Israeli Diamond Bankers Have no Sleepless Nights
March 31, 05When an Israeli banker recently remarked that the local industry’s banking debt was well beyond $2 billion, we joked that collecting that debt will be the problem of one of his own successor’s successors. Some view the banking debt as a permanently revolving facility that, just like diamonds, will revolve forever. Debt reductions represent an “aberration” – the trend is up and up. Our industry’s leadership feels comfortable with the rise as it closely follows the increases in business turnover. Total imports and exports last year grew by 19%, which is far more than the 12% growth of banking debt from $1.8 billion (at end of 2003) to $2.1 billion (end of 2004). Israel’s debt is about 19% of the industry indebtedness of the four major markets (Belgium, Israel, India and New York), which totaled $9.95 billion at the end of last year. That figure excludes some $500 million of debt securization, in which accounts receivables and diamond inventories are financed through the issuance of bonds. So the worldwide debt is well above $10 billion.
Banks are less concerned with the totals – their focus is on the “quality” of the debt, the available collateral, and on general sectorial risk assessments. One aspect of diamond banking in Israel (and we have reasons to believe that this is an international trend) is the growing concentration of the lion’s share of the debt in fewer hands. In Israel’s five diamond banks, the diamantaires maintain 1,180 accounts, about 3% less than in 2003. This decline in accounts represents a process of consolidation and mergers, not a process of “leaving” the industry.
Bankers note that the debts of the largest clients grow much faster than those of the smaller and mid-size companies. The financial strength of the Israeli diamantaires is underscored by the fact that (in 2004) there were only 640 accounts which utilized credit facilities. Even though the DTC in its Supplier of Choice logic prefers to see clients working with borrowed funds (and therefore the return on ones own equity is greater), the Israeli industry is still rather conservative and tends not to borrow when this isn’t needed. The fast growth of the debt of the larger clients may be partly attributed to the Supplier of Choice sightholder criteria and aimed at “better scoring”, in addition, of course, to financing the Sightholders’ greatly increased marketing costs.
According to the Bank of Israel, 10% of all the 640 diamond accounts (i.e. 64 accounts) borrow 70% of the industry’s banking indebtedness. To underscore this even more, 1% of all account holders (thus six companies) are taking 33% of the total industry debt, a significant increase over the 30% they held in 2003. Moreover, there were two companies in the Israeli industry that utilized credit in excess of $50 million.
As many of the larger Israeli companies also have overseas operations and may enjoy credit facilities in other countries with other banks, the relevance of these data for some of the larger companies may be limited. It is, however, indicative of the Israeli banking sector – that also operates under certain constraints imposed by the Bank of Israel which regulates the ratio between a bank’s own capital and its exposure to a single industrial sector or, for that matter, to that of a single client.
An analysis of the data shows that the 30 largest exporters (those whose annual polished diamond exports are above $30 million) represent only 3% of all exporting companies, and represent 50% of the total value of the polished exports. Those same 30 exporters are holding 65% of the credit extended by the five diamond banks to diamantaires.
“Concentration”, however, is truly in the eyes of the beholder. According to the central bank’s research, the 10 largest exporters sold $2.1 billion worth of diamonds, representing 33% of total polished exports (at $6.3 billion). If this sounds like an excessive concentration – be assured, it isn’t. The diamond industry still has a long way to go in terms of consolidation.
According to an internal Bank of Israel memorandum, which compares the diamond sector also to other sectors in the Israeli economy, the level of concentration in the diamond industry is “substantially lower” than in Israel’s overall industrial exports in which 3% of the companies (i.e. 360 companies) are responsible for 80% of the nation’s industrial exports.
With all these debts, the rank-and-file of the diamond business in Israel is still in very good shape. An analysis of the banking data shows that 70% of all the diamond clients of the five diamond banks each have less than $1 million of banking debt.
The following table illustrates the 2004 export activities of the 1,039 companies in the Israeli diamond industry:
Careful analysis of banking data reveals many interesting aspects of the diamond industry. There are some 40-50 foreign diamond companies operating in Israel, mostly Indian, but also Belgian, Russian and Japanese companies. The trend is upwards: every year some half a dozen new foreign diamond companies open their doors in Israel (five in 2004, six in 2003, etc.) An analysis of their activities shows that they are steadily growing and they may well indicate an eventual moving of these companies’ core business to Israel.
In their banking behavior, the Israeli diamantaires remains conservative and “solid”. The Bank of Israel points out that “there is no visible speculative behavior in the diamond financing business.” About 97% of all foreign currency credits are in dollars with an insignificant 3% in yens and other currencies.
So Israeli bankers have no reason to have sleepless nights. Even though the larger companies that operate internationally may not be as transparent as some of the banks would like (and the Bank of Israel points to the fact that many companies have associated and affiliated firms overseas of which little information is available), the banks have comfort on the side of collaterals.
Collateral requirements to cover the industry’s indebtedness vary from bank to bank and from customer to customer. The central bank's basic guideline is that this collateral must secure the banking debt. The collateral can be divided into six categories, according to its quality. The first category consists of foreign currency deposits, bank guarantees, savings accounts and real estate. It is estimated that in 2004 about 20.1% of the industry's banking indebtedness was secured with this type of collateral.
The second category includes “post-dated checks” for diamond accounts. The credit secured with this type of collateral is estimated at 17.5% of the total collateral. The third category, foreign drafts, represents 2% of the security held by the banks. Unlike recent years, today the Israeli diamond banks hardly use diamonds any more as collateral. In 2004, diamonds (deposited in banks or in trust with brokers) cover barely 1.8% of the total collateral. This is the lowest figure in decades.
From a risk point of view, the “riskiest” are the fifth category, accounts receivables and, the sixth level, exports to affiliated companies and personal guarantees. These two categories account for 19.5% and 39.1% respectively. In a way, this is seen by bankers as “open credit”. If we make an international comparison, the Israeli banking debt is very well collateralized and the “open credit” is much smaller here than in other countries.
So it isn’t unusual for bankers to make some jokes about the business. They are well collateralized, the debt growth is in tandem with the business and – they may not want to admit this – the diamond banking profitability seems to have increased in 2004. According to the Bank of Israel the effective interest rates paid by the diamantaires at the end of last year was about 4.7% (including risk commission and credit facility fees), compared to 3.3% and 3.6% respectively in 2003 and 2002. Of course, part of this is explained by the increase of the prime rates in the United States (in July 2004) – but that is only part of it.
This analysis makes it clear that Israeli diamantaires and bankers, as well as all other readers, have good reasons to enjoy their weekend.