Inside Mortgage Investment Corporations (MICs)

Some believe Mortgage Investment Corporations (MICs) are one of the best undiscovered income-producing investments in Canada.

We wanted to investigate that a bit, so wWayne-Strandlund-Fisgarde took the opportunity to chat with one of the pioneers of the Canadian MIC industry, Wayne Strandlund.

Wayne is the founder and CEO of $250 million Fisgard Capital Corporation. Fisgard is one of Canada’s larger MICs. Over the past 16 years, Fisgard has placed over $50 million in mortgages each year, and paid dividends averaging 10.79% net per year to its investors.

Wayne is also the author of this very practical checklist of what to look for in a MIC before making an investment. See: Pic-A-Mic

Here’s part one of our two-part interview…

Intro to MICs

Before we begin, let’s define what a MIC is.

A MIC is an investment that lets people pool their money to be lent out as mortgages. 100% of the net profits from those mortgages flow through to the investors.

MICs have been around since 1973 when federal legislation was enacted to promote private financing and make it easier to invest in mortgages.

MICs are one of the lesser known asset classes, despite yielding solid long-term returns and despite being RRSP, TFSA, RRIF and RESP eligible in most cases.

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CMT:  To what extent would you say MICs are an undiscovered or underrated asset class in Canada?

Wayne:  The MIC was established by federal legislation in 1973 but it didn’t take hold until the mid ‘90s when it really started to take off, principally because it was the most accommodating investment structure to replace mortgage syndication. Mortgage syndication had been damaged by a number of debacles at the time, most notable of which was ‘Eron.’ Eron had lost millions worth of investor money.

Thanks to the MIC, instead of owning a syndicated (often unregistered) interest in a mortgage, investors could now be shareholders in a non-taxed flow-through entity. MICs, with their strict audit and reporting regulations, are a more streamlined, transparent and effective way of investing in mortgages and real estate.

Early MIC managers didn’t give much thought to the MIC structure beyond its facility to raise investment money. Their focus was predominately raising capital not only through cash investment but also through various registered retirement and savings trusts such as the RRSP, RRIF, DPSP, LIF, LRIF, LIRA, IPP and RESP. Today we also have the TFSA and RDSP.

The MIC flourished after 1995. Today there are hundreds of MICs in Canada. Some have as little as $1 million capital, and are essentially “convenience MICs” of maybe twenty or so shareholders. You might find those MICs in real estate offices, for example, where their main function is to facilitate sales for the office’s marketing staff.

On the other end of the spectrum are the larger MICs which are basically mortgage banks with hundreds of millions of dollars and thousands of shareholders.

The MIC is now fairly well established, but underrated as an investment asset class. Not being particularly well suited to public trading, MICs have not been recognized by financial advisors and stock and mutual fund traders who prefer investments that are publicly traded and generate fees and commissions.

This lack of attention has nothing to do with the quality, security and dividend production of the MIC.

CMT:  What are the biggest differences between MICs today and MICs 15 years ago?

Wayne:  Today there are many more MICs struggling for a share of a market that is not growing in lock-step with the increasing amount of mortgage money available through MICs as well as institutional lenders.

Fifteen years ago it was easier for a MIC to place money in secure mortgages than it is today. Competition for good mortgages is fierce, and growing.

MICs are practicing the same type of lending they were fifteen years ago. Despite the intense competition for quality mortgages and the recent global recession, most MICs have done well for investors. Yet, they have not received the recognition they deserve, despite outperforming many investments in terms of capital preservation and dividends. The MIC is still a niche investment, not well known or understood.

Securities regulation NI 31-103 was introduced in 2008 and made law in September 2010. It is too early to say, but I believe the new regulation will change the MIC industry. It could be that small MICs may not be able to meet the onerous requirements of the new regulation, including increased capital, bonding, disclosure, compliance and so forth, and simply close shop, or merge in order to survive.

