September 2009

SPECIAL REPORT: The Pawnbroker
by James Panero

With the art lending business facing challenges, a startup tries an unconventional approach.

If the art of business has revolutionized the business of art in the past decade, Tony Barreiro and Ray Parker Gaylord are firmly in the vanguard. The San Francisco-based company ArtLoan, which they founded in 2004, lends money against the value of art collections owned by individuals and galleries. In this venture they join more established art financiers in New York. But unlike these large players, who lend only against big-ticket items, Barreiro and Gaylord say they want to change the way the world views even its smallest collectibles. Essentially, they aim to turn art and antiques at every level into ATMs.

Barreiro and Gaylord say they formed ArtLoan after a fateful visit to the local bank. They wanted a loan backed by a Picasso painting that Gaylord had inherited from his father, Charles, a dealer who specialized in antique mantelpieces. “We went to a major bank in San Francisco because they had extended credit to us based on real estate,” explains Barreiro, “but the idea of lending on a Picasso made no sense to them. They said that it had no value to them. We said, ‘There’s something wrong with this.’” The artwork, after all, could be appraised through auction results, just as real estate could be evaluated based on similar sales.

Eventually, they came to see the history of real estate as signaling an opportunity for the art market. “I remember the days where if you wanted to access money from your house, you had to sell your house,” Gaylord says. Home equity loans then made it possible to unlock the liquidity in real estate while still retaining ownership. The availability of money for equity fueled an unprecedented rise in home prices. This history, say Barreiro and Gaylord, shows that widespread access to an asset’s liquidity increases its value.

Asked whether the recently-imploded real estate market is the best model for lenders, Barreiro draws a distinction: “The real estate meltdown occured largely as a result of properties being overvalued and over-leveraged,” he says. “People were lending on 110, 120 percent of value. They were lending against future value, which is not how underwriting should work. We are not going to lend against what a Warhol is going to be worth five years from now.”

The ability to borrow against art is not altogether new. “Prior to the advent of modern banking and commerce,” Barreiro points out, “people borrowed against and bartered their personal property. Table silver, jewelry, furniture, porcelains and even rugs were used like cash. The business of art financing and lending can play an important role in making these objects readily liquid once again.” Even modern banking and finance gradually got back into the act. In 1979 Citibank formed an art advisory service, with two employees, out of its private banking division. The auction houses were not far behind, offering their own financial services in the form of bridge loans to sellers against consigned property and occasional financing to big-ticket buyers. Sotheby’s formed its Financial Services division in 1988. The year before, the auction house lent $27 million to Alan Bond, the Australian industrialist, to purchase Vincent van Gogh’s Irises. The purchase price of $53.9 million made it, at the time, the most expensive painting in the world, and the picture itself served as collateral for the loan.

Art prices, like real estate prices, have experienced their own recent rise and fall. Lending against equity has played a supporting role in this process by helping to drive auction returns. Even in 1987 some observers thought the Van Gogh purchase had been inflated by Sotheby’s loan.

During the past decade private equity firms, operating outside of banking regulations, have entered the business of art finance with headline-making deals that are turning expensive artworks into an ever more liquid commodity. For the first time art financing has come about not as an adjunct to other businesses but rather as an independent money-making venture.

“We are a private finance company, and not a bank” explains Ian Peck, who founded the New York-based Art Capital Group in 1999. “We are like a hedge fund.” In 2005 Andrew Rose, a former ACG director, started another private lending firm called Art Finance Partners, along with ACG’s comptroller Christopher Krecke. Since these firms operate outside of the FDIC regulations restricting bank-based lending, they could offer, for example, “non-recourse” loans—those backed only by art collateral for which the borrower is not personally liable (meaning that defaults have no effect on credit scores). The availability of such financing meant that art could be more than a luxury item. It could be a nontraditional asset in a diversified portfolio, with a suite of financial instruments at its service. In the fall of 2008 for example, the photographer Annie Leibovitz reportedly borrowed $24 million from ACG and a subsidiary against personal real estate and the reproduction rights for all her photographs.

Yet as art financing evolved over the past several years, only a small fraction of the collecting public could take advantage of it. “Our minimum loan amount is half a million dollars. Rarely do we do anything below that,” Peck explains. Since loans at ACG are made on 50 percent of the art’s value, he says, “to get to the half-million minimum you need to have artwork worth over a million,” or a combination of art and real estate with that value. Bank-based financing likewise serves only high-value art and high-net-worth individuals. Emigrant Bank Fine Art Finance, founded as Fine Art Capital by Andy Augenblick in 2004, advertises loan amounts between $1 million and $100 million on art and antiques.

“The competitors that are out there are primarily focused on very high-dollar artwork,” says Gaylord. “We realized that the market out there is not generally comprised of multimillion-dollar works of art. Most sales are $100,000 and under. And that means that dealers are not all buying multimillion-dollar Picassos and Warhols. They are buying stamp and coin collections, and their most valuable coin might be $25,000. Yet the ability to access cash from those collectibles is almost nonexistent because firms like Art Capital don’t want to deal with a $25,000 transaction.”

