Lending against art collateral, once a small, quirky and conservative corner of the financial world, is a rapidly growing business. “Since May we have a lot more art [linked] borrowing than in the past few years,” says Jane Heller of the Family Wealth Advisors unit at Bank of America. “It’s as if the customers all picked up a book somewhere that I don’t have.”

Such numbers as are available in this secretive sector show the growth trend started earlier. Sotheby’s Financial Services, the auction house’s lending subsidiary, increased its revenue by more than 40 per cent from 2004 to 2005, to $8.3m.

Suzanne Gyorgy, who manages art advisory services at Citibank’s private bank in New York, says: “Our art lending portfolio has been growing by 20 per cent annually for the past four years.”

Apart from Sotheby’s, which is a public company, nobody else will break out the size of their art lending balance sheet. The banks involved in the business say the worldwide total of loans against art is still small, possibly in the $3bn-$5bn range. They are eager to increase their book of business, though they face competition from a handful of specialised non-bank lenders. You can see why they would be interested. Few losses are being incurred in art lending, and the rates are high.

Frequently, a lending business that is growing at double digit rates is heading for imminent disaster. Lending is, or should be, a get-rich-slow business.

And art-based lending sounds as if it should be a shaky, speculative business. It turns out to be rather low risk, possibly because the people engaged in it have a cautious view of both their customers and their collateral. For example, Mitchell Zuckerman, the president of Sotheby’s Financial Services, says that of the roughly $5bn he has lent since the early 1980s, he has written off $15m in loan losses.

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Behind the low loss numbers is an industry-wide conservatism. Sotheby’s and the other art-based lenders will advance no more than 50 per cent of the appraised value of a work of art, or collection. It was not always thus. “Back in the 1980s,” recalls Sheldon Kaye, of Rosenthal & Rosenthal, the privately held New York secured lenders, “they would give people a loan of $20m against a purchase price of $20m. They had unbelievable loan-to-value ratios in those days, like 60 to 80 per cent. Then, if the value of the art went down, you had a 120 per cent loan to value.”

That is exactly what did happen in the art market decline of 1989 to 1992, the industry’s last tough period.

The 50 per cent loan-to-value ratio should preserve the collateral coverage against that sort of decline for a diversified collateral pool. “I don’t want to eat my own chocolate,” says Kaye of R&R. “So I use the auction houses to appraise works of art, but I use my own head too. I use Artnet (an online pricing service) and I have to like the art.

“Also, it’s not just the appraisal, it’s the marketability. How long will it take to get out if it does go to a problem? So I check activity in the market for an artist.”

The early 1990s bad times were even more traumatic for the dealers, who until recently were reluctant to releverage. While disclosure in the art world is derisory compared with other financial markets, one has the impression that the real growth in leverage is with the art collectors rather than the dealers. “They haven’t been borrowing the way they did,” Kaye says.

Abigail Asher, a partner in Guggenheim Asher, a leading art consultancy, says: “I know some collectors whose entire collections are fin­anced with borrowed money, though that’s not true of any of our clients.”

The art price cycle is a long one, rather like real estate. When the decline hits, it seems to continue for three years or so, then recover over the course of a decade. However, the art lending business is likely to remain strong, and, if anything, grow over the next several years, cycle or not.

Ian Peck, chief executive of Art Capital Group of New York, a secured lender, takes a macro view of the industry. “Private banking clients’ assets in the world are about $7trillion. The banks estimate that about 15 per cent of those assets are comprised of artworks. That means there’s about a trillion dollars worth of art that can be lent against.” That would make art one of the least leveraged bankable asset classes. “What will really get this business to take off will be securitisation.”

A former dealer himself, Peck believes specialist lenders such as Art Capital and R&R have competitive adv­antages over banks and auction houses. “Unlike auction houses, we don’t have an interest in pushing the collector or dealer to sell.”

Banks do demand more security, and accounting for cash flows, than secured art lenders. But they also offer lower rates. “We are very competitive,” Gyorgy says. “We are typically Libor-based rather than prime based, and the average rate on art-based loans is below Libor plus 200 basis points.”

While that is cheaper than specialist art lenders, it is better than rates on most secured lending these days, so other banks are trying to enter the business. For example, Emigrant Savings Bank, the largest privately held US bank with about $15bn in assets, has set up an art lending operation, Fine Art Capital, in partnership with Andy Augenblick, art aficionado and former real estate executive.

“We’ll take the loans under $5m that don’t interest Citibank,” says Augenblick. Like other banks, though, Augenblick looks for personal guarantees, and has to do all the Patriot Act-required due diligence.

That can create a com­petitive advantage for the auction houses. Zuckerman at Sotheby’s says: “We don’t put the borrower through a credit check. We don’t look at statements or balance sheets. We only look at the value of the collateral, the marketability of the collateral, and the ownership.”

It may be that this growing market may provide a significant way for distressed collectors to get some liquidity in the next economic downturn. A trillion dollars is a large asset class to leave almost entirely fallow. Hedge fund operators, big contributors to the latest art bubble, may force the development of more creative art lending structures. The dealers may try to releverage to take on the volume of force-sold collections.

So even in a difficult art market, the lending business is likely to grow.

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