Banking on diamonds

Avi Krawitz

Having improved its creditworthiness before and during the pandemic, the industry is learning to rely less on its lenders.

In both financial and diamond industry terms, 2017 seems like an eternity ago. Bankers at the Dubai Diamond Conference in October of that year gave a stark warning to the diamond sector: The trade is over-financed, insufficiently transparent, not profitable enough, and altogether too risky. This was their unanimous observation, to the discomfort of the audience.

With bank credit amounting to an estimated $13 billion at the time, lenders claimed the industry could function sufficiently on just $8 billion. Bankers were already reducing their exposure to the trade’s risks, and many had closed their diamond units altogether.

Today, bank credit has reached that $8 billion level, according to estimates from Bain & Company (see graph). Meanwhile, the diamond industry appears to have enhanced its stature among lenders. In an unexpected twist, the midstream radically improved its liquidity position during the challenging pandemic period.

We’re seeing that our clients had much better profitability in 2020 than 2019,” reports Davy Blommaert, head of diamond lending at the Dubai-based National Bank of Fujairah (NBF). Because supply was limited, he explains, diamond value went up during the pandemic, whereas 2019 was a tough year that saw an excess of polished on the market.

As factories closed and rough buying froze during the lockdowns of 2020’s second quarter, diamond cutters were able to reduce the inventory that had been weighing on their businesses. The lack of new polished meant other suppliers, too, could focus on selling old stock that had been difficult to move.

Unlike in previous years, when the decline in financing was due to banks’ reluctance to take on the risks the industry carried, last year’s dramatic drop resulted from lower demand for funding. When banks finance a diamond company, they look at its assets, which are typically inventory and receivables — the outstanding payments that clients owe the company — explains Blommaert. Less inventory means companies are more liquid, he says, and the more liquid they are, the more they want to buy for cash rather than on credit terms, since they have sufficient funds and can get a discount with cash.

Currently, inventory and receivables are both low, meaning diamantaires are holding fewer assets that need financing, Blommaert observes, adding that he personally has “never known leverage in our industry to be so low.

Profitable rough

Many credit De Beers and Alrosa with the improvement, as they allowed greater flexibility in their rough sales during the crisis. The two miners — which combined account for about half of global rough production — let clients refuse goods between March and September, thereby reducing supply while keeping prices stable.

As a result, there was less need for financing, since the banks usually fund those rough purchases, explains Olya Linde, a partner with Bain & Company’s energy and natural resources division, as well as coauthor of Bain’s annual diamond report.

Meanwhile, prices at rough auctions and tenders fell 20% to 30% as smaller miners that needed liquidity were forced to sell. Many in the trade took advantage of that, Linde notes — and Blommaert says they are reaping the benefits today, since both rough and polished prices have recovered.

Before Covid-19, rough from a given mine would sell at around $100 per carat, but that dropped to about $73 during the pandemic, Blommaert elaborates. While it has since gone back up to around $110, those who bought at the lower rate are now enjoying increased profitability. Manufacturers usually achieve a margin of some 3%, he says, but if their cost was $73 and they are selling polished at the same price as before, they’ll suddenly see significant gains.

Improving the risk profile

All of the banking and industry professionals Rapaport Magazine interviewed agree that 2020 was healthy for the midstream, which improved its profits despite the challenging conditions.

[The trade] embraced technology and the changes that were forced upon it,” says Linde. “And it was able to clean up its inventory due to the disruptions in the supply chain.

Importantly, there were very few reports of bankruptcies in the manufacturing and trading centers. That has raised banks’ tolerance for the industry, according to one India-based banker who has requested anonymity.

When the pandemic and lockdowns were declared, there was some resistance from banks to extend finance, as they thought the trade would face more risk, challenges and stress,” says Colin Shah, chairman of India’s Gem & Jewellery Export Promotion Council (GJEPC). “After one year, the trade has come back strong, standing on its own feet, and operating with near-normal capacity. So the earlier concerns perceived by the banks are no longer relevant.”

Even before Covid-19, the industry was slowly improving its risk profile among lenders. That was largely because banks were steadily leaving the industry or taking steps to protect themselves from its hazards. Antwerp Diamond Bank, Standard Chartered Bank and Israel’s Bank Leumi all stopped funding the sector in the last six years, resulting in more than $2 billion worth of credit leaving the trade.

Read full article 

Source Rapaport