Your guide to mortgage investment corporations

Your guide to mortgage investment corporations | Smart Association - PCMA

Your guide to mortgage investment corporations

While a huge chunk of mortgage financing in Canada, both for residential and commercial properties, is provided by regulated financial institutions (FIs) which include banks, trust companies, insurance firms, credit unions and pension funds, the so-called mortgage investment entities (MIEs) and mortgage investment corporations (MICs) occupy a space which these traditional FIs could not fulfil.

According to AUM Law, MIE can be regarded as an alternative private lender that provides mortgage financing. It amalgamates capital raised from investors and uses the fund to provide loans to borrowers who may not have the access to mortgage financing by the traditional FIs.

"The market for first mortgages on residential property is highly competitive and characterized by thin margins. Lack of profitability is exacerbated in a low-interest rate environment," AUM Law said.

However, MIEs can charge borrowers a higher rate of interest for loans, resulting in a lucrative yield for investors.

MICs belong to a sub-category of MIE, which meets certain criteria in the Income Tax Act. This means all MICs are MIEs but not all MIEs are MICs.

A MIC has the benefits of pooling capital from many investors and employs diversification, which reduces the investment risks. A MIC investor spreads the risk out over a portfolio of mortgages, as opposed to being exposed to the credit risk of a single mortgage.

"The mortgage portfolio can be managed and maturities staggered so that a steady income stream is produced and capital is more continuously utilized. If the MIC is open-ended, then investors enjoy liquidity to greater or lesser degrees, through requesting that their investment be redeemed," AUM Law said.

A MIC is considered to be a "flow-through vehicle" that can deliver income through investors without attracting tax at the level of the corporation. This means that as long as a corporation is a MIC throughout the applicable taxation year, it has the right to deduct taxable dividends paid to shareholders during the year. Additionally, it is also entitled to slash half of any capital gains dividends paid during the year.

The table below shows different conditions that a corporation must meet to qualify as a MIC throughout a taxation year.

AUM Law said a common form of MIC is a business corporation with one class of common shares and one or more classes of non-voting, redeemable, retractable preferred shares.

"A significant benefit of qualifying as a MIC is that the shares can generally be purchased by Registered Retirement Savings Plans (RRSPs), Registered Retirement Income Funds (RRIFs) and other registered plans," AUM Law said.

So how are MICs regulated? AUM Law explained that while the mortgage is a debt instrument that is a security, trading of mortgages is not covered by securities legislation. In Ontario, mortgage trading is covered by the Mortgage Brokerages, Lenders and Administrators Act, administered by the Financial Services Commission of Ontario (FSCO).

However, since trading in the shares or other securities issued by MICs or other MIEs is not trading in mortgages, the carve-out is not applicable.

"There is an internal logic to this: when an investor invests in a mortgage, the investor acquires an interest in the real property, and the transactions are conducted in compliance with the MBLAA. In contrast, when an investor purchases a share of a MIC, the investor’s rights are as a shareholder, with no direct claim to the underlying mortgages," AUM Law said.

While there are a few public MICs, a lot offer their shares on private placement.

"Whether a firm needs to register with a securities commission will differ depending on its circumstance, but we believe that the Ontario Securities Commission (OSC) generally will take the view that any widespread distribution of MIC shares trips the business trigger," AUM Law explained.

To put it simply, MICs that have an offering memorandum, a marketing deck, and factsheet would likely be required to spread its securities through a registered dealer (which can be an IIROC dealer or an exempt market dealer).