MICs: Make money on debt

Double-digit returns and a good income stream is what mortgage investment corporations offer.

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Mortgage investment corporations (also pronounced MIC, as in Mick Jagger) are alternative fixed income investments. They’re are becoming more popular because of their sustained double-digit returns.  Yes, you read correctly: double-digit returns. According to a report from Greg Shannon, a lawyer with Miller Thomson LLP, “it’s quite normal for MICs in registered plans to achieve rates of return in a range between 9% and 14%, or sometimes a bit more.”

(For more explanation on how a MIC works and the general application of a MIC in a balanced portfolio, please see my column available exclusively in the print and digital editions of MoneySense magazine.)

Of course market veterans are quick to point out that with great reward comes great risk. Considering the stagnant stalwarts of fixed income—GICs and government bonds—are struggling to offer investors a rate of return of at least 1.5%, wouldn’t that put MICs in the great risk category? Not when you consider the underlying assets. Because MICs must keep 50% of their holdings in mortgages backed by residential real property (or in CDIC-insured holdings), the majority of risk revolves around residential mortgage default rate—a rate that is notoriously low in Canada.

“Even in the 1990s, when the Canadian real estate market crashed, the default rate for residential mortgages never climbed higher than 0.66%,” explains Jane Knop, the Harvard-educated managing director for First Swiss AM, a Toronto-based MIC that specializes in residential first and second mortgages. Compare this to the average default rate of North American corporate bonds—which sits at 1.01% between 1982 and 2010.

Examine the risks

With apparently lower risk and higher returns, does this mean you should liquidate your fixed income holdings and plow the money into MICs? Not necessarily.

The truth is not all MICs are created equal. While all are legally mandated to keep 50% of their investments in residential mortgages, what constitutes as a residential mortgage can be quite broad—and this can seriously impact the level of risk and volatility of a MIC’s investment portfolio.

For instance, residential debt can include first and second mortgages. If you hold a first mortgage you have priority if a default occurs. This makes second mortgages more profitable, but much riskier.

Residential debt can also include construction loans or bridge financing for residential new-builds or repairs—a much riskier form of debt given its commercial nature. (Although, the debt is still considered residential under the Income Tax Act.)

Other risk factors include:

  • A high loan to value on any one property;
  • Whether or not the MIC is too geographically concentrated. For instance, if all loans are in Northern Alberta, these loans could be seriously impeded if oil commodity prices drop and homeowners are left unemployed and forced into foreclosure;
  • If a MIC is highly leveraged this may be a bad sign. That doesn’t mean MICs with lines of credit or that use leverage are poor investment choices. In fact, a MIC that doesn’t have access to a line of credit or excess capital can actually be worse, but you don’t want to invest in a MIC that’s boosting their returns through leverage. The returns should come from their portfolio of holdings, and the leverage used to establish solid holdings for long-term performance;
  • Whether or not the MIC has policies limiting the maximum percentage or total dollar amount that can be invested in any one mortgage or borrower.

Evaluating those risks

“It’s about due diligence,” explains D.G. Southen—a London, Ont.-based real estate investor who started with bricks and mortar holdings and added MICs to his portfolio just over two decades ago.

But just like buying a corporate bond or a sector ETF or mutual fund, the more you know about the underlying asset, the better you can asses the level of risk associated with the investment. When evaluating a MIC, make sure you examine the underlying portfolio of debts. This analysis should include:

  • A list of addresses where mortgages are held;
  • The property values and their loan values on each address (or sector, at the very least);
  • And the purpose of the loan—is it for construction, will it be used as a bridge loan, is it to establish future income-producing cash flow. Also, verify whether the mortgages are first or second mortgages. While you’ll get the opportunity of a greater return on a second mortgage, you’re also adding much more risk.

You should also ask to see independently audited financial statements as well as the MIC’s dividend statement—the annualized net returns offered by the MIC since inception.

In the end, though, what you’re really buying is the manager’s performance, says Michael Nisker, managing partner of Trez Capital, a firm that offers only a handful of publicly-traded MICs on the TSX. “In that respect, you need to answer two questions: What is their record? And how long does that record continue?” Consistent returns—not one year high and the next low—with a close to zero loan loss for a decade or more shows a well-run book of business.

It was this due diligence that enabled Southen to earn a 12% annualized rate of return over the last 22 years. “I have not held a common share in my RRSP since 1991,” says Southen. “The reason? I make more money with debt investments than I ever would with common shares.”

Keeping it tax efficient

For those interested in MICs, be aware that you don’t make money on the appreciation of the shares you own. Instead, you earn a dividend-like payout every month (or quarter or year) based on the interest collected from the pool of mortgages owned by the MIC. The more shares you own the larger the payout, which is taxed at your top tax rate as interest income.

