C&B Notes

Writing Puts for Art

In what is a growing “insurance” market, third-party guarantors are writing puts for art pieces up for auction.  While it is perhaps a more aesthetically pleasing form of speculation, let’s hope these insurers like the art that they may well end up owning for a dear price, especially as an influx of new guarantors lowers expected returns.

Several dozen risk-takers have already signed contracts promising to buy at least 84 works for an estimated $611 million combined, or 39% of the entire sales’ expected value.  Even if rivals outbid them, these prearranged buyers — called third-party guarantors or irrevocable bidders — stand to profit by taking as much as one-third of the sellers’ proceeds above their pledged prices.

Auction houses have long wooed owners by promising their property would sell no matter what, to the house if no one else.  Now, auction houses say the number of third-party guarantors has multiplied to over 90 from just a dozen five years ago.  And unlike the handful of seasoned dealers and collectors that Sotheby’s , Christie’s and Phillips used to rely on to help shoulder this risk, today’s newer guarantors often don’t even want the art.  Increasingly, the goal is to earn a quick payout from the fees surrounding guarantees rather than to bring home any actual paintings.  New investors, many from real-estate and international finance, have discovered the guarantee and want to reshape it into a financial instrument entirely distinct from collecting art, with its own margins and strategies.  All of this is roiling the houses and old-guard collectors, with some warning that the new generation is propping up the art market.

“Doing it right means you don’t get the picture — you get a check in the mail later,” said adviser Tom Mayou with the London firm Beaumont Nathan, summing up the thinking of investment-minded guarantors.  His firm only brokers guarantees on behalf of collectors who want to keep the works, he said. Risks abound because guarantors who misjudge demand for an artist — or stake a work one bid above its catnip price — can be compelled to buy an asset that’s difficult to offload quickly, tying up cash for years, said Luke Nikas, art lawyer at Quinn Emanuel, which has helped clients arrange guarantees. When the 2008 recession hit, Sotheby’s and Christie’s were left owning $63 million in art they had staked with house money.  The market is stronger now, but since then, the three houses have shifted most of their guarantees to third parties.

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Here’s how a guarantee is designed to work, though the model is evolving.   Guarantors who pledge to bid if no one else does will likely get an undisclosed financing fee from the house for participating.  (Sotheby’s doesn’t necessarily dole out a fee to those who place, and win, their irrevocable bids.)  By and large, the promised bids hover between the seller’s secret minimum accepted price, called a reserve, and the work’s low estimate.  The opportunity for guarantors comes when they negotiate a share of the work’s overage if the art sells for more than the guarantor pledged, according to art lawyer Thomas Danziger.  Guarantors said they also often negotiate a share of the house’s commission, a sweetener called a give-back.  All three houses said they insist that winning bidders, including backers, pay the buyer’s premium.  Before the recession, the handful of people doing third-party guarantees often reaped 50% of the overage and half the buyer’s premium in exchange for staking a work.  Today, guarantors say their expanding ranks have already started whittling typical returns to between 15% and 30% of the overage…

As the third-party guarantee becomes the norm, a swath of art businesses has cropped up in part to service them.  Guarantors are forming syndicates to offload shares of the risk to silent partners — each of whom is legally allowed to bid on the art while it’s being auctioned.  Art-financing companies like Athena Art Finance offers loans to investors they expect will guarantee works and publish lists of auction offerings that look like safe bets, including more than 230 works on sale this week.  Other companies also offer art-backed loans to guarantors required to buy works they staked and no one else wanted.  One London firm, Pi-eX, is even trying to turn the guarantee into a derivative, with shares of risk being parceled out to conceivably dozens of investors who don’t know one other, much less share the same taste in art.

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