Mounting Financial Perils

Covenant, covenant… Heaven knows how many diamond companies are technically in breach of their credit covenant with their banks, just because the facility’s linkage to sales, profit or inventory ratios have gone down far more than the indebtedness. As it turns out, De Beers is no different from any other diamond company, though its interest-bearing banking debt is “slightly higher” at around $3 billion.

The De Beers lending bankers’ consortium reviews every six months whether the company’s indebtedness is still in line with the parameters agreed in the borrowing agreements. Apparently, it has become clear to De Beers that there is a probability that when the credit line is being reviewed in September, the company may find itself in breach of its loan agreement. That’s a euphemism for “default.”

I want to be very precise about this: De Beers is not in breach yet. Whether it will or won’t be depends on the company’s sales and profits and whether trading conditions will improve.

Not taking any chances, De Beers is doing what most other diamond companies are doing, which is renegotiating with its banks. De Beers has found an extremely innovative solution: it simply has asked the consortium to temporarily suspend certain “triggering” conditions, or ratio tests, which might put it in breach of the agreement or, more simply, in default. If the potentially problematic clauses are removed – there will be no breach.

De Beers’ lenders seem to have considerable faith in the company - probably because they are aware of enormous shareholding restructuring, which is in the making and, if successful, would enormously widen the asset base of De Beers (We’ll come out with that story in the weeks ahead.) But, also, if there were no restructuring coming, the bankers basically have no choice and must continue their support.

But banks are smart – you don’t get something for nothing. Not even a waiver of certain terms. The main lending consortium to De Beers (which would include the Dresdner Bank, RBC, ABN AMRO, HSBC, and others), which apparently already agreed to waive certain clauses, are asking for a quid pro quo: they want an up-front fee of about 0.35 percent, which would basically make the cost of borrowing higher, reflecting a lower rating of the company. In terms of money, it means an extra $10 million payment.

In the meantime, negotiations for the renewal of the De Beers $1.5 billion credit facility, which expires in March next year (this amount is part of the $3 billion), is continuing and seems to be going fairly well. Here, too, the pending shareholding restructuring, which was initiated by Nicky and Jonathan Oppenheimer’s shareholding companies early this year, seems to be evolving positively. This sounds good for De Beers. The company’s clients in South Africa should be that lucky. Just keep on reading.

Nedbank Gets Cold Feet

In an awfully complicated “proposed new funding methodology to the DTC Sightholders,” Nedbank, southern Africa’s major diamond-industry financing institution, has now simply advised clients that “Our previous policy of funding of sights has been terminated and all funding in the future will be based purely on normal commercial principles along with the Implementation of the Basel II framework and the subsequent pricing of the lending to mitigate our risk profile.”

In sophisticated legalese, Nedbank continues to say that it has “established that our current security which is held vis-à-vis stock and debtors, does not allow for acceptable mitigation of our risk and as such we have been forced to consider additional/different security.” This was brought about by the bank’s fears that “in a default position we have been unable to perfect our security with inventory, which, in most cases, will be outside the southern African borders falling under the control and charge of the overseas banks.”

We’ll save our readers a listing of the some 20 different guidelines, which will henceforth govern Nedbank’s lending. But the bottom line is that southern African diamond manufacturing companies owned by overseas diamond firms will have to get a 100 percent guarantee from overseas banks for their bank debt in South Africa. And that is not likely going to happen. Foreign banks will not finance rough purchases in Africa if that rough is cut and polished in the beneficiation countries.

The problem is not just South Africa. In Botswana, there seems to be a “de facto” freeze on further lending. The government’s dream for a “diamond hub” may simply “unhub” itself because of lack of domestic credit. Some investors feel this is a breach of the implied promises made to attract them to Botswana.

Is there a solution? Yes, there is. Sightholders should – just as De Beers is doing – initiate worldwide consortium financing, meaning, one agreement to which all lenders are party. It probably will cost a fortune in legal fees to arrive at a base agreement.

Incidentally, Nedbank, if it has the overseas guarantees, will only finance a three-month Sight cycle. There will be no money for Sight number four if the first one has not been repaid. And if a company doesn’t take one or more Sights, the facility may be downward adjusted accordingly. When rough diamond is exported, the parent company must pay for it within a week.

State Diamond Trader: A Blind Date with Nature?

Maybe one should just forget about the DTC Sight and turn to South Africa’s State Diamond Trader (SDT) for rescue. After all, it also purchases rough from De Beers to sell to local industry. Surely, its terms are more “user friendly.”

Forget it; don’t even think about it. The virtually bankrupt and hopelessly mismanaged SDT has now initiated a brilliant new policy. You want rough? First pay the entire amount in advance. Then the SDT will go to De Beers and purchase on your behalf. Then come and pick-up your pre-paid parcel – and pay a four percent commission to the SDT.

At the moment, the only supplier to the SDT is De Beers. Regarding the legally mandatory the supplies of other producers, no agreement has been arrived at on the purchase price. The SDT’s purchases from De Beers are a straight 10 percent run-of-mine goods. In other words, the huge majority of the volume is unusable rubbish or diamonds unfit for local processing. But the SDT sells run-of-mine parcels, thus the targeted beneficiation clients – the small manufacturers – are not able nor do they need to purchase those goods. In fact, a handful of rough diamond dealers are the only buyers. (There may be a question whether it is even legal to sell to dealers, but let’s ignore that minor point.) One way or another, for the buyer, it is a blind date with nature. He will not see the goods before he has paid for them.

With some trepidation we awaited Minister of Mineral Resources Susan Shabangu’s budget speech to see what she would say about the SDT. We were not disappointed. “The State Diamond Trader (SDT) has been severely affected by the global economic crisis, with diamond prices losing considerable value since the implosion of the global financial crisis. The challenges facing the State Diamond Trader are compounded by the standing financial model, which is essentially not developmental, but a classical business model,” she told parliament this week. Classical? Blind Dates?

Then the minister assured parliament that “the department is assessing the prospect of a new business model for the State Diamond Trader, which will allow the Trader to continue implementing their core mandate of promoting equitable access to and beneficiation of diamond resources, addressing distortions in the diamond industry and correcting historical market failures to develop and grow South Africa’s diamond cutting and polishing industry.”

For all practical purposes, no such change will go into effect before 2010-2011. The expectations are that by that time, the beneficiation experiment for small local manufacturers will be over and forgotten. What will remain will be the debts of the SDT. Though it only pays the producer after it has collected money from its clients, the SDT has already been able to amass a debt of $1.5 million. That’s small in absolute terms but significant when one looks from a local Rand perspective.

The minister is nevertheless optimistic. “We intend to finalize these corrections during this financial year so that the Trader can maximize its contribution to socio-economic development when the upswing in the economy returns.” This underscores that the current road to catastrophe is nevertheless paved with the most honorable intentions. At the end, whoever we are and whatever we do, without normal access to financing, we won’t remain a player and our game will be over.

Have a nice weekend.