Why Are Banks Leaving the Industry, Continued

Last week’s post Why Are Banks Leaving the Industry received a huge response, and so I’d like to continue the discussion on why this is happening and what it might mean.

A person with knowledge of both the financial world and the industry writes in with a few more factors that have made lenders skittish: 

Most of the major banks have consolidated, and there is a little institutional knowledge about the industry when a bank gets bought. It used to be billion-dollar loan portfolio was a big deal to the bank. But now, they look at the industry and all they see is the reputational risk. A bank doesn’t want to be involved in, say, conflict around the world, or whether a company is doing things legally. They see it as very expensive to monitor these things. And they don’t believe they can price sufficiently for the cost and risks associated with doing so.

Fluctuating commodity prices, especially for gold and diamonds, add another layer of risk. Rising commodity prices mean the numbers can get very large for these loans quickly, and the ability to monitor, hedge, and secure (physical security) the collateral becomes more challenging. Of course, bankers that lend to, say, the apparel industry take more of a collateral risk, in that it’s fashion sensitive and has no intrinsic value/liquidity. But the numbers aren’t as big.

All the publicity about bad loans at banks both in the U.S. and overseas doesn’t help, either. When a bank doesn’t do well with an industry, whether it was their own fault or not, whether they took a risk they should have or not, the people at every bank say we are not going near this business. Sometimes it just takes one fraud for a bank to leave an industry.

Howard Feller, a partner at Marketing Management Group, emailed his vision of what this lack of financing will mean for the industry. It’s not a pretty one: 

– The cost of capital will increase as the remaining lenders in the industry gain pricing leverage in the face of diminished competition. Vendor’s costs will increase while profit margins remain slim. Smaller, poorly capitalized businesses will not survive in the future.

– Even among larger vendors with balance sheets that can garner financing, lenders will place stricter requirements on them to better manage risk. Only those vendors with sophisticated systems to manage and track consignment sales will be looked upon as favorable credit risks. 

– Retailers will look around the vendor community for suppliers who can play by their rules and find fewer and fewer options. The result: A handful of large, well-capitalized suppliers will take more market share. In all likelihood, those suppliers will be linked very closely to the sources of both precious metals and gemstones, thereby continuing to remove layers of the supply chain. 

On a more positive note, Boston-based Gordon Brothers contacted me to say that it has increased its lending to the business, pointing to a recent loan it did for Samuels Jewelers and a $15 million deal it did with Diamonds Direct. And a representative of Metropolitan Commercial Bank appeared at the Diamond Dealers Club on Jan. 29, showing interest in financing the industry. And hopefully, we will soon see other lenders enter this space.

Finally, some thoughts.

While some of these factors are outside the industry’s control, there appears to be a clear consensus that companies in this business need to pay more attention to sourcing and regulatory issues. And it’s not just our industry. Here is a piece from Wednesday’s Wall Street Journal:

Under fire from several regulators, U.S. banks increasingly are rejecting customers involved in activities that are legal but might attract government scrutiny, according to executives, consultants, and lawyers.

While the temptation to deal with certain businesses might be high, some banking-industry veterans said, it isn’t worth provoking regulators or adding more resources to ensure that the clients are meeting industry standards. And in the overall banking industry, such pullbacks aren’t likely to hurt profits.…

[J.P. Morgan is ending] relationships even if there isn’t any indication that the customer has done anything wrong, the person said. Instead, the bank doesn’t want to spend the extra time and effort tracking activities of people who may be difficult to follow. 

While this article deals with thornier industries than diamonds and jewelry, it’s striking how similar some of the concerns are. I talked with one banker recently who told me that the diamond business has known for the last decade that it needs to be more transparent. And while it has made strides, it still has a way to go. Clearly, if the industry wants to keep having the support of banks, it needs to move in a more transparent direction.

JCK News Director