The reasons for NI (National Instrument) 31-103 are still being hotly debated and rationalized based on whose ox is being gored, the small MIC struggling to raise a bit of capital or a giant bank’s brokerage house that is not particularly fond of anyone else playing in what the bank sees as its very own sandbox (the world’s investment money). At any rate it appears that the capital-raising field has been levelled by NI 31-103 and MICs as well as their managers and investment referral agents must now meet strict regulatory standards in order to raise capital through public markets. The positive outcome is that qualifying MICs will now become “institutionalized” in the eyes of the public, and will benefit from the legitimacy that comes with achieving new levels of licensing and registration. Short term pain, long term gain.

CMT:  From a general risk and return standpoint how would you say investing in a MIC compares to investing in (for example) a rental property, assuming the same dollar investment?

Wayne:  A rental property may appreciate in value and may experience the tax advantages of depreciation and other expense allowances. A MIC is a “flow through” investment and, in fact, the MIC must distribute 100% of its net profit to its investors every year. It is not designed to accumulate profit and is not likely to increase in value as a rental property might.

While a rental property is likely to be an active investment involving hands-on management, the MIC is more a passive investment. It simply flows dividends through to its investors, in whose hands the dividends are treated as interest income for tax purposes. The MIC sometimes, but rarely, flows capital gains or losses through to its investors.

A MIC is likely to be purchased at a nominal $1 per share, for example, and end at a $1 redemption or wind-up value. It will provide dividend income throughout the investment period. In exceptional circumstances the MIC might experience a capital gain if, for example, the MIC buys a property or forecloses on a property, takes it into inventory, and sells it at a profit. The MIC may flow capital gains – and capital losses – to its investors, but these are relatively rare occurrences.

As stated, dividends paid to MIC investors are treated as interest income for tax purposes. Income from a rental property is taxed differently depending, for instance, on whether it is held personally or in a corporation. Investors should consult tax experts when choosing between a MIC and a real estate investment, such as rental property.

CMT:  Are there any major 3rd party distribution channels for the MIC? For example, do any big banks or investment brokers sell them to clients? If not, why not?

Wayne:  To date most MICs have raised capital themselves with negligible support from financial planners, advisors and brokers. Most MICs do not trade on the public market, and therefore do not attract the attention of brokers who make a living through fees based on trading volume.

Also, most MICs raise capital by way of Offering Memorandum as opposed to Prospectus. This precludes certain investment firms from investing in them as a matter of policy.

CMT:  Will returns suffer going forward as more investors throw money at MICs, and as more MICs and private money join the fray?

“If there is a crisis of money in Canada, it is not that we don’t have enough, but that there are too few simple, understandable and reliable places in which to invest it.”

Wayne:  MIC returns are normalizing. The high private interest rates that have fuelled double-digit MIC returns for nearly two decades are not sustainable in the borrowing world at the present time, particularly with the slowdown in construction and development which is traditionally an active lending market for several MICs.

Not only will MIC returns normalize due – at least temporarily – to a shrinking market for mortgage money, but also because more money is choosing the MIC investment resulting in what might turn out to be an over-supply in some cases.

The MIC’s advantage is that the average investor understands what real estate is and what a mortgage is. Investors appreciate that a MIC investment is uniquely Canadian and secured by real property located only in Canada. These are simple important facts that make the MIC such a comfortable, easy-to-understand “investment” compared to the thousands of impossibly complex financial products being pedaled daily on the public market. Simplicity is one of the MIC’s most popular attributes.

The law of supply and demand will prevail, and borrowing rates (hence MIC returns) will be influenced not only by bond yields but also by the sheer volume of money now seeking the relative safety of mortgages secured by Canadian real estate property.  If there is a crisis of money in Canada, it is not that we don’t have enough, but that there are too few simple, understandable and reliable places in which to invest it.

Real estate – the mortgage security – is one of the last bastions of conservative long-term investing, and there is no indication of this changing any time soon. We may look for the MIC to become very popular as a mainstream investment and special purpose lender.

CMT:  Do you foresee more distribution channels evolving for MICs in the future?

