The introduction of tougher stress tests for insured mortgages that took effect on Jan. 1, 2018, has led to a surge in business for mortgage investment corporations (MICs), which provide mortgage loans to borrowers at interest rates that are significantly higher to those of the chartered banks.
The appeal for investors is clear: MICs, which raise financing for mortgages by pooling money from investors, produce an average annual return of 7 per cent on invested funds compared with 1.9 per cent, on average, for one-year guaranteed investment certificates (GICs) and 2.3 per cent for five-year GICs. Compared with Government of Canada bonds, which pay about 1.24 per cent for 10 years, the appeal is even greater. However, the risks of putting money into MICs are unquestionably higher.
According to the Canadian Mortgage Housing Corp.’s (CMHC) Residential Mortgage Industry Report for the third quarter of 2018, released on July 16, MICs had an average residential mortgage of $194,760 with interest rates ranging from 7 per cent to 15 per cent. In contrast, the chartered banks had an average residential mortgage of $220,650 at interest rates ranging from 3.3 per cent to 5.4 per cent in the same period.
The risks in MICs’ lending show up in their default rate. Delinquency rates on MIC-held mortgages were 1.93 per cent, eight times higher than the 0.24 per cent delinquency rate of mortgages held by chartered banks, the report states.
In addition, investors in most private MICs have to make arrangements for redemption typically three months in advance or at specified calendar dates such as the end of the year.
“There’s no question that the lower liquidity and higher default risk, which is still very low, is worth it,” says Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C. “The investor has to be cautious and selective, but there are hundreds of MICs, including some public ones traded on the Toronto Stock Exchange. If you pick wisely, you can have a superior yield with acceptable risk.”
There are between 200 and 300 active MICs in Canada, which invest mostly in single-family home and condominium mortgages. Some MICs also funnel money to developers building multi-unit residential housing. MICs can lend on raw land for housing and residential projects under construction. There is also room for non-residential building as long as half the operating capital of the MIC is in residential housing or in cash deposited with Canada Deposit Insurance Corp.-insured institutions awaiting deployment in accepted housing, says Nick Kyprianou, president, chief executive and director at Toronto-based River Rock Mortgage Investment Corp.
MICs, though numerous, are a niche in the Canadian residential mortgage market. Their loans total $13-billion to $14-billion, which is just 1 per cent of the entire residential lending market, according to the CMHC report.
MICs’ loans are not insured by the CMHC. So, MICs control their risk exposure by lending at lower-value ratios than chartered banks: While banks may lend 80 per cent to 100 per cent of a home’s appraised value, MICs lend no more than 60 per cent to 85 per cent.
River Rock, like other MICs, covers its risks with far higher interest rates than chartered banks charge. As Mr. Kyprianou, notes, the firm’s interest rates start at 6.99 per cent on first mortgages and 9.99 per cent on second mortgages. The mortgages are for a year, renewable and mostly on homes bought for less than $1-million.
“We are a parking lot,” he explains. “If people cannot satisfy all the tests and ratios that the bank wants, they can bring their credit challenges to us. After an average of three to six months, maybe as much as a couple of years, people resolve their credit issues and then refinance at a bank. We do our due diligence very carefully with the result that we have taken back and sold only four properties in the five years we have been in business.”
Still, due diligence on MICs is required for those who are interested in gaining exposure to these lenders. Although there are about two dozen MICs that are traded publicly on the Toronto Stock Exchange with two-day settlement – including Timbercreek Financial Corp. (TF-T), Firm Capital Mortgage Investment Corporation (FC-T) and Atrium Mortgage Investment Corporation (AI-T) – the vast majority of MICs are private and have strict liquidity rules.
Liquidity is specific to each MIC, says John Mercuri, president and director at Premiere Canadian Mortgage Corp. as well as president and managing director at Classic Mortgage Corp., who notes that some investors in MICs are content to remain invested for the longer term.
“We have plenty of cash,” Mr. Mercuri says of the two Kelowna, B.C.-based MICs. “We like a 30-day notice, but we can accommodate redemption in 30 days or less for Premiere [Canadian Mortgage] and 60 days for Classic [Mortgage, the latter of] which has a smaller asset base.”
The challenge for would-be investors is to pick among the MICs as all are not created equal. “You have to read the offering documents and review previous annual reports to shareholders,” Mr. Mercuri explains. “Look for the principals’ track records. What is their experience? What is the default rate?”
The bottom line is that MICs are envelopes of mortgages that are expected to be short term in nature. MICs have to generate new mortgages or they die. The goal is to keep business coming in from borrowers rejected by banks, who can still make payments on time, and to keep them coming because turnover is high.
“[The] typical loan life span is 18 [months] to 24 months or until the mortgage is paid out via a bank loan,” Mr. Mecuri explains. “We are, in the end, not a long-term solution.”