When Sotheby’s recently published its six-month financial statements, one fact generally went unnoticed – the firm’s only profitable segment in the first half of 2009 turned out to be Finance.
Sotheby’s Finance segment provides certain collectors and art dealers with financing, which is generally secured by works of art that the company either has in its possession or permits borrowers to possess. According to Sotheby’s financial statement, “the Finance segment generally makes two types of secured loans: (1) advances secured by consigned property to borrowers who are contractually committed, in the near term, to sell the property at auction (a “consignor advance”); and (2) general purpose term loans to collectors or art dealers secured by property not presently intended for sale (a “term loan”). A consignor advance allows a consignor to receive funds shortly after consignment for an auction that will occur several weeks or months in the future, while preserving for the benefit of the consignor the potential of the auction process.”
In the first half of 2009, Sotheby’s realized a profit of USD 3.8 million from this activity (a margin of over 63%!) while its auction and dealer segments reported net losses.
Like any other high return activity, Sotheby’s Finance segment operates with significant risk. To lure borrowers, the company targets a 50% loan-to-value (LTV) ratio for the loans. This figure is significantly higher than market rates, as there are so few capital providers who are willing to lend against art, which is generally viewed as a relatively illiquid asset class that carries significant ownership costs and unique risks, such as authenticity, which do not exist with other types of collateral.
And even this is not enough – according to Sotheby’s Form 10Q disclosure, “certain Finance segment loans are made at initial loan-to-value ratios higher than 50%. In addition, as a result of the Company’s normal periodic revaluation of loan collateral, the loan-to-value ratio of certain loans may increase above the 50% target loan-to-value ratio due to decreases in the low auction estimates of the collateral. As of June 30, 2009, Finance segment loans with loan-to-value ratios above 50% totaled $64.7 million and represented 42% of net Notes Receivable and Consignor Advances. The collateral related to such loans has a low auction estimate of approximately $99.8 million…As of June 30, 2009, one term loan of $20.7 million (collateralized by works of art with a low auction estimate of approximately $55.2 million) and one consignor advance of $18.5 million (collateralized by works of art with a low auction estimate of approximately $56.5 million) comprised approximately 13.4% and 11.9%, respectively, of the net Notes Receivable and Consignor Advances balance.”
So the stakes are high again for the upcoming auction season with over USD 65 million in loans issued by Sotheby’s to clients who risk default in the event their artworks fail to sell. Generously valued collateral could make it difficult for Sotheby’s to sell quickly enough should these loans go into default. This risk is the price that Sotheby’s will have to pay for the USD 3.8 million in profits from the company’s Finance segment in the first half of the year…