Trade Resources Industry Views The Reduction of Bank Credit Available to The Diamond Industry Is a Game Changer

The Reduction of Bank Credit Available to The Diamond Industry Is a Game Changer

The reduction of bank credit available to the diamond industry is a game changer that will influence the market for many years to come. Therefore, this column has chosen bank credit as its most important story of 2014, rising above other strong candidates for the title.

The tone was already set in late 2013 when ABN Amro notified its diamond manufacturing clients that, effective January 1, it will only finance 70 percent of rough purchases, rather than the previously allotted full amount. Other banks were instituting similar measures as their own compliance and transparency requirements meant that they had to lend to robust and bankable companies and industries.

It emerged in 2014 that the diamond market has a long way to go to improve its “bankability” – a term coined by ABN Amro’s Eric Jens at the recent World Diamond Conference in New Delhi (see editorial “Normalizing the Diamond Trade,” published on December 19, 2014). Bankability is the sum of profitability plus transparency, he explained. Jens stressed that the industry needs to polish its operations to comply on both accounts and be attractive to lenders.

The decision to close Antwerp Diamond Bank, which lends about $1.6 billion to the industry, brought additional urgency to find new vehicles of credit. With reduced bank credit, companies have had to self-finance more of their rough purchases, thus weakening their overall position in the market.

Astonishingly, rough demand remained fairly robust for most of 2014, particularly for primary supply from the major rough mining companies. De Beers rough price index rose 7 percent during 2014, according to Anglo American, while estimates suggest that prices on the secondary market were about flat for the year having declined in the second half.

Polished prices, meanwhile, fell in all categories except 0.50-carat to 0.90-carat goods, as reflected in the RapNet Diamond Index (RAPI™) at press time on December 25. An in-depth review of polished prices will be published shortly in the upcoming Rapaport Diamond Statistics Annual Report 2014 in the January edition of Rapaport Magazine.

Given the imbalance between rough and polished prices, manufacturers consistently complained of tight profit margins, or none at all. Cutting center liquidity was consequently under increased pressure.

Indeed, tight liquidity was a sure candidate for story of the year as reduced bank credit, low profit margins, weak global demand and grading delays at the Gemological Institute of America (GIA) all contributed to manufacturers’ languishing cash flows. In fact, each of those factors were considered for their notable influence on the diamond market in 2014.

Using more of their own money to pay cash for rough, manufacturers waited for more than six months for their goods to be returned from the GIA. That meant that from the time the rough was bought, through manufacturing and grading, they were only being paid some nine months to a year later when the resulting polished was sold in the market – often with generous credit terms given to their polished buyers.

The Diamond Story of 2014

That said, a faster release time by the GIA may have resulted in an oversupply of polished that would have further pressured polished prices to decline. In a sense, the GIA backlog helped support polished prices in 2014. Still, the year has ended with an oversupply of diamonds throughout the distribution chain, partly since the GIA has reduced its backlog more recently.

However, inventories also rose as demand was relatively weak. While U.S. demand remained healthy, other markets have been cautious for most of 2014. Most significantly, uncertainty filtered to the diamond trade as China’s economic growth slowed and the government’s anti-corruption campaign intensified. India, meanwhile, is still hopeful that the newly elected “friend of the industry” Prime Minister Narendra Modi will restore economic growth and consumer confidence.

Manufacturers were therefore squeezed from both ends of the market as they tried to juggle high-priced rough with weak polished demand.

The mining companies staked their claim to exerting the most influence on the market by notching up a record year on the back of high rough prices. Indeed, Rapaport estimates that De Beers rough sales rose 14 percent to exceed $6.5 billion, while production levels were kept basically stable.

Jewelry retailers, meanwhile, were carefully managing their inventory levels and also continued their process of consolidation. Undoubtedly, the most headline-grabbing story of the year was Signet Jewelers’ acquisition of Zale Corporation. Chow Tai Fook also turned a few heads by purchasing the high-end diamond brand Hearts on Fire.

The Diamond Story of 2014_1

Retailers also continued to streamline their activities, encroaching on diamond manufacturers’ space, as more rough is being sold to jewelers than ever before. Given the stronger profit margins that jewelry retailers enjoy, they are arguably better positioned to pay for high-priced rough than traditional diamond manufacturers.

Diamond manufacturers and dealers therefore look back at a tough year in 2014. Their relationship with the laboratories also came under scrutiny by Rapaport’s exposé about grading inconsistencies after Rapaport Group banned EGL from its RapNet trading network.

However, 2014 wasn’t all bad. For one, consumer demand for diamonds is expected to have grown slightly, and there were more initiatives to raise the industry’s branding and marketing presence.

There were also stronger trading periods during the year. The first quarter was a fairly profitable one for the trade as jewelry retailers replenished inventory they had sold off during the preceding Christmas period. Manufacturers enjoyed some profitability as they were selling them higher-priced polished that was manufactured from rough they had purchased when rough prices fell in the fourth quarter of 2013.

But while polished prices increased in the first quarter, the increases were short-lived. And so were suppliers’ profit margins as rough prices simultaneously rose, and rose further. Margins were squeezed from around April onward.

Bewildered manufacturers continued to buy rough with more of their own money. They were constantly faced with a choice to scale down their operations or keep their factories running, and their workers working, albeit at a loss, with the hope that another strong quarter will emerge as it did in early 2014. Perhaps they will realize that pride got in the way of practicality as they struggle into 2015.

The banks are expected to force a change to that mindset. The trade simply does not have the cash to continue to finance the profitability of its mining suppliers and its retail customers. To gain more bank credit, diamond manufacturers will need to show that they are viable, prudent and bankable businesses.

Jens stressed that there is good money available for good clients. But the banks are looking for improved asset controls, consolidated reporting and clear corporate governance. Diamond manufacturers and dealers will need to reduce their inventory levels and step down as the financiers of the industry by paying cash for rough and giving credit for polished. And, they will be forced to show the added value they bring to the trade.

To gain the banks’ favor, the industry will need to be more transparent with its operations, systems and reporting, while the banks have also been increasingly considering the corporate social responsibility activities of their clients and their ethical standards. Doing business with the trust that the industry was historically afforded is simply no longer good enough.

This past year proved that the industry needs to break the cycle of tight liquidity and low profitability that has been prevalent for so long. Therefore, many of the candidates for this column’s 2014 story of the year were dismissed for their inability to break that unhealthy trend. As painful as it is, the reduction of bank credit and new requirements from the banks aim to do just that. And in so doing, they will hopefully influence more profitable years ahead for the trade than 2014.

Source: http://www.diamonds.net/News/NewsItem.aspx?ArticleID=49948
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The Diamond Story of 2014
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