I had a very interesting chat with Ian Peck, the CEO of Art Capital Group, this afternoon, trying to learn a bit more about his business and how it works. Art Capital is a business which specializes in lending money to liquidity-constrained art owners; business, says Peck, is booming these days, since most other lenders in the market (private banks, the auction houses) have pretty much closed up shop.
The main thing I was interested in was the underwriting process. The average Art Capital Group loan is $5 million and has a duration of just two years: if someone doesn’t have $5 million now, what are the chances that they’re going to be able to repay that kind of money in two years’ time?
Certainly Art Capital does quite well, a lot of the time, if its borrowers do end up defaulting on their loans. They take the painting, sell it, and then pay themselves a 20% commission for selling the painting before paying themselves back everything they’re owed in terms of principal, interest, penalties and the like. “The commissions and fees are designed to be prohibitive,” says Peck.
Still, if you can’t repay the money, that doesn’t mean Art Capital won’t lend to you: “we are an asset-based lender,” says Peck. If Art Capital doesn’t think you’ll be able to repay the money easily, it’ll try to structure something else: a bridge loan, perhaps, against its own future sale of the painting. “We’re not in the business of providing ninja loans,” he says, “but we will do a pre-planned sale where you get 50% of the value now, and we’ll consign it to Christie’s or Sotheby’s for sale.” Peck says that one third of his deals are designed from the get-go to end with a sale, rather than just the repayment of a loan.
Art Capital will also finance the purchase of art: if you need a bit of time to pay for a painting, whether it’s bought from a dealer or at auction, Art Capital will help pay for it. The downside, of course, is that you probably won’t be able to put that painting on your wall: Art Capital likes to have possession of the art that it’s lending against, since art is highly mobile and a lien won’t do you much good if you can’t locate the art in question. Besides, in jurisdictions like Switzerland, France, and Italy, the courts won’t recognize a security interest unless you have physical possession of the art in question. Sometimes, however, Art Capital can arrange for art to be loaned to — and displayed at — a museum, instead of languishing in its own warehouses.
Art Capital rarely if ever buys art outright, which is one reason it doesn’t have a big business providing guarantees to auction houses. The paintings always belong to the collector, until they’re sold — Art Capital just has a lien on the paintings, and takes what it’s owed out of the proceeds before passing the rest on to the borrower.
The business sounds like it’s very profitable: Art Capital’s clients often need cash in a hurry, and have few other places to turn. At the same time, the company is building up a set of strong relationships with its own lenders — banks and hedge funds, mainly — as a way of minimizing its own cost of capital. Some of the structures it’s put in place are pretty sophisticated: at one point Art Capital sold a portfolio of loans to a hedge fund, which then repackaged them into a collateralized loan obligation. Unsurprisingly that business seems to have shut down for the time being.
In general, Art Capital is happy to be inventive when it comes to relationships with its own lenders, who might well end up sharing in some of the fee and commission income when its art is sold. “Historically, art funds were equity funds,” says Peck — investors would put up money and the fund would use it to buy art. But that doesn’t work well, because exits are so hard. Peck is taking the next step and essentially setting up debt financing for art funds, where lenders share in some of the upside of the art market but don’t rely on perfectly-timed entrances and exits.
Peck is pretty puritanical about bankruptcy — he won’t lend to people who have declared bankruptcy in the past, and he’s afraid of what might happen to his liens in bankruptcy court, so he wants to avoid that if at all possible. But at the same time he recognizes that people who have fallen hard do have a tendency to get back up on their feet and do quite well again: the likes of Alan Schwartz and Dick Fuld, for instance, still have highly-paid jobs.
Is there art that Art Capital would be hesitant to lend against? Damien Hirst, probably — or, at least, they’ll only lend at a fraction of the valuations that they would have used last year. The dot paintings, in particular, have come down in value a lot, says Peck’s colleague Baird Ryan. It seems they were bought up in bulk by Wall Street types, who liked the fact that there were so many sales of similar works, with values going up and to the right. These days, rarity is becoming sought-after again, and overswamped markets like the dot paintings could take a very long time to recover — if they ever recover at all. My guess is that they probably won’t.
Update: Art Capital’s flack wants me to clarify that the “prohibitive” commissions and fees exist “to encourage borrowers not to default”. And Abnormal Returns notes that at least one old-fashioned art fund seems to be alive and well — even if its grasp of the English language is a little on the weak side.