Is Canada’s Love Affair With The MIC (Mortgage Investment Corporation) Misguided?
So, you bought a Mortgage Investment Corporation (MIC)? Or maybe you are considering purchasing one? Or, even worse, you invested a bit. Then, after those monthly (8% per annum) yields started pouring in, you made a larger purchase. And now the mighty MIC makes up 50% (or more) of your overall portfolio. In any event, its time you understand exactly what you are buying, and the true risks involved. As a result, you can take action, and possibly avoid one of the biggest investing mistakes of your life.
What is a MIC?
A MIC is an investment and lending company designed specifically for mortgage lending. They generally qualify for registered plans such as RRSPs, TFSAs, etc, and are provincially regulated. There are certain rules of structure, such as the fact that at least 50% of the assets must be in residential mortgages and/or cash and insured deposits at CDIC-insured institutions.
Basically, the MIC lends money, takes property as security, and charges an upfront fee and a high interest rate. As the MIC normally collects interest monthly, it is able to flow some of the interest to you, the investor, monthly. The MIC may charge an upfront fee, perhaps collecting the first 2 or 3% of interest, and then distribute the remainder to investors. Or, the MIC may choose to pay investors a prescribed “target rate” first (say 8%), then collect the remainder as profits. It is important that an investor understand the structure of the MIC under consideration, as this is important, and can speak to the motivation of management to issue quality loans.
Important MIC Considerations
- What Too Many Investors See- In today’s low interest rate environment, many investors are “starving for yield”, and search for alternatives to low interest GICs and bond rates. They see that juicy yield of, say 8%, and become predisposed to switching their GICs for MIC units. “What can be more safe and Canadian than real estate-backed mortgages?” they reason. What they do not realize is that the reason MIC rates are higher is because they ARE NOT guaranteed like GICs. Risk can be much higher than a GIC, and the risk of investment loss must be taken into consideration, or major disappointment can result.
- Concentration- A MIC is constrained by a certain asset class, generally residential mortgages, and this can dramatically increase risk. For example, let’s say that the U.S. housing market presents an opportunity to purchase mortgages at 0.65 on the dollar, and Canadian mortgages are at par. A Canadian MIC cannot decide to go across the border and invest in the less risky mortgage. It must stay confined to its concentrated parameters. This very situation actually played itself out over the past few years. There are other lending strategies that were able to take advantage of this opportunity. If you owned a MIC, you missed out.
- Yield Compression- Over the past few years, MICs have become extremely popular, with many hundreds of millions pouring into these vehicles. As a consequence, competition for loans has caused MIC lenders to reduce fees or interest rates charged to lenders. Now you know why your sweet 8% yield turned into 5% (or 11% into 7.5%).
- Defaults- A MIC can be great when it is small and nimble. At $10 Million in loans, it is able to be choosy about the loans it issues, and maintain high quality and integrity of the portfolio. Then it can become a victim of success. Before you know it, an individual investor who started with a $10,000 purchase has now placed $400,000 with the company. After enough investors do the same thing, the MIC may balloon to many hundreds of millions in size. In order to continue generating return, they need to place more capital into more loans, and overall quality may suffer as a result. More firsts become more seconds, and eventually a 2% default rate turns to 3, 4, or 5%. Now you know why your $1 principle unit value changed to 0.95, then 0.90, etc.
- Regulatory Issues- Let’s say you purchase a MIC because of its long track record of success. This MIC may have paid out successful and timely distributions for 10 or 20 years. Shortly after you invest, this “safe” MIC, which has been touted as a certain core portfolio holding, is “cease-traded” by securities regulators. This means that the MIC must freeze distributions while it works out its issues. If you are relying on the regular income to supplement your retirement, too bad, you are cut off. The more money you have concentrated in that single MIC, the worse your problem.
- Fraud- I know of a situation where an investor purchased a MIC from one of his “good friends”. The yield was 18%, investors were paid on time for a number of years, and everyone was happy. My acquaintance eventually invested 50% of his life savings into the MIC. Then the interest payments suddenly stopped. The MIC operator became difficult to reach. I was told, after all was said and done, that the approx. $10 Million of units outstanding, there was only perhaps