• Auctioneer's credit line increased by 140% in 18 months
  • Debt level is higher than during recession, rating firm says

Three months after Sotheby’s said it doubled its credit line to finance art loans to clients, Moody’s Investors Service warned that the debt spike could hurt the auctioneer’s credit rating in a downturn.

“The art market is highly cyclical,” Margaret Taylor, Moody’s senior vice president, wrote in a report published Monday. “It’s not ‘if,’ it’s ‘when’ there will be a down cycle."

The New York-based auction house has been under pressure from its activist investors, including director and hedge fund manager Dan Loeb, to boost profitability amid record art prices. The company increased its ability to finance art loans by more than 140 percent in the past 18 months to $1.035 billion in June, according to Moody’s. If Sotheby’s fully taps the credit from a consortium including General Electric Capital Corp., it could almost double its art loans to clients to $1.3 billion.

Sotheby’s declined to comment on the report.

“Although the finance segment’s earnings generate the highest margins and are poised to continue growing rapidly, Sotheby’s is sacrificing its balance sheet to support its loan portfolio,” Taylor wrote.

Under Pressure

Fully tapping its $1 billion credit line “would materially weaken Sotheby’s credit metrics and its corresponding credit profile during the next cyclical downturn, compared to the last recession -– potentially putting the company’s ratings under pressure in this scenario,” according to the report.

When the down cycle starts, the ratio of debt to earnings could lead to a downgrade of Sotheby’s (Ba2 stable) by Moody’s, Taylor said. Sotheby’s current debt level is significantly higher than in 2008, when the previous down cycle began.

Earlier this month, Sotheby’s also increased by $200 million its credit facility to finance auction guarantees, which help win competitive consignments, to $800 million, according to a regulatory filing on Sept. 16. This credit line is separate from the one for the finance segment.

Sotheby’s growing debt burden comes amid shrinking profit. Net income in the second quarter fell 13 percent to $67.6 million from $77.6 million for the same period in 2014. Profit was down about 47 percent from the same period in 2011.

Though small, Sotheby’s finance segment generates highest margins and is the company’s fastest growing business, Moody’s said, adding it expects this to continue through 2016. The unit’s revenue reached $16 million in the second quarter, up from $12 million for the same period in 2014, according to Sotheby’s.

Auction Sales

Sotheby’s had funded its loan portfolio mostly with excess cash until February 2014 when, “under shareholder activist pressure,” it put in place a $350 million revolving credit facility to provide its finance segment with capital to increase the size of its loan portfolio, according to the report.

Financing art can help Sotheby’s on several fronts. Unlike its auctions, art loans are not cyclical. They can also boost Sotheby’s auction sales because the company “typically only lends to current or future auction clients," Taylor wrote.

One risk area is if Sotheby’s increases the loan-to-value ratio and offers financing to individuals with more risky credit profiles, Moody’s said. Currently, Sotheby’s revolving credit facility allows clients to borrow as much as 60 percent of an artwork’s value, up from 50 percent before, according to the report.

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