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“U.S. GOV’T GUARANTEES LOANS TO DIAMOND MANUFACTURERS”

History was made this morning at a breakfast signing ceremony in Botswana. Barclays Bank Botswana signed a $125-million credit guaranty agreement with the Overseas Private Investment Corporation (OPIC), through which the United States government will share 75% of the credit risk in financing diamond beneficiation in Botswana. Barclays is taking a first tranche out of a total available guarantee of $250 million.

 

Chaim Even-Zohar
credit:Chaim Even-Zohar

Together with the $83-million matching banking partner share, this guarantees an availability of $333 million of credit for Botswana’s manufacturers – only for manufacturing – which is well above the industry’s foreseeable requirements. Eventually, it is expected, other banks in Botswana will join the program, providing a new rationale to diamond manufacturing in that country. Botswana’s main attraction will be credit – not just rough diamonds!
At a time when several banks are exiting the diamond manufacturing and trading sector (the “midstream” in the diamond value chain), or reconsidering their exposure to it, the U.S. government’s commitment to both Botswana and its diamond sector could hardly come at a more critical moment. In some ways, this agreement may be far more important psychologically than financially. In the current market recession, with diamond prices falling and demand slackening, many diamond companies will have to rethink their business models and their way of operating.

 

A “Fresh” Direction: Financing Certainty

The Botswana manufacturing option now has an added factor, a new dimension, in any diamond company’s long-term planning. Lazare Kaplan International’s (LKI) Chairman, Maurice Tempelsman, whose company acts as the statutory required U.S. private party in the OPIC Guaranty Framework Agreement, clearly hinted to this when he said at this morning’s signing that “this facility will not on its own resolve the many challenges the diamond industry faces, but it does point in a fresh direction.”

“It is fitting that this new direction should be signaled here, in Botswana. For it is Botswana that has set the global standard for responsible stewardship of mineral resources. It is Botswana that has championed the principles of accountability and transparency that our industry needs. And it is Botswana that has faced up to the test of sustainability, through development of secondary and tertiary economic sectors that can remain even after the primary diamond deposits begin to wind down,” said Tempelsman earlier today.

These are inspiring words. However, we are not deluding ourselves. With possibly a few exceptions, most southern African beneficiation partners have yet to find a long-term formula for sustainable manufacturing. While guaranteed access to rough remains a cornerstone of the beneficiation rationale in Botswana, the risks of protracted periods of raw-material mispricing and a virtual absence of margins are not mitigated by the implementation of the OPIC agreement.

 

OPIC Advances U.S. Private Interests

What motivates a remote U.S. government agency to put hard money behind Botswana’s diamond beneficiation? On the broadest level, OPIC supports U.S. foreign policy objectives. The United States considers Botswana a model for stability in Africa. The bilateral relationship is strong and grounded in a shared commitment to democracy, good governance and human rights.

The United States views Botswana’s deepening economic diversification and its promotion of regional economic growth and development as a distinct and vital U.S. strategic foreign policy interest. In many ways, Botswana represents a rare exception on its continent. The bilateral relationship covers many spheres, including the military arena. Admittedly, these are political objectives.

However, in the United States, private companies are encouraged to advance government foreign policy objectives by investing in and otherwise being active in overseas priority development areas. To assist the private sector, OPIC was established. Its specific mandate is to “mobilize private capital to help solve critical development challenges and in doing so, advancing U.S. foreign policy.”

Because OPIC works with the U.S. private sector, it helps U.S. businesses gain footholds in emerging markets, catalyzing revenues, jobs and growth opportunities both at home and abroad. OPIC achieves its mission by providing investors with financing, political risk insurance, and support for private equity funds.

OPIC officials point out that decades ago, private capital flowing into developing countries was a small fraction of U.S. aid dollars. But in recent years, that ratio of aid to investment has flipped, and the amount of investment flowing to the developing world far exceeds aid dollars. As a development finance institution, OPIC was created on the premise that the resources needed to address major world challenges far exceed the resources of the public sector, and that private businesses and investors have an essential role to play. A few months ago, for example, it provided a $45-million loan guarantee to the African Banking Corporation of Botswana for the purpose of expanding its small and medium enterprise (SME) and financial inclusion loan portfolio in Botswana. However, De Beers’ sightholders are not considered SMEs; the diamond needs are quite different.