ArtLoan is still a startup. Barreiro and Gaylord will not discuss the volume of their business. They operate ArtLoan out of the same address as Charles Gaylord & Co., the company started by Ray’s father, where the two serve as dealer-partners. Yet they see their loan model as having the potential to change the art world. “There are people in New York who have been doing it longer than we’ve been doing it,” says Barreiro, “but they do it differently. We wanted to be the first to have a Web-based procedure, for it to be easy-no mystery, no 25-page contracts.” The two have taken out patents on several online business models. When financing becomes available, they plan to institute an auction financing system “as simple as Netflix,” says Barreiro. They also have a proposal to preapprove works sold at auction for loans, which could be activated by the buyer at any time after a sale.

Unlike other art lenders, ArtLoan is able to make small loans thanks to the particular regulatory structure Barreiro selected for their company—a structure that might surprise some in the art world. ArtLoan is a licensed pawnbroker. “Sadly, a lot of people have dim views of pawnbrokers,” says Barreiro. “They think they are going to take you to the cleaners or fence goods. But that’s not what we do here. I went to a pawnbroker’s convention in Sacramento and made the decision that this license makes so much more sense than any kind of banking license.”

Barreiro says the pawn license allows him to use simple contracts with low fees and no interest triggers. Once a work of art comes in for evaluation, ArtLoan bases its lending offers on the liquidation estimate of the collateral, minus the cost of storage, processing and depreciation. There is no court process on defaults. “There is a 10-day default grace period, and on the 11th day we vest in the property.” The pawn license also means that ArtLoan only makes non-recourse loans, in which the asset serves as the sole backing and approval requires only title and lien searches on the property and an in-house appraisal, not a credit search. “We don’t care whether the borrower is employed or whether they have paid their mortgage,” Barreiro says. Likewise, because these are nonrecourse loans, defaults do not adversely affect credit scores: “If you default on a loan from us, you are not a bad guy.” Finally, the license requires that all security must be sent to ArtLoan for safekeeping during the dura- tion of a loan.

According to Barreiro, the flexibility and simplicity of ArtLoan’s procedures make the firm attractive to his credit facilities (the companies that supply the cash) as well as to his borrowers. “When you borrow from a commercial bank,” he says, “you have to go through all the financial disclosures and credit-worthy tests, but many people cannot jump through those hoops.”

Barreiro believes that many lenders aim to encourage default through interest-rate hikes and fees hidden in their long contracts. “My bankers rub their hands like Shylock, hoping for default” in order to take possession of the art, he says, “but I don’t want our customers to default.”

Some high-end borrowers have run into trouble with their loans. In late July, The New York Times reported that ACG sued Leibovitz for allegedly refusing to cooperate with attempts to sell her houses and photographs to pay back her loan. Also accord- ing to the Times, the artist Julian Schnabel took out a loan from ACG in 2006 to help fund a real-estate venture and later sued the company over what saw as its “exorbitant fees.” ACG made a counterclaim against Schnabel for additional interest and fees because the artist did not disclose that there was an existing mortgage on his property.

Barreiro and Gaylord say they steer clear of such litigation. The real challenge for ArtLoan, as for all players in the art finance industry, is the current lack of availability of cash to make loans. “Cash is king, more than ever, and it seems to wear a big crown,” says Barreiro. “I would be lying if I said we are not challenged. Banks tell us they can get 15, 18 percent on their money all day long.” The retail rates for ArtLoan’s cash vendors mean that the company charges credit-card-like interest to its borrowers, with rates that can go as high as 24 percent.

Peck says ACG faces a similar cash crunch. “We have a lot of private equity, but our commercial lines are limited. As a result of the current market, where we used to have seven commercial banks, we now have one or two.” The cash crisis, says Peck, has recently forced many of his large competitors to shut their doors. “At the moment ACG is one of the few if not the only active lender in this space.” Christie’s officials say the auction house will still consider making loans against consigned artworks. Interview requests made to Emigrant Bank for this story were declined.

In the economic downturn, there could be an upside to ArtLoan’s small size. The multimillion-dollar loans made by the larger lenders were supported by the securitization markets and the ability to sell those loans into bond packages. That market is now largely closed. In addition, the pawnbroker license gives ArtLoan a great deal of latitude in its practices. “We are structured differently,” says Peck. “We are much more institutional.”

The art financing industry largely disappeared in the economic downturns of the 1980s and ’90s, only to rebound and grow. In the current climate the demand for art finance is offset only by the availability of cash to lend. The revolution that Barreiro and Gaylord anticipate in art-equity lending might come to pass in the next recov- ery. “There is a lot of house cleaning in the art and antiques world,” says Barreiro, “and this century is going to change the way that the antiques and fine arts business has always operated.”

Peck agrees, but advises caution about the road ahead: “Thirty years ago, only 5 percent of the buying public financed their cars; now that number is inverted. I am envisioning over time the same thing becoming true for the art market. People are going to use their collection as a margin account. Americans love to leverage their assets. Yet there has to be a balance with what the market says things are worth and the ampli- fier of financing. Real estate got out of control. There was such easy credit—you could borrow 100 percent of the purchase price for a home. There has to be a balance.”

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