated as additional new funding flowing into the industry. The industry would benefit from more funding sources, but certainly not from more overall funding. The latter would, in our view, be detrimental to the industry.”
   Nelemans concluded that “Future diamond financing will be less, rather than more, and it will be more expensive rather than cheaper. To face that prospect, diamond companies should strive toward an adequate capitalization and controlled leverage. Diamond companies should focus on higher margins on trading and polishing rather than overleveraging their presently low-margin business.”

Article from the Rapaport Magazine - October 2014. To subscribe click here.

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