 

It All Began with the President’s Beneficiation Aspirations

We asked OPIC Vice President James C. Polan, who is the main “architect” of this unique diamond-financing program, how it all started. He recalls that it began with the friendship between LKI’s Maurice Tempelsman and the former president of Botswana, Festus Mogae.

When President Mogae considered embarking on the course of diamond beneficiation, and actually leveraged mining-license renewals to extract beneficiation concessions from De Beers, he repeatedly expressed fears of what would happen if, suddenly, for whatever reason, financing would no longer be available. If that were to happen, he argued, then the entire beneficiation effort, including all of the human contributions and the resource investments, would be in vain. The president was looking for a structure that could withstand times of crisis. He wanted a local industry that generated such confidence that, no matter what were to happen, there would always be money for the entire manufacturing sector – his emphasis was on a beneficiation sector in its totality.

It was these concerns that led President Mogae to request OPIC to provide help. “OPIC has assisted Botswana for well over 50 years in various programs, so we were no strangers to each other,” remembers Polan, who himself had served in Botswana earlier in his career.

By law, in order to invest, OPIC needs a U.S. “sponsor.” This is the reason that President Mogae turned to one of Botswana’s earliest beneficiation partners, Maurice Tempelsman, to become the U.S. private partner. Tempelsman’s commitment to African development is well known – and goes well beyond just diamond interests. At President Mogae’s request, Polan and Tempelsman explored ways to guarantee credit availability in Botswana irrespective of economic cycles. This resulted in the conclusion of the Lazare Kaplan International Framework Agreement of 2008. Today, finally, it starts operating.

However, it should not be lost on any stakeholder that the agreement was negotiated and approved by the U.S. government at the very depth of the 2008 financial crisis. That demonstrated a degree of trust in the future of beneficiation. If the OPIC guaranty is fully implemented, Botswana’s diamond industry will have become immune against the calamities of any future credit and liquidity crunch or banking crisis.

 

Financing Availability Guaranteed for Ten Years

It’s fresh in our minds how, only a few weeks ago, representatives of Standard Chartered Bank made discrete “house calls” with clients in Antwerp to discuss the timetable for returning the debts and/or for them to seek another bank. Walking in the footsteps of Antwerp Diamond Bank, Bank Leumi, and some other banks, financing uncertainty has catapulted to become the single largest threat to stability and continuity in the diamond sector. It is axiomatic that no diamond business can function without being able to plan cash flow, to commit to investments in training, marketing, infrastructure, and to enter into long-term supply agreements, without predictable and reliable financing sources.

 

Each Loan Reported to Washington

DIB asked James Polan how the agreement signed this morning actually works – and to explain the meaning of the “ten years.” Polan explained that, in fact, the $250 million is for thirteen years from today. Specific loan agreements with sightholders will initially be for one year. However, they can be renewed for up to three years. Basically, the promise is this: Loans made in the tenth year of the program can thus be extended for three years – and then the guaranty agreement expires.

We asked James Polan what happens after 13 years. He explains that the basic objective of OPIC’s work with banks is to allow them time to gain the experience and “comfort” to finance in certain developing countries or lending sectors. If the experience of the banks is positive and they have confidence, then after 13 years, they may be ready to assume the entire risk themselves – and they won’t need OPIC anymore.

There is no way we can predict what the situation in Botswana’s diamond industry will be like in 13 years. According to Polan, if the program works satisfactorily but there is still a need for a new guaranty framework agreement, “we certainly may decide to consider that.” Stresses Polan: “Don’t forget, the consortium of banks in the agreement also pays us. There are also commercial considerations for the banks to consider.”

Polan made it clear that $250 million guarantees are the absolute maximum amounts, the upper ceiling, of any guarantee limit OPIC is allowed to extend to any single project in the world. When the agreement was signed in 2008, it was then one of the few commitments ever made on that scale. The Botswana agreement is the only diamond industry guarantee OPIC has ever entered into.