To minimize the taxes you pay look for corporations that offer holdings in registered savings plans, such as an RRSP, TFSA, RRIF, RESP, RDSP, among others.

To keep your MIC holdings in a registered plan you’ll need to pay the corporation administration fees, and some are definitely more economical than others. Typical costs for an RRSP holding range between $100 to $150 per year, while an RESP or a TFSA holding will cost you $25 to $75 per year in administrative fees.

Also, keep an eye out for set-up, closing and redemption fees—you’ll want to know these up-front so you can factor in these costs for entering and exiting the investment.

Will you get double-digit returns?

Finally, don’t be surprised if MIC returns have—or continue—to drop. At present, most stable MICs are providing a net 5% to 10% return to their investors, depending on the risk level. “There’s more capital competing for the good, quality debts and that pushes rates down,” which impacts returns, explains Knop. This may change as more individuals and businesses find it difficult to qualify for mortgages, but for now, even MIC returns are feeling the pinch. That is if you consider a 5% to 10% annual return on a fixed income investment pinched.

Where to find a MIC

Finally, if you’re really interested in MICs you’ll need to do a bit of your own research. For those interested in private placement MICs—corporations that sell shares through Offering Memorandum, you’ll need to do a search. There are hundreds of MICs in Canada—some large and some small. For accredited investors, there is ample choice and MICs can be found operating in almost every province, but you’ll need to really examine the investor materials provided. Remember you’re looking for consistency, longevity and a lower risk profile for sustained returns.

For non-accredited investors, or investors with a lower minimum sum to invest, consider publicly-traded MICs. Up until 2011 you really had only three options to choose from. However in the last year, the number of publicly-traded MICs on the TSX has risen to about a dozen. The advantages of these market-traded MICs are as follows:

  • No minimum investment or accredited investor requirements;
  • Better liquidity;
  • Potentially better disclosure by virtue of it being a listed, public company;

Current list of publicly-traded MICs (in alphabetical order):

Atrium Mortgage Investment Corp. (TSX: AI)

Mandate: One or two year terms with 85% first mortgages an 15% second mortgages on income-producing residential real estate, with 65% in residential and 35% in commercial residential.

Weighted average loan-to-value of mortgage portfolio is 66.7%

Current Yield: 7.35%

Distributions: Monthly

Fees: Not apparent

Eclipse Residential Mortgage Investment Corp. (TSX: ERM)

Mandate: Single family residential mortgages

Current Yield: 6% to commence after anticipated closing date of June 28, 2013

Distributions: Monthly

Fees: Not apparent

Firm Capital Mortgage Investment Corp. (TSX: FC)

Mandate: Mostly conventional first mortgages in Ontario

Current Yield: 7.64%

Distributions: Monthly

Fees: Management fee of 0.75%; mortgage banker fee of 0.1%; performance fees charged on mezzanine and equity investments

First National Mortgage Investment Fund (TSX: FNM.UN)

Mandate: Single-family residential mortgages and multi-unit residential and commercial mortgages across Canada

Current Yield: 6.56%

Distributions: Monthly

Fees: Management fee of 1.35%; performance fee of 0.20% over hurdle rate (hurdle rate based on 2-year GOC bond yield plus 4%)

MCAN Mortgage Corp. (TSX: MKP)

Mandate: Uninsured single-family mortgages and residential construction loans with core markets in Alberta, Ontario and B.C.

Current Yield: 6.86% ($1.42/share)

Distributions: Quarterly

Fees: $0.04/share

ROI Canadian High Income Mortgage Fund (TSX: RIH)

Mandate: Commercial mortgages

Current Yield: 6 %

Distributions: Monthly

Fees: Not apparent

ROI Canadian Mortgage Income Fund (TSX: RIL)

Mandate: Commercial mortgages

Current Yield: 5.04%

Distributions: Monthly

Fees: Not apparent

ROI Canadian Real Estate Fund (TSX: RIR)

Mandate: Commercial mortgages

Current Yield: 6%

Distributions: Monthly

Fees: Not apparent

Timbercreek Mortgage Investment Corp. (TSX: TMC)

Mandate: Primarily residential and retail mortgages in Ontario, Alberta and Quebec. No leverage

Current Yield: 7.79%

Distributions: Monthly

Fees: Management fee of 1.2% per year

Hurdle rate: 2-year Government of Canada Bond Yield plus 4.5%

Timbercreek Senior Mortgage Investment Corp.(TSX: MTG)

Mandate: Shorter-term first mortgages (or customized first mortgages) in residential and multi-residential, as well as office, retail and industrial properties located in large urban markets

Current Yield: 6%

Distributions: Monthly

Fees: Management fee of 1.0%

Hurdle rate: 2-year Government of Canada Bond Yield plus 3.5%

TREZ Capital Senior Mortgage Investment Corp.(TSX: TZS)

Mandate: 50% in residential and the remainder in office and retail mortgages. Loan terms up to 36 months with a concentration in Ontario, Alberta and B.C. (but some holdings in Saskatchewan and Nova Scotia)

Current Yield: 5.0%

Distributions: Monthly

Fees: Management fee of 1.0%.