Wayne:  Yes. The world of Exempt Market Products – which includes qualifying MICs – is poised for growth. NI 31-103 will have the effect of institutionalizing MICs and MIC managers that meet the new requirements. As a result a broader spectrum of the investment community will invest in MICs, regardless of whether they are publicly traded or not. The so-called ‘liquidity’ touted by stock and mutual fund brokers is not what it’s cracked up to be, and more and more investors now realize that it’s much too expensive. Good old-fashioned fixed term investments are trumping liquidity in many cases.

Exempt Market Products are about to experience wide acceptance and popularity amongst mainstream investment dealers. EMPs are no longer the poor cousins of publicly traded stocks and mutual funds. The popularity of the MIC as an Exempt Market Product is growing and attracting the attention of institutional investors. The credibility of the MIC is greater than it has ever been.

CMT:  What would you consider a high default (impaired loan) rate on a typical Canadian MIC? (e.g. 2%?)

Wayne:  MIC lending is private as opposed to conventional lending, so risk and reward must be viewed from that perspective.

The number of impaired mortgages as a percentage of the total number of mortgages in a MIC at any given time is one consideration.

The dollar volume of impaired mortgages as a percentage of the total dollar volume of the portfolio is another.

The level of impairment is also a consideration. For example, an NSF cheque is one level, non-payment of property taxes, insurance or strata fees is another, and non-payment of the mortgage on maturity yet another.

Ten percent of the number of mortgages in a portfolio (e.g. 40 out of 400 mortgages) is probably an acceptable ratio on the impairment scale, erring on the high side.

Five percent of the dollar volume (e.g. $25 million out of $500 million) is also on the high side. Impairment doesn’t mean a loss of interest or capital. At any time a MIC may have 10% of its loans in an impaired state, but that does not mean it will lose 10% of its capital. It may not lose any capital.

Impairment level takes into account the composition and relative risk of a MIC’s mortgages, and risks vary from one MIC to another. Some MICs underwrite conventional 1st mortgages (including insured mortgages), some MICs underwrite more risky 2nd mortgages, and some MICs underwrite the full spectrum of mortgages: 1sts, 2nds, land development, construction, mezzanine financing, and so forth. It is difficult to assign impairment ratios without carefully considering the portfolio mix. It’s the degree of impairment that one must consider.

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Part II of this interview will follow later this month. It will focus on a MIC’s internal workings, managing a MIC, and more.

Please note: This information is for general education purposes only and is not a recommendation to invest. Consult a licensed financial advisor before acting on any such information.


Rob McLister, CMT

  1. Thanks everyone!
    It’ll be interesting to see how MIC returns are affected as the supply of cash to MICs increases. A lot of MICs we know no longer accept new investors because they already have too much cash.
    Cheers…
    Rob

  2. Rob:
    Another great post! Given the volatility of the stock markets over the last three years, the attractiveness of a well managed MIC, with a dividend distribution north of 8%, that does not roll with the TSX is, well… spectacular!
    Wayne says: “The MIC’s advantage is that the average investor understands what real estate is and what a mortgage is”. I believe that to be true.
    Here is the frustration … the average investor – who I define to be any Canadian homeowner with a mortgage – is NOT ALLOWED to buy MIC shares under NI 31 – 103.
    I’m aware of the North-West exemption, which I believe covers everyone west of Manitoba, but in Ontario, we’re stuffed unless you want to purchase a minimum of $150,000 in a single transaction.
    Show me a high quality private MIC that distributes 8% or more to investors that an average Ontario homeowner can actually buy – and I’ll sell that puppy ‘til the cows come home!

