Art financing: magic dust for the soul?

When Pablo Picasso said “Art washes away from the soul the dust of everyday life,” he could not have imagined how dusty some of our souls may have felt during 2020 and 2021. But perhaps that explains the significant increase in the number of art finance transactions the firm has advised on during the past 18 months.

What is art financing?

Art financing is certainly not an everyday part of the armoury of many law firms, but here at Farrer & Co we have been delighted to see a recent and pronounced growth in our art finance practice, allowing us to showcase our arguably unique cross firm expertise in this specialist area and our close and valued connections with external professional experts across the art world.

Art financing is when a Lender lends money secured on works of art, instead of more commonly used assets such as property, shares or receivables. Borrowers usually tend to be companies, businesses or individuals (such as collectors or investors) who are happy to store their art in a secure warehouse or gallery, rather than keep it on show in their homes. Lenders will require a solid valuation, good evidence of authenticity, provenance and title (usually all provided by an independent expert), high coverage insurance and a direct relationship with the storage facility in order to restrict the Borrower’s access to and prevent disposal of the relevant works. Different lenders will accept different types of collateral into their security pool and lend at different loan to value ratios depending on their own expertise, market knowledge and risk appetite (often these LTVs are slightly lower than we see offered against other assets such as property, to account for the subjective and fluctuating nature of the value of art).

What are the key areas of risk?

The portable nature of the asset class, combined with difficulties of establishing title, provenance, authenticity and of course, value, all create complexity and introduce risk for a lender meaning art finance is not necessarily for the faint-hearted lender!

Large UK banks have historically struggled to convince credit committees of the guarantee return on their loans because of fluctuations in the valuations of the underlying art (and uncertain performance of the market). The UK also lacks a central registry of security over art work and certain other chattels which has concerned risk and legal departments, and when that is combined with slightly antiquated and inadequate legislation in this area, it means there has been a general resistance to art being taken as collateral unless in extremis. Consequently, the English art lending space tended to be limited to auction houses, specialist lenders or to exceptional loans made by private banks to their key UHNW clients as part of a larger relationship and portfolio.

The picture (forgive the pun) is changing slightly...

New opportunities

We have seen more private equity funds and non-bank lenders spotting high yield opportunities in the space. New entrants (often with a higher tolerance for risk) are starting to break into the market for the right deal.

Depreciation of “traditional security”

The recent dust-kicking of our everyday lives caused by the COVID-19 pandemic has affected lenders and borrowers alike and we have certainly witnessed a resultant flight to collateral. Whilst values of traditional security such as city commercial property have been uncertain, lenders have been searching for additional assets to bolster their credit support and maintain loan to value levels. Often high value art collections can form assets of real value that may be offered (sometimes when all other assets have been exhausted) to increase the security provided to lenders and prevent default.

The emergence of the art market from the pandemic

Where default cannot be avoided, some of our lender clients have taken steps to enforce on long term non-performing art loans as they have found the art market to be buoyant, with good performances in the February 2021 sales (when those fortunate enough emerged from the worldwide lockdowns ready to wash away the dust with joy and treat themselves to a piece of art!). This has provided new lenders with increased confidence in the asset class as collateral.

How can we help?

Whilst the risks of raising finance against art are inherent and here to stay, art finance can be a very useful tool for lenders and borrowers alike, and we expect the market to keep developing. If the abandoned Law Commission’s suggestions of a central security register and goods mortgages are ever dusted off themselves, art lending in the UK may grow even more significantly.

No one quite knows when the dust will settle on the pandemic or what everyday life will look like in the medium term, but until such time we remain ready, willing and very able to assist all of our clients with using art or finance in as effective a way as possible – even if only to wash away the dust.

If you require further information about anything covered in this briefing, please contact Bethan Waters, or your usual contact at the firm on +44 (0)20 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, June 2021