No Money for Nothing
April 23, 09Indian diamond banks (and they are probably not the only ones) definitely have some serious sub-prime quality diamond clients. Some of these sub-prime clients may act in ways which will not only figuratively “rob the bank,” but also endanger the entire industry’s future access to affordable credit or to credit at all.
As we are writing these lines, an Indian Diamond Trading Company (DTC) Sightholder, a prominent Kathiawari dealer, who owes some $200 million to the State Bank of India, is waiting for an answer to a “friendly ultimatum” that he posed to the bank: You wave one-third of our debt; you agree that we repay the balance over a period of 10 years; and we shall not pay any interest. The bank hasn’t replied yet, because, as is frequently the case in India, the bank acts mainly as the lead lender in a wider consortium. The fact that the credit is spread over a number of different banks increases the likelihood that the sub-prime borrower may actually have it his way.
Officially, this is called Corporate Debt Restructuring (CDR), and the State Bank of India is engaged simultaneously with a number of players. Hence the relevancy of “precedent.” There is nothing wrong in itself with a borrower negotiating a way out of his default with his banker – it is rather the overall context that concerns us.
What we find incomprehensible, is that one believes that one can default in a mammoth way, while having comfort that one can simply stay in business and continue to conduct trade as “business as usual”. That is eating your cake and leaving it whole.
What is even more disturbing is the fact that a DTC Sightholder can do so and still remain on the rough suppliers’ active client list. Even if the DTC is desperate to sell, it really cannot and should not degrade the status of “Sightholder privilege” by tolerating the club membership of such sub-prime clients, who are clearly endangering the business at large. I won’t even mention that they infringe on Best Practice Principles to which they are contractually bound to adhere. The client is clearly counting on the DTC’s past tolerance of defaulting clients by simply hiding behind some lame and irritating legal excuses that “the actual specific entity within a group that takes the Sight has not yet defaulted.”
The sub-prime client may also have taken a cue from the alarming practice in the trade wherein suppliers are asked to waive a considerable part of the debt owed to them as a precondition to getting anything (meaning: their money) to begin with. When the suppliers agree to such often non-genuine hardship deals, the defaulting party remains in business ready to repeat the same exercise on others. It is a marvelous way to increase one’s liquidity position, but it remains “quasi-theft” for lack of any better description.
A few months ago I called this the “Madoffization of the industry.” The fact that presumably decent, upright, honest people suddenly do not hesitate to act differently.
Don’t Cry for Me, India
This Indian situation should worry us all. Let there be no mistake: There is little sympathy for banks which knowingly financed so-called circular trade, which knowingly financed fictitious polished exports, and which knowingly applied subsidized credit (earmarked for financing priority sectors) to finance real estate deals or stock market speculation. In a way, at the end of the day, such banks will eventually reap the sour fruits they sowed.
But this is not about sympathy, this is about the current credit crunch, and the very “financeability” of the diamond industry in the future. If there are massive defaults and bank write-offs of debts (which may include losses that might have been incurred in real estate or totally unrelated business, but are attributed to diamond industry financing), then the diamond sector will quickly cease to appear attractive to banks.
In the back of our minds we should be aware that the new minimum bank capital adequacy requirements (commonly referred to as “Basel II”) make a direct link between the diamond industry’s risks and the level of capital the bank itself has to maintain. Because of Basel II, the greater risk of diamond financing translates directly and immediately into a higher cost of capital for the bank, and thus of a higher interest rate to the client.
Huge losses will lead to huge interest rises for all. Moreover, in a world where credit has become exceedingly scarce, diamond industry credit has to compete with other sectors. If the industry loses the attraction to the banks there simply will not be sufficient money available. Distress sales will then become the norm, rather than the exception. Though we like to make a lot of laudatory noise about new banks entering the business, the hard truth is that those exiting the business or reducing their exposure greatly exceed the number of newcomers. Also, the so-called “newcomers” have, so far, done little business.
A few months ago, I had a meeting with a number of diamond bankers in Mumbai where we discussed various aspects of the industry crisis. I found the bankers there to be very positive. “Compared to other sectors, our experience with the diamond industry has been excellent. They rarely default, and to us they are the best of clients,” said one of those bankers, with others nodding in agreement.
That was in November, it sounded like music. Indeed, given the sheer size of the Indian industry, the number of major diamond industry defaults in India proper have always been minimal. That is probably also the very reason that the banks have been so tolerant in condoning a great variety of uses of the borrowed money. So if the record is so good, what is there to worry about? It is the bandwagon effect. It is the fear that if one or more major clients get away with this it may create a stampede in which many other decent companies will be tempted to join the sub-prime league. What the crisis has taught us is that changes can come swiftly, decisively and unstoppably.
My Money is Over the Ocean
Essentially, looking through the value-chain, variations of such sub-prime behavior can be found in many places. The frequent Chapter 11 jewelry retail bankruptcies in the United States are another blatant example. Often, the main purpose of a Chapter 11 is for a jeweler to get out of his long-term rental leases in malls and high streets, to rid himself of the unsecured creditors, and to continue business with a few very successful store outlets. Looking at the “first day” court filings of any bankruptcy shows weeks or months of preparation. And, while planning, why make payments to suppliers? Indeed, it seems that many payments are delayed for months and months, because of “the situation.”
Some 75 years ago, there was a British movie called “Money for Nothing,” a comedy
It is since then that we know that there is such a thing as “money for nothing” and this is anything but a comedy. Who foots the bill for getting nothing? In the jewelry retail bankruptcies it is the diamond suppliers who are the unsecured creditors who pay the price.
In India, it will be the mostly state-controlled banks that will pay the immediate price. Some industry participants may echo the words of an industry leader who, commenting on a huge default in Israel, noted that it was the banks rather than the trade that took the hit. That should be no reason for comfort. When taking the banks to the cleaners, at the end of the day, the industry may find no money for nothing – or, actually, no money for anything.