Pulling the Plugs
June 11, 09“We are now some ten months into the most serious industry crisis since the early 1980s. In the
This question came up at the recent Antwerp Diamond Town Hall, and the short, public relations-type of answer, mumbled under the breath, was something
The banks don’t determine the underlying conditions of their clients; they do, however, have some discretion in the decision of when to pull the plug. They will do so if and when it is good for the banks. Yet if it is in the best interest of the banks “to work with the customer,” they’ll do so – up to a point.
So far, if there are any “winners” in the current crisis, these are mostly the diamond banks – but they don’t get any prizes. Their clients are selling out of inventory, they need little “new money,” and, mostly, their credit exposure is going down. Meanwhile, the value and quality of the collateral held by the banks seems to be going up and up – though this issue is too complex to make generalizations.
Let’s say that before the crisis, one’s “open credit” was
The worldwide cutting center banking indebtedness has gone down by some 25-30 percent in the present crisis so far. This reduction has been mostly achieved by the payments of accounts receiv
After the “good accounts receiv
This process is rather similar in all cutting centers. What is the end result? After the accounts receiv
No banker will ever say: “you have reduced your debt by 25 percent, so now we’ll release some of the pledged real estate” or “we don’t require so many bank guarantees anymore.” No way. (One of my economist friends pointed out that if the “open credit” part is not covered by tangible assets and needs to be repaid out of future earnings, assuming a highly optimistic return of 15 percent on equity, and depending on the equity-debt ratio, it would take between 6 and 10 years to pay off one’s debts. Will the banks have the patience to wait? They need to see that the industry makes money!)
Demanding Additional Collaterals
The debt security issue is far more complex. The steep fall in rough diamond prices, and the emergence of “damaged collateral,” has become the pretext to demand ever more security. In
In general, diamonds in bank vaults are diamonds that are not being sold or worked on by their owners – they are a net withdrawal of “liquidity” in a diamantaire’s business. Moreover, the pledged diamonds are valued on their present value, not the price at purchase, and then these values are discounted (for credit purposes) down to some 60-70 percent at most, depending on the bank’s policies.
But it isn’t just diamonds. In the banks’ scramble for ever more collaterals, some diamantaires have already pledged most of their personal assets – in some instances including valu
To avoid misunderstandings, whenever a client doesn’t honor a commitment to his or her bank, a material clause in the loan covenant, this amounts to “default.” However, we have learned throughout the crisis that banks employ consider
Do I blame the banks? No, they are managed by corporate or semi-government employees doing what they are paid to do – defending the banks’ assets. If anything, they are doing such a splendid job that really no need has arisen to force a client into formal bankruptcy – so far.
There are also powerful commercial considerations why it is not in the interest of the banks to pull the plug now. Foremost, there is a pragmatic matter: there is no way in the world that banks acting as receivers or liquidators of client assets would be
Then there is an accounting issue. The bulk of diamond loans are subject to hold-to-maturity accounting, which – in contrast to so-called fair-market accounting – typically does not recognize losses until the loans default. As the short-term loans in diamond banking are typically viewed as revolving loans (overdraft), where the maturity is technically extended automatically twice a year or more, “working with the clients” en
There is a downside to all of this: banks collectively maintain the illusion of robust industry solvency in the diamond cutting centers. The renewed speculation in rough diamonds (especially by Indian players), the creation of a new mini-bubble in rough prices and the return to some of the traditional
If one wouldn’t know better – one would call this period the “golden age” in the banks’ relationships with clients.
New Credit? Pipe Dreams?
If things are so good, why do we need governmental guarantees? As we discussed at length (and in depth) a few weeks ago, in Antwerp it is believed that warehousing another $1.5 billion of “dead” or “slow-moving” stocks will en
What is the issue is that this “new collateral” would partly be used to shore up even more the existing collateral (50 percent) of the current debt and partly (50 percent) to allow the diamantaire to obtain new credit. The Belgian scheme in a way tries to get around the prohibition to finance stocks and to accept stocks as collateral. It wants a “legal circumvention,” i.e. it wants a system approved by the banking regulators – something that hasn’t happened yet.
Whoever worked out this scheme (and much credit is due to ABN-AMRO’s Victor van der Kwast) realized something that is only gradually being grasped by the industry at large: the problem will start when the crisis comes to an end – when new credits are needed. That’s the moment of truth for the cutting centers. That’s the moment of truth for each and every company. That’s why both in
We want to be precise: every account and every client represents a different story – and even today, some clients are expanding their debts. These are also days of miracles to some companies, such as the Indian conglomerate that negotiated a long-term debt maturity date for its existing debt and secured new credit to facilitate a mammoth purchase of rough in
But, basically, with each and every jewelry retail Chapter 11 bankruptcy in the
So another part of the answer to the question “why-no-business-failures” is simply that banks will not force anyone into a bankruptcy situation when these clients’ debts are going down and collaterals are being strengthened. Why would they? And even when the client runs out of new collateral, there is still little to gain from pushing the client into liquidation.
Borrowing Base Marching Downwards
As De Beers Managing Director
In the post-crisis period, all kinds of automatic triggers come into play. Banks will then put on the brakes when reviewing (what is called in the
The diamond industry requires short-term, activity-based financing. In its most basic form, it goes something like this: show me your accounts receiv
Credit Will Remain Tight
It seems to me that each and every credit-dependent player should start to prepare for “the day after.” The contours of some of the new “day-after” realities are already clearly visible.
Banks will have less money to lend – and they will prioritize sectors. Money for diamonds will compete with money for almost everything else. As we reported before, in the
Guido Segers, the head of KBC’s Merchant Banking Division, informed us through a KBC spokesperson that in context of a strategic review of activities, KBC is “reviewing how we can make optimal use of our capital (reduce risk-weighted assets) and which activities are and which are not deemed essential/core for our company in the current challenging economic circumstances. This exercise is ongoing. … We are already reducing (e.g., certain activities of KBC Financial Products or will reduce a number of niche activities,” said the spokesperson.
Then came the key line, “For the time being, no change in policy is planned for our subsidiary Antwerp Diamond Bank.” Maybe we should try to get used to the fact that no bank anywhere can be taken for granted today. Everything is for sale, all of the time. Whether the ADB is owned by KBC or another player will, at the end of the day, make little difference as long as the oldest diamond bank remains in business. In the meantime, KBC’s denial is noted.
When we come to “the day after,” the total size of the diamond jewelry market will not go back so quickly to its pre-crisis size. Closed jewelry stores will not immediately open up again. Rough supplies will embark on a declining trend. Prices may go up, but (unit) volumes will decline. The industry shake-up that had been expected, but didn’t arrive, may still be ahead of us. Call it, euphemistically, a capacity alignment to new realities. In this exercise of survival of the fittest, the bank will play a major role.
What Plugs to Pull…
Over a luncheon in
This scenario is not likely to happen – the banks will not allow it. Whether in
It is easier to pull the plug on marginally smaller and medium-size players. As odd as it may sound, to some players “pulling the plug” may provide a preferred exit route out of the industry.
It may not be an appropriate metaphor, but think in medical terms
This is, of course, conjecture. The point this column wants to make is that we cannot afford complacency in our relations with our banking partners. It is a joint industry and it is in the banks interest to have maximum st
It is “the day after” we should worry
Have a nice weekend.