Hurdle rate: None

TREZ Capital Mortgage Investment Corp. (TSX: TZZ)

Mandate: 50% in residential, 40% in office and remainder in industrial and retail. Loan terms up to 36 months with a concentration in Alberta and Ontario, but with holdings in New Brunswick, Nova Scotia, Quebec, B.C. and Saskatchewan

Current Yield: 7%

Distributions: Monthly

Fees: Management fee of 1.35%.

Hurdle rate: 4.5% over 2-year GOC bonds

(NOTE: All MIC yields are based on $10 issue price of shares.)

6 comments on “MICs: Make money on debt

  1. First…"Examime"? Proofread please. Thank you.

    Second, great article. I've never even heard of MIC before. Thank you for an informative article!

    Reply

  2. I would not touch these high risk investments with a ten foot pole.People actually believe a 9% to 14% rate of return is sustainable for a 10,20.30 years plus period.This is why people run into trouble with their future retirement and financial,life goals.There is no substitute or replacement for savings and earning a decent but realistic rate of return.

    GIC's,government bonds are not not struggling to offer at least a 1.50% rate of return,I don't know why so many of you financial authors push down guaranteed,safer investments like government bonds,GIC's.There are GIC's that are 2.50%-2.85% 5 year terms,even 3 year GIC's at 2.35%,2.25%,2.10%.There are 5 year TFSA,RRSP GIC's that are 2.85% to 3.15%,3 year TFSA,RRSP GIC's that are 2.55%,2.35% and 4 year at 2.55% to 2.65%.

    As for government bonds,provincial strip bonds are the higher yielding at 3.60% 10 years,4.10% for 18 years,4.35% for 21 years and above.The last issue of Ontario Savings bonds 10 year fixed rate bond was 3.10% annual pay.Longer term provincial bonds 25 year terms range from 3.85% to 4.10% annual yield, semi-annual paid interest.Also,10 year provincial bonds are 3.20% to 3.40%. The 15-20 year provincial bond maturities are 3.50% to 3.75%.

    As bond yields,interest rates rise and normalize, a 4.50% to 5.25% should be the rate of return a person can rely on for sustained long term bond yield or rate of return. A 7%,8%,9% etc. gives a sense of less savings is needed and likely a much lower income and assets as one might thought could result.This is irreversible after 30 years of planning,saving.

    Reply

  3. Excellent article. I find it hard to find non biased information about the MICs.
    I am very interested in these to add diversification to my portfolio with these as it has been shown time and again that diversification is the thing that counts towards giving you the best overall long term returns. I want to add these to my fixed interest holdings of bonds, preferred shares and REITs. I would really like to have more information about their performance and ratins. And where to find this on an ongoing basis.
    To the first poster, these are NOT high risk. If you are happy with the lousy interests from GIC than dont complian when down the road the inflation will eat away your money. These GICs dont even keep pace with that.

    Reply

  4. As with any investment there are risks involved so the investor must do his /her diligence to minimize the risk before advancing any money.
    An alternative to investing in a MIC is to invest in private mortgages yourself. You would have a mortgage agent/broker bring a client's application to you. A property appraisal would have been done along with all financial details and property details and reasons why this type of mortgage is being sought. You have 2 days by Ont law whether to loan the money as a first (or second) mortgage. It is usually set up as an interest only loan for 1 year (your choice to renew) where the clients pays all your legal fees etc. The client submits a year of postdated cheques to you. You could even add an acceptance fee (perhaps 1% of the total mortgage given to you at closing) as part of the deal.
    The risk is a default on the loan but through careful examination of all the information you can minimize the risk.
    With federal regulations allowing only up to 80% refinancing second mortgages will probably become more popular in the next year or two. Whether investing in a MIC or directly yourself in private mortgages there will be good return on investments.

    Reply

  5. All of the MICs that you have listed have single digit yield … so, where did the amount 9 – 14% return come from?

    Reply

  6. I recently discovered something very disturbing about a MIC I own in BC. It sounds like our MIC charges standard broker fees to the end client (borrower) but instead of paying those fees to the MIC for distribution to shareholders, the MIC pays these fees to the management company. These fees are paid to the Mgt. Co. in addition to the annual 1.5% annual mgt. fee.
    Is how all MIC’s are supposed to work?
    Please comment.
    Tim

    Reply

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