A perusal of the documents shows that 100% of sightholder activity is not intended to be financed. Says the agreement: “The [diamond beneficiation financing] project will augment private capital in the financial sector to supply credit to diamond manufacturers.” They are matching a bank’s own exposure. The individual banks’ lending conditions, in terms of collateral requirements, or in terms of a borrower’s own equity to credit ratios, continue to apply.

 

Presently Credit Facilities in Botswana are Not Fully Utilized

While President Mogae’s fears of a sudden falling away of financing may have been seen as quite inconceivable at the time, they have become far more of a reality today. Presently, there is diamond financing, because demand has slackened. The total locally available financing facilities offered by a handful of Botswana banks in the range of $210-220 million is not fully utilized. Maybe it is cheaper to borrow elsewhere?

Whether more credit is needed right now is not the issue. The importance of the OPIC facility is far more strategic – and it is more like an insurance – that whatever may happen to the industry in the market, it will not fail simply because of a lack of access to money. Polan stresses that excess financing availability is generally rare, and that in the diamond industry there will be shortages, including in Botswana. Today’s excess availability is partly attributed to a reluctance to purchase sight boxes some months ago.

The complexity of the multi-stage process and multiple agreements rules out “fast track” options. The OPIC Framework Agreement states: “Participation in the Facility by other banks may be permitted after completion of due diligence and normal OPIC approval procedures.” The announcement today is simply because Barclays has become the first bank to meet and accept all the terms and condition set by OPIC and pass their acceptance thresholds.

James Polan and his LKI colleagues will make the rounds among other banks in Botswana this week. “We are interested in placing the entire $250 million with a consortium of Botswana banks,” he stresses. If all beneficiation financing is done by consortium members, there will be a level playing field.

Polan laughs at my “fast track” remark. “As now we have a model and a set of agreements in place, the due diligence required could be accomplished within six months. Maybe even faster. So any new bank that shows an interest this week could be in business by early next year. All banks will have to agree to precisely the same terms and conditions,” he adds.

 

Financing for Beneficiation – Not for Box Trading!

These terms specify that Barclays Bank’s customers must apply the OPIC-guaranteed credits solely to finance rough purchases used for manufacturing in Botswana. If Barclays also wants to finance rough trading, it should be financed from the bank’s other capital resources. DIB observed that, for all practical purposes, in any given situation, a small part of the box might be traded or immediately exported from Botswana.

Polan knows this. “There is a matter of trust here. We rely on our banking partners that they will honor their commitments.” DIB didn’t dwell on this point too long, as there might be serious questions on how a bank can actually monitor how the money is used. Polan reminds me that “money is fungible.”

Today, virtually all current beneficiation factories are foreign-owned. In many instances, the actual selling of the polished is done through a parent or associated company overseas. In rough diamond financing – as it is done at the moment – the bank is extending credit to pay to the rough supplier and, after 120 days, a foreign associated company will pay off the loan. (In practice, the first sight purchase will be repaid before the bank extends credit for the fourth sight.)

The repayment will generally be done through a remittance from a group company member overseas. Few, if any, of the intermediate transactions may be visible to the Botswana bank. This is an issue that needs to be addressed as part of the Credit Risk Management [discussed below.] A bank actually may not see whether the sight box that is financed is manufactured in local factories. If the bank cannot know, how does OPIC?

James Polan was very specific on this. “There is definitely an expectation by OPIC that our partner bank, Barclays, will know exactly what rough is being manufactured or what is exported. This will also come up in the policy review we will conduct from time to time.”

 

Key to Success or Failure: Quality of Credit Risk Management

The history of credit defaults and banking impairments in the diamond sector shows that more often than not the losses were caused either explicitly or indirectly by weaknesses in credit risk management. Usually, there are key problems that simultaneously take place in several management areas, some of which, such as concentration, failures of due diligence, and inadequate monitoring, tend to recur with uncomfortable frequency.

