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At the Christie’s evening sale this May in New York, the Los Angeles-based artist Ed Ruschas metaphor-rich word painting Heaven and Hell, 1989, sold for $1,010,500.

That result was comfortably above the conservative estimate of $600,000to $800,000 but painfully shy of the $1,248,000 the picture fetched atthe same house in May 2006.

The price gap was a telltale sign of a distressed seller.

As it turns out, the owner, a 30-something West Coast collector, hadpledged the painting as collateral for a loan from a private bank. Theproceeds went directly to the lender to stave off a default.

It’s an oft-told story in these troubled times: As borrowers of allstripes find credit harder to come by, those with significant artholdings are using them as collateral for loans from private banks andshort-term boutique lenders known as factors. In the process, they arechanging the nature of this bespoke financial specialty.

"There’s been an increase in the number of inquiries for art-backedloans and in the size of those inquiries since September," says Andy Augenblick, president of Emigrant Bank Fine Art Finance (formerly Fine Art Capital),in New York. "And while we’ve always had people come to us looking forliquidity, we’re now seeing debt substitution" — that is, borrowingagainst art instead of real estate mortgages or securities-backed loansand the like.

"People are beginning to understand that these collectibles can be monetized and can be leveraged when they need money," says Ray Parker Gaylord, president of Artloan Financial Services(AFS), a five-year-old San Francisco venture that bills itself as theonly Web-based private lender to the antiques and fine-art community.

Just as demand for art-backed financing is rising, however, supplyis contracting. Except for short-term loans against upcoming sales,auction houses have pretty much departed the business and some privatebanks that had been active in the field are no longer active at all.

"If you came to me [a few years ago] with your family collection of Picassos or Chagalls, there were more banks and institutions willing to provide you with a loan based on your art as collateral," says Viola Raikhel of the London-based art advisory 1858 Ltd. "When the global financial crisis kicked in, several of these loan providers completely disappeared."

Today, besides Augen-blick’s Emigrant division, the major New York-based art-backed lenders are Art Capital Group (ACG), Art Finance Partners (AFP), Citi Private Bank, Rosenthal & Rosenthal, Sotheby’s Financial Services and U.S. Trust, Bank of America Private Wealth Management. In London, major private banks won’t make these loans directly, but some, like HSBC Private Bank, can guide high-net-worth clients to lenders via their art-advisory departments.

While the providers of art-backed loans, unsurprisingly, tout theirmerits, borrowers can find the process confusing, if not downrightpainful. "They make the terms so impossible and make you sign so manydifferent pieces of paper, it makes it easy for them to take over thecollateral," says one New York Impressionist- and modern-art dealer,who now taps collectors for financing. "If you contest something in thecontract, there’s even a clause in there that says you’ve breached thecontract."

Terms vary from lender to lender, as does the availability of funds.Many private banks treat art-backed borrowers like mortgage seekers,requiring extensive disclosures about income and net worth. But somelenders just want the value of the collateral to be two or more timesthe amount borrowed. At Emigrant, for example, qualified borrowers mustput up $2 million to $3 million worth of art against its minimum loanof $1 million. The bar seems higher at Citi Private Bank, which makes art-backed loans available only to clients with net worths of at least $25 million, according to Suzanne Gyorgy, the head of Citi Art Advisory, in New York.

"The typical client will be approved for, let’s say, $10 million andwill use the loan and pay it back again, just as people use chargecards," says Gyorgy. "Some people, like a hedge-fund manager, will usea term loan, where they’ll draw the whole thing right away. We have artdealers, real estate developers, private equity — basicallyentrepreneurial people." Some loans must be paid down monthly or everyfour months, while others function like balloon mortgages, withlump-sum payments of interest and principal due at the end of theirterms.

Acceptable collateral also depends on the lender. "We lend againstthings where there’s an active auction market," says Augenblick ofEmigrant, which takes rare musical instruments as well as fine art.Rosenthal, on the other hand, won’t allow Old Masters (too difficult toauthenticate) or antiquities (too hard to store).

Another variable is the interest rate. Citi Private Bank charges just a few points above the London Interbank Offered Rate.Libor, currently 1.66 percent, is what big banks charge each other forovernight loans — in other words, it’s the lowest commercial rateavailable. In contrast, places like Rosenthal, ACG, AFP and Artloancharge 12 to 24 percent annually.

Who keeps the collateral is another question. In general, private bankslike Citi allow borrowers who are U.S. residents to keep pledged works,while factors like Rosenthal, which lend primarily to dealers, wantthem handed over.

The issue of possession becomes critical if a borrower defaults.Works in a client’s home are difficult to seize; those in a storagefacility controlled by the lender are not. Either way, failed loans canhave serious repercussions for all the parties involved.

For borrowers the consequences are clear: They lose their property. Ask Veronica Hearst.The socialite had to give up several valuable Old Masters when shedefaulted on a 2008 loan to ACG. But lenders also are at risk. FirstRepublic Bank suffered tens of millions of dollars in losses on loansto Larry Salander that were backed by the Old Master inventory of his Salander-O’Reilly Galleries. Now that the business is being liquidated, many of those works are missing or mired in litigation over their ownership.

If, despite the caveats, you still want to borrow against yourcollection, the first thing to ask yourself is what do you want to dowith the money and how long will you need it. If you want a long-termloan, Citi Private Bank might be the way to go. While many lenders turnto auction houses to appraise collateral, Citi has its own in-housespecialists.

If you need the money in a hurry, however, you may want to go to an auction house.

Sotheby’s shies away from long-term commitments but will provideshort-term bridge financing to consigners who need it to, say, payestate taxes ahead of an auction. A client might be able to borrow halfthe low estimate of his or her artwork’s value at three percentagepoints above the auction house’s own borrowing rate.

"The emphasis is on the business that will come up for auction in the next six months to a year," says Jan Prasens,the managing director of Sotheby’s Financial Services, "as opposed todoing just straight-term financing for an undefined period wherethere’s no certainty of any immediate business."

Christie’s has a similar view. "We loan almost exclusively in regardto upcoming sales, as opposed to a long-term lending portfolio, whichwe don’t have," says the firm’s president, Marc Porter."We’re not actively soliciting lending business unless it isconsignment based." Christie’s also tacks on just three percentagepoints to its cost of funds.

While the auctioneers are hoping to boost their current business viaart-backed lending, the private banks are looking to the future. "We’rewith our clients in the bad times so they can be with us in the goodtimes," says John Arena,senior vice president and custom-credit executive at U.S. Trust, Bankof America Private Wealth Management. "We do have a very involvedart-finance program, and the deals are in the millions of dollars," hesays. "We’ve actually seen a pickup in clients looking to takeadvantage of the pullback in art prices by purchasing more art."

"The Matter of Factors" originally appeared in the July/August 2009 issue of Art+Auction. For a complete list of articles from this issue available on ARTINFO, see Art+Auction's July/August 2009 Table of Contents.