  3. I agree with a rental property or MIC in an investment portfolio…but remember these distributions are taxed as interest income.
    Say you were generating $180,000 in rental income…this nets out to about $120,000/yr after tax, assuming no other income. $60,000/yr to CRA.
    Or add in some eligible Canadian dividends that keep up with inflation.
    To generate $120,000 yr in after tax income using dividents, you would only need to be paid approx 135,000 in dividends, and only pay $15,000 a yr in taxes.
    I can’t wait until all these people who have multiple rental property and only rental properties complain about losing their OAS when they are older, I see it all the time with my elderly clients….they care more about what they are paying CRA and their damn OAS clawback

  4. Your 135K dividend creating 120K after income example must assume no other income right? And not in every province… This is definately an unemployed person…or maybe an older retired person…like a crusty old senior losing their OAS :)

  5. Take a look at FMIC.ca it is offered by prospectus and has a 10 year return of 6-7%. Secured by real estate around the Ottawa region and has no leverage. This is a great article. Thanks!

  6. MIC’s are interesting and gaining momentum. There is a lot of money being invested which could saturate the market and lead to a riskier investment if they are forced to invest in mortgages rather than make sound investing decisions. We saw this with the mutual fund market as investors received such an influx of funds that they had too much money to invest and not enough investment solutions. Do you see this becoming a problem?

  7. Thanks Sandy.
    You bring up a key point. Some provinces (like Ontario) have onerous accredited investor requirements. That topic is worthy of a story on it’s own…so we’ll do one soon.
    As a side note, I’d be interested in your opinion. For a well-qualified investor, how do you feel about MICs being part of one’s Smith Manoeuvre portfolio?
    I use “Smith Manoeuvre” purely as a generic term to encompass various forms of home-equity-based investment strategies.
    Cheers…
    Rob

  8. Rob
    As you know, our variation of the Smith Manoeuvre (SM) is the Tax Deductible Mortgage Plan (TDMP), so I can speak to that, which may not apply to all SM investors out there per se.
    Homeowners in the TDMP are seeking the benefits of leveraged investing first and the tax benefits that come along with it second. Therefore, in the simplest terms, that means they need a positive spread between their return on investment and their cost of borrowing over time.
    While stock market returns have proven to outperform cost of borrowing throughout history, over the long term, the problem is that markets are volatile in the short term. That means over a very short few years, TDMP or SM become increasingly risky!
    MIC investing potentially solves this problem for short timers!
    In a MIC strategy, the TDMP goal is the same, but the spread is now driven between the borrowing costs of a qualified “Prime” borrower and the borrowing costs of a less than qualified or “Sub-Prime” borrower (less costs).
    As an example, if a TDMP client borrows $150K in a HELOC at Prime plus 1% and buys MIC shares which pay Prime plus 3%, they are guaranteed a Return equal to the spread of 2% every month, which is perfect for the TDMP (the same principle applies to fixed interest rates).
    There are different risks to a MIC investment which are always disclosed in the Offering Memorandum (OM). In my opinion the biggest risks are usually operational risk and liquidity risk. Most MICs are relatively small. For many, one mismanaged bad mortgage and the returns can be wiped out and investor’s capital would also be at risk.
    In my view, the concept of a highly qualified TDMP borrower leveraging the equity in their home to lend to Sub-Prime mortgage customers at higher interest rates, through a MIC, makes perfect sense. That’s assuming MIC management can underwrite the deals against the OM mandate and the TDMP investor both understands the OM investment mandate and accepts the aforementioned risks. Note that the normal TDMP tax benefits will go away because MIC dividends are treated as interest in the investors hands. BUT the spread and lack of market volatility should make up for that.
    I think that the recent overregulation of mutual funds combined with the brand new regulation of exempt prospectus financial products like MICs in Canada could make MICs are a very interesting option for some TDMP and SM investors going forward.
    Time will tell…

  9. Really helpful perspectives. Thanks Sandy.
    I guess one would also have to ensure the chosen MIC allows small enough monthly contributions (since some MICs have minimum ongoing investment requirements).
    Anyhow, cheers for now,
    Rob

  10. I have a 3 income properties in the prime downtown core of Toronto.IM interested in utilizing funds from a Reit. they produce 20000.00 per month in income is this to small for a Reit to consider.

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