In Conversation: Unlocking Liquidity From Art and Collectibles

O ne of my favorite parts of working at a top-tier global auction house like Sotheby’s is having access to human capital resources like my colleague, Monika Merchan (MM), who has a unique depth of knowledge and experience in her field of financing. Monika is a former J.P. Morgan banker and trusts and estates attorney, who now runs the West Coast business for Sotheby’s Financial Services (SFS). I (SC) spoke with Monika to debunk myths for fiduciaries advising clients to leverage their art and other collectibles for financing in the United States and abroad.

SC: Why do clients seek to use their art and other collectible property to secure financing? In the trusts and estates world, there’s the common quagmire of an astute elderly collector who’s relatively illiquid but has some special artwork they’ve owned for decades. They prefer not to sell art during their lifetime due to concerns about incurring significant capital gains tax liability.

MM: Art is increasingly being acknowledged as an asset class that’s widely marketable and thus can be financed. This bodes well for clients who have purchased substantial art because they enjoy it but also have seen their art appreciate over time. For clients with significant collections, leveraging their art can provide a way to access built-in appreciation without selling the art. Clients can use their art collection to boost assets and overall returns on their balance sheet. These private clients are no different than corporations that do this as part of their overall strategy. Over the past few years, I’ve seen clients use “leverage” to invest in their business, fund commercial real estate projects, pay taxes and bridge short-term cash flow needs. For the elderly collector with low basis art, borrowing can be a particularly useful strategy. They can keep their assets in the estate while unlocking annual cash flow from the collection—almost like an annuity. The source of repayment could be a surgical pointed sale of art during their lifetime or a broader sale on death, after the step-up in basis.

SC: This past November in New York, we sold a conceptual work by Maurizio Cattelan called The Comedian, which, in essence, was a banana with duct tape, for a world record price of $6.2 million. The buyer was a tech entrepreneur who purchased the work in, of course, cryptocurrency. Is that something that firms would loan against? What about collateralizing motor cars, rare books, jewelry, watches and other luxury assets or collectibles?

MM: The banana caught everyone’s attention to the point of being featured in a Super Bowl commercial! However, that type of art is unusual to lend against. Given that we have the data to know the underbidding activity of that sale and double-click on the analysis of the art, we would be well-positioned to find a path to lend against an unusual asset like Cattelan’s banana, even if purchased with cryptocurrency. As an asset-based lender, Sotheby’s looks for a collateral base with works of art that have liquid markets with broad interest and appeal, providing pricing support. Our unique access to specialists in luxury categories like collectible cars, rare books and watches allows us to be comfortable with a wide range of asset types as collateral. Other lenders may stick to more traditional fine art categories, including so-called “blue chip” artists such as Picasso, Warhol and Basquiat, who have consistent, robust markets.

SC: I’m familiar with your team at SFS and similar offerings at other auction houses, but what are some key differences between obtaining an art loan from SFS verses a “big bank”?

MM: I worked at a large bank for over 10 years and can say that the process of getting an art-secured loan from a bank versus a specialty lender is very different. A bank will request personal financial statements and make sure there’s recurring cash flow to repay the loan. A specialty lender is solely focused on the art or collectible and will work to understand the liquidity and possible sale strategy for the art to repay the loan. The main difference between a bank loan and a specialty lender loan is that the bank has less comfort with the art as a source of repayment and instead will rely on financial covenants connected to the borrower. A differentiator for specialty lenders is they’ll typically allow collateral to travel to a museum for display, which can be important for augmenting the value of the art. When comparing the specialty lenders to each other, one of the main differences will be the maximum loan size per borrower, which goes to their source of capital. Recently, SFS closed the very first art-secured backed financing, which allowed us to close loans up to $250 million per borrower.

SC: Once a client decides to explore the options for obtaining an art loan, what happens next? Who’s responsible for valuing the property, and what kind of valuation is required? What, if any, personal guarantees are required? How long does the underwriting process take?

MM: The loan process begins with understanding the client’s goals and collection. SFS completes a complimentary appraisal of the proposed collateral based on low and high auction estimates, allowing us to provide a proposal that’s tailored to the client’s goals. Other lenders rely on a third-party fair market value appraisal for collateral purposes. SFS will request due diligence items related to proof of title, with a goal to close the loan in a short time frame (typically around 30 days from receiving all requested information), which is expedited given it’s anchored by the valuation and doesn’t require underwriting an individual’s financials. The specific terms of each loan differ based on the ownership, but we typically have an individual borrower or, if an entity owns the art, we’ll ask for an ultimate beneficial owner to be a guarantor. In community property states, lenders will require spousal consent, if applicable. Most lenders are comfortable offering a loan-to-value ratio up to 50% so that they may offer a $5 million loan against a $10 million art collection. The use of proceeds can be a wide variety of things, which aren’t controlled as a loan covenant. On an annual basis, SFS updates valuations and conducts site visits to confirm collateral location and condition.

SC: Because I run a global team, and collectors with major collections have art and residences across multiple jurisdictions and borders, I wanted to dig into the capacity to secure financing for art loans with art located in different countries and outside of the United States. What are some of the issues that fiduciaries should consider when art may be used as collateral in an international context?

MM: We want collectors to be able to enjoy the art where they currently have it and not have to move it. In the United States, collateral can be held in their residence, principal place of business or at an approved third-party storage facility. This is primarily because, in the United States, lenders can securitize their loans by filing a Uniform Commercial Code-1 (UCC-1) financing statement. If the collateral is abroad, there are several approved jurisdictions where the collectors (whether an individual or entity) can keep their art, either at Sotheby’s or at an approved third-party warehouse that acts as an agent for the lender. This list includes Switzerland, the United Kingdom, Mexico and Canada. To my knowledge, there’s no UCC-1 filing equivalent in other jurisdictions for individuals. However, there are ways to securitize assets (or register a charge) held by entities such as limited liability companies (LLCs) in the United Kingdom pursuant to the Companies Act.

SC: Often, the most challenging hurdle is addressing the cost of the art loan. What’s the scope of fees for an art loan? What’s the difference between the London Interbank Offered Rate (LIBOR) and the Secured Overnight Financing Rate (SOFR), and how do these rates impact the loan charges? Can loan fees be deducted from distributed funds? Is there a general flat processing fee?

MM: The pricing of an art loan comes down to several factors, including loan size, collateral, structure, proof of ownership and competition. The cost basis is SOFR, which replaced LIBOR several years ago as the prevailing rate used by lenders. SFS lends against the 3-month SOFR rate, meaning the client’s all-in rate is SOFR plus a spread, and that all-in rate will reset or float every three months. A facility fee is charged to cover internal costs, and the client pays any third-party fees associated with closing, like title work. These fees can be deducted from the loan proceeds at closing. Insurance is typically already in place, and the client only needs to adjust the coverage to add the lender under the policy as an “additional insured” and “loss payee.” If the work is on exhibit at a museum, the museum will typically cover insurance for the work during the exhibit, and the lender would be added to the policy.

As outlined above, art lending is a powerful tool increasingly used by savvy collectors (holding art individually or in trusts, estates and LLCs) to create liquidity for any number of reasons. In 2023, the art lending market in the United States alone was estimated to be as much as $34 billion.1 This is a significant increase from five years ago when the market was as small as $20 billion.2 This upward trend will likely continue as floating rates decrease, making art lending-related costs more palatable. Staying up to date on current commercial lending practices is imperative for fiduciaries with clients holding art and collectible assets.

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Endnotes
1. Deloitte Private, “Art & Finance Report 2023”(8th Edition).
2. Ibid.