The first area, concentration, represents probably the single most significant cause of credit problems. Credit concentration is defined as any exposure where the potential losses are large relative to the bank’s capital, its total assets, or the bank’s overall risk level. Concentration risks include a concentration of credit to single borrowers or counterparties, to a group of connected counterparties, or to economic sectors or industries.

The OPIC guaranty reduces Barclays Bank’s concentration risk, thus enabling the bank to expand and deepen its exposure to the diamond sector. However, apart for setting strict terms and conditions, OPIC has little influence over other measures such as success or failures of due diligence and adequate or inadequate monitoring, which are wholly functions of the credit-granting and monitoring process.

There are excellent customers – and, unfortunately, also a few rotten apples waiting for an opportunity to take the bank “for a ride”. Likewise, there are excellent bankers, and some who are also influenced or incentivized to put personal interests over those of the institution they work for. The problem is – when you find out who belongs to a certain category, it is already too late.

Bankers refer to this as moral hazard – the risk that a party to a transaction has not entered into the credit contract in good faith, has provided misleading information about its assets, liabilities or credit capacity, or has an incentive to take unusual risks in a desperate attempt to maximize profits before the loan needs to be repaid. It arises when both the parties have incomplete information about each other. In the diamond industry, and not only in this sector, moral hazards refers to a conflict between “insiders” and “outsiders” based on a double-edged asymmetry. Information is asymmetrical – insiders always possess superior knowledge (over their own company, over market trends, over their own risks or recklessness) than the outsiders have.

In our interview with OPIC’s James Polan, the question of whether their partner banks really know precisely how their borrowers use the OPIC guaranteed loans was raised. The word “trust” was used frequently. OPIC trusts its banking partners – and they know that the participating banks want to enjoy the advantages of an OPIC guaranty for the long-term. Moreover, OPIC has its own continuing and very professional monitoring process.

 

Lending Will Be Different: Borrowers Must Meet OPIC Requirements

Thus OPIC will be reviewing the bank’s risk management. “The Framework Agreement requires us to review each downstream borrower, thus essentially every loan,” says Polan. “Each borrower will be known to us. No, we don’t need to ‘sign off’ as such – we must just be certain that all OPIC statutory requirements are met.” The agreement makes a reference to environmental guidelines and to certain social conditions.

States the relevant OPIC document: “As with all such facilities, OPIC will review and provide environmental clearance on each downstream loan prior to granting consent for each such loan. OPIC will require mandatory environmental language to be included in downstream loan documentation applicable to downstream borrowers.”

Polan clarifies that this is rather broad. “We must verify that the labor force in the factory is properly treated; that working conditions meet the required standards. The bank may need to collect more information than it currently may be requiring and provide these to us. Of course, when a particular borrower gets multiple loans, we don’t need to check on these matters each time. But, especially in the first years, each new loan will be screened in accordance to the OPIC guidelines,” explains Polan.

DIB queried about OPIC’s monitoring. Polan used different terminology. “The participating banks must submit reports to us – and, yes, we will know about each loan to each borrower. But we use the information for policy reviews” – to make sure that the facilities are used for what they are intended to do: beneficiation financing,” explains Polan.

 

Turning Existing “Bad Loans” into OPIC Loans Prohibited

The U.S. government is willing to accept that one day, in a disaster scenario, it might have to pay out a quarter of a billion dollars. But it will not “throw out” money – it will take all preventive measures possible to assure the quality of the lending by its partners.

Thus, the OPIC due diligence process focuses also (or very much so) on the quality of the credit portfolio of the bank that wishes to partner with it. Partner banks will not be able to reduce their own financial risks on non-performing assets in their existing loan portfolio by turning these into OPIC-guaranteed loans. This is not allowed.

Stresses Polan: If an existing customer of Barclays is considered for an OPIC loan, it must have repaid its previous outstanding; it must be a borrower “in good standing” who has always met his obligations. Over time, existing clients may all become OPIC-loan clients – provided that the credit is fully applied to diamond cutting and polishing in Botswana. Theoretically, all diamond beneficiation companies could become OPIC-loan recipients over time – in conjunction with the respective banks additional financing from own funds for a client’s other needs.

