Would you spend more money on art if you thought that you could borrow money against its value? After all, buying art can be an expensive business and collectors are often loathed to part with it. Even collectors who do want to sell soon discover that art is an illiquid asset. If you could borrow against your prized Picasso, so much the better, and if you could borrow that money cheaply and channel that cash into something with a higher yield, art would start to look considerably more appealing as an investment.
The reality, though, is that art is hard to value and hard to authenticate and few mainstream banks want to lend against it. Some banks do offer art-secured loans at very low rates of around 2.5% to 3% to ultra high-net-worth collectors such as Steve Cohen, whose art collection is worth an estimated $1 billion.
Collectors at this level (and let's face it, not many collectors are) can use these cheap loans to buy property, businesses or even more art, but there's a big catch, and that it to arrange these loans, banks typically need to hold other assets with that institution that can be used to repay it. These borrowers are essentially taking out a loan against their whole portfolio, not just their art collection. Auction houses such as Sotheby's and Christie's also offer loans at competitive rates - as long as you are buying or selling art through them.
It is possible to take out a non-recourse, general purpose loan that is just secured against the value of your art from one of the other specialist lenders in the market. Interest rates here range from high single digits to well over 20%, but most lenders are only interested in making loans of over $500,000 and typically will only lend 40% of an artwork's value. That means you need to have an artwork worth at least $1.25 million to be considered.
Some companies like Borro will make short-term loans against lower value art and collectibles, but will charge you interest of between 35% and a staggering 83% on an annualized basis. Then there are the so-called loan-to-own lenders, who bet that borrowers will default on the terms of their loan so that they can sell their precious artwork and keep the profits for themselves.
Put all these different lenders together and current size of the art lending market is estimated at pound;6 billion ($9.6 billion) a year, according to Deloitte and ArtTactic's 2014 Art amp; Finance report, which was published last month. When you consider that global art sales last year were an estimated $63 billion, that isn't very much at all.
However, the same report predicts the art secured-lending market could triple in size with the help of some new art insurance products, including those that allow collectors to keep the art they borrow against hanging on their wall.
If their art is located in the US, collectors can already do this. Under the Uniform Commercial Code, lenders can place a charge on the art collateral in someone's home, but in most of Europe (except France, Belgium and Spain) and in other major art centers such as Hong Kong, lenders cannot register charges against art assets, so borrowers often have to hand over their art to their lender during the loan, which is not exactly an appealing prospect.
Today, though, some insurance companies are offering new products to protect the lender against the risks of letting the borrower keep the art. If the borrower grants a charge against the art collateral to someone else, or takes off with the art, or refuses to give it up if they default, the insurers will cover the lender for its loss.
Is this really going to result in the rapid growth of the art lending market, though? Dr. Tim Hunter, the head of Falcon Group's new art division, Falcon Fine Art, which has just launched in London, says the company plans to allow clients in England, Wales and potentially other countries, on a case-by-case basis, to keep possession of their art.
That is certainly a departure from the norm, but the company isn't relying on insurance to underwrite the risk. "Allowing clients to keep possession of their artworks is an important part of our model, but we're not relying on any external product that may or may not be able to insure this service," says Hunter, who is also an art adviser and spent 16 years at Christie's, where he was a senior director in its Old Master and British Pictures department, a director in its Impressionist and Modern department and head of 19th Century European Art. "Falcon Group have been doing asset-backed financings for 20 years and I have 20 years of experience in the art world. In the end, there's no short cut to knowing your client."
Falcon Fine Art plans to offer clients non-recourse loans of one to three years, with the option to extend, financed from the Falcon Group's own balance sheet. Although the terms will depend on the type of art, Hunter says interest rates will typically be in the high single digits and loan-to-value ratios will be 40%.
However, Paul Ress, managing director of Right Capital, another UK-based art finance company that matches borrowers, either individual collectors or professional dealers, with high-net-worth individuals that are willing to lend, thinks that the new insurance products for art lenders are one of the most interesting developments in the industry.
"They will allow more borrowers to keep collateral, while differential insurance, which hopefully is also coming soon, will insure lenders against a loss of capital if a painting has to be sold and doesn't cover the amount of the loan. In theory, that shouldn't be too expensive if you've done the right due diligence up front."
Right Capital, which is about to open an office in Luxembourg, organizes asset-backed, non-recourse loans of between pound;500,000 and pound;5 million ($800,000 and $8 million) at interest rates ranging from 8% to 13%. Its typical loan-to-value is 35% to 45% and the company is currently looking at ways to bring multiple lenders into individual loans to spread the risk. Ress hopes that as more companies start offering art loans, there will be more standardization throughout the market, which will bring costs down for borrowers and lenders alike.
Right now, though, organizing art loans is a complex business, because art is a complicated asset. Ress and Hunter say that each loan takes four to six weeks to structure, which includes the time it takes to put together all the documentation on the title of the art, its value, its provenance and authenticity. Valuation is particularly subjective and contentious and art prices are also volatile.
"Valuation can be so variable when it comes to art," says Ress. "We always form an internal view on what we think the valuation should be, obtain an independent view for the borrower, and insist that the lender obtains their own valuation too." Even then, he says that lenders are sometimes only comfortable loaning 30% of the value of some contemporary works.
That is why art lending is still a niche market. There may be an increasingly large mountain of money tied up in art around the world, but there's hardly a flood of new lenders that are dying to serve this market. On that basis, there's not going to be a three-fold increase in art lending any time soon.
Follow me on Twitter or find me on Facebook.