For those of you who’ve known me for more than a few years, also know that, for the first two decades of my working life, I worked for a bank, and during my banking tenure, basically did one job- commercial lending. Regardless of the type of entity, be it C-corp, LLC, LP- the business was always the alter ego of the principal owner, and it was with the owner that I sought to establish the relationship. And, too, relationship was key. We always sought to provide all the customer’s financing needs, not just because we wanted the business, which we did, but because so-called split financing situations, in the unfortunate circumstance of requiring legal means to collect a debt, inevitably resulted in a squabble amongst creditors. The technical term for this squabble was ‘pissing contest.’
While split financing was something the larger banks still seek to avoid, smaller banks and those new on the scene trying to build loan totals, always were the ones who, for lack of any other lending opportunities, would insert themselves into what is invariably a risky lending arena. However, one old aphorism, that no loan is ever bad when it is made, is true enough. They go bad, and for a few quarters, at least, loans that have inherent flaws, until there is actual payment default, are, for balance sheet purposes, good loans. And loan growth- what it is that actually earns money for a lender- is of paramount importance. After a year or two- and this happens to all new banks- the flawed loans default, the bank scrambles for capital to cover losses, and the original management team is fired. This phenomenon is cumulatively known as the pigeons coming home to roost.
It is therefore interesting to see the growth in art market lending, carried on by non-traditional lenders including the major auction houses, making what amounts to loans based on the underlying value of the art collateral offered by clients. In one respect, the doing of this makes some sense for an auction house, as with the hypothecation of art collateral, a collector-borrower can then use the borrowed proceeds to make additional purchases from the auction house. Revenue enhancement, of course, realized not just through saleroom commissions, but interest earned on loans. So far, so good. But of course, this provides the classic opportunity for split financing, and it begs question, why did the collector-borrower not obtain his financing from his own bank? The answer must always be that the art market lender is willing to provide financing on more liberal terms, usually allowing a higher rate of advance against the pledged art collateral. And why would the art market lender be willing to do that? Ostensibly because art market lenders claim they know more about the value of the collateral, and if its liquidation becomes necessary, it has a greater ability to make itself whole. Sure. That’s why, over the past few years, the major auction houses have lost, and continue to lose, their tails on selling art objects that they have guaranteed or in which they otherwise have a financial stake.
The real reason for the growth in art market lending has been precisely for short term revenue enhancement- growth in assets, and growth in booked- but unrealized- revenue, in a competitive environment where more traditional sources of revenue, like sales commissions, are shrinking. All I can say is good luck, because these lenders will need it, not just to ensure the performance of their art market loans, but to make sure they have exited the premises prior to the pigeons coming home- and they will- to roost.