Barclays Bank of Botswana has a formidable presence in Botswana. It is a leading publicly listed commercial bank in the country, employing 1,200 people with 41 branches throughout the country. Its managing director is Mrs. Reinette Van Der Merwe, who came in some three years ago after being with the Absa Bank in South Africa.

Though it is a subsidiary of Barclays Bank plc., it is said to be independently managed. Theoretically, this is quite different from other banks, such as ABN AMRO or Standard Chartered, where ultimate management control (and decision-making on diamond issues) takes place in remote offices in Amsterdam or London. The parent company may be involved elsewhere in the diamond sector, mostly in mining finance we understand, but the Barclays Bank Botswana develops its own business model. Lending decisions are – or will be – made in Gaborone. [Presently the bank is in a transition phase and overseas parents are still considerably involved, as they have the industry know-how skills. This sounds like prudent and responsible banking.]

 

No Competition on Pricing of Loans

One of the reasons some banks are reducing their exposure to the industry is the perception that it is a risky lending business. The global banking industry sees more demand for credit than they have resources, and they have “the luxury” to decide to what sector they allocate their resources. When a bank gets into the money market with a portfolio that is largely guaranteed by the U.S. government – rated AAA, or non-risky – it will extract more favorable borrowing rates. Theoretically, the bank’s cost of capital will therefore be reduced.

It is our understanding that, presently, interest rates charged by the diamond banks in Botswana used to be around 2.5% to 2.75% above the three months Libor rates. This has gone up to the 2.5% to 3.0% range today. As the 3-month Libor rates are currently around 0.6% to 0.7%, the interest rates paid by sightholders are now above 3%. The spread is considerable!

There is no doubt that diamond industry financing is “a good business” for the banks. Will Barclays be able to offer lower rates than the competition? May the OPIC facility create some kind of market distortion? Though Polan has consistently avoided making comments about specific banking practices, he did confirm that “the agreement with the banks address these issues.” In a general way, he stated that the competition will not be based on interest rates. The rates would fluctuate in context of the normal competition among competing diamond industry banks.

 

Ample Room for More Banks to Grow in Diamonds

According to our sources, Barclays Bank presently holds some 30% of the local diamond-financing market. Its facilities are estimated at around $70 million, of which some $50-60 million is utilized. Polan fully expects that the bank will attract new diamond clients – that its existing portfolio will grow.

ther sources echo the view that growth should not just come from clients shifting from the exiting Standard Chartered Bank (SCB) – that currently has about 50% to 55% of the market with some $110 million facility and most probably only $90-100 million utilization. In any scenario, SCB is expected to stay in Botswana with a handful of diamond clients that are viewed as “regular clients” – just like those from any other sector. Stanbic Bank holds some 10% to 15% of the diamond-financing market, with the remaining 5% in the hands of other banks.

The OPIC agreement puts obligations on the banks that go beyond just financing. “The lending facility must have a positive developmental impact by contributing to the Government of Botswana’s diamond beneficiation efforts. Diamond beneficiation is expected to have multiplier effects in associated sectors such as construction, insurance, and jewelry, and is also expected to increase local job opportunities,” reads the Framework Agreement.

“Any bank in Botswana that finances the manufacturing activity of a duly registered and licensed local diamond factory is invited to apply for participation in the $333 million revolving finance facility,” concludes Polan. “Any local manufacturing company should have access to financing. That, in a nutshell, is what this is all about.”

There is nothing else like this agreement anywhere in the diamond world. It truly provides a new lease on life for the struggling Botswana beneficiation sector. It’s coming not a day too early.

 

Box1: African Continent’s Oldest, Longest-Term American Friend

This morning’s speech by Maurice Tempelsman was far shorter than it takes to recite his biography. Maurice is probably one of the best-known American personalities on the African continent in the last half century. On the podium today, Maurice represents Botswana Finance LLC, the U.S. partner company that is the cornerstone of the OPIC Lazare Kaplan International Framework Agreement.

Maurice is also, of course, Chairman of the Board of Lazare Kaplan International Inc., a company with a history of over 110 years in the diamond industry, and a long-term investor in Botswana, Namibia and other diamond producing countries.

Maurice served on the International Advisory Council of the American Stock Exchange. He also chaired The Corporate Council on Africa. He is a past Chairman of the Africa-America Institute and a member of the Board of Trustees of the Eurasia Foundation. Maurice is a director of the National Democratic Institute for International Affairs, the Center for National Policy, the Business Council for International Understanding, and the U.S.-Russia Business Council.

In addition he is Chairman of the International Advisory Council of the Harvard AIDS Institute, and is an honorary trustee and an honorary member of the corporation of Woods Hole Oceanographic Institution. He is a prominent member of the Council on Foreign Relations, and was named a Visitor to the Department of Classical Art of the Museum of Fine Arts, Boston, Mass. A director of The Academy of American Poets, Maurice has also served as a trustee of the Institute of Fine Arts, New York University, and on Lenox Hill Hospital’s Advisory Board.

As his closeness to several U.S. past and present presidents is well known, it is not surprising that Maurice has served on several Presidential Commissions, including the President’s Commission for the Observance of Human Rights, the Citizen’s Advisory Board of Youth Opportunities, and the National Highway Safety Advisory Committee. He was also appointed to the New York Council on International Business. Born in Belgium in 1929, Maurice came to the United States as a child.

Maurice’s name wasn’t mentioned in the press release issued by OPIC today in Washington, D.C. – which was probably what he preferred. This editorial box will fill the void.

 

Box2:New Chance for De Beers to Fulfil its Beneficiation Promise

If the U.S. government is willing to put up a quarter of a billion dollars to assist the beneficiation in Botswana, it is not unreasonable to expect that De Beers will do its share. The company knows what to do – though there are concerns that “when it has clients with money, it tends to adjust prices upwards rather than downwards…” The OPIC Guaranty would miss its purpose if it allows De Beers’ clients to take all that’s offered – while the industry continues to falter nevertheless because the goods it received cannot be economically cut and polished.

As we already mentioned, OPIC comes at a critical time. Some observers are skeptical. One government official called the “timing unfortunate. For reasons well known the mood and appetite to manufacture in Botswana is at an all-time low. The attitude of the sightholders here is completely different from five years ago. So for me, I am not sure whether the facility will make any difference.” That might be so – but he may miss the point. Sightholder attitudes are as volatile as the prices of the rough they buy (or “leave on the table”), and a few sights can easily turn a manufacturer’s despair into exuberance.

It is no secret that, historically, De Beers opposed beneficiation in producer countries, especially in Botswana. At the end it decided to support the government’s aspiration, and “cajoled” sightholders to open factories in Botswana. That was a decade ago. Today, there are hardly 1,000 workers – and many of these get paid without having much or any rough to polish.

 

Economically Viable Rough Supplies

It may be useful for all concerned to remind ourselves of the specific contractually obligations De Beers has entered into with the Botswana government in respect to local rough supplies to sightholders – purchases which from now on may be covered by the OPIC guaranty.

De Beers has warranted that all such diamonds as are supplied to DTC Botswana will:
be of sufficient size so as to be economically viable for cutting in Botswana;
be supplied in boxes in a non-discriminatory fashion as between the customers who qualify for supply for beneficiation in Botswana, other than as to volume, and include a proportion of “special stones” corresponding to the proportion of “special stones” in the diamonds comprising the De Beers Purchase Entitlement [rough it bought from the Debswana company – i.e. from rough produced in Botswana].

As will be discussed below, OPIC loans will not apply to rough trading or manufacturing of rough outside Botswana. Thus the success of the U.S. government assistance depends to a large degree on De Beers keeping its promises at well. With economically viable rough supplies, this OPIC guaranty framework injects an unprecedented stability factor into the calculation: it guarantees credit availability for at least ten to thirteen years. There is nowhere in the diamond world where such certainty exists. That’s the difference this facility makes!

 

 

By: Chaim Even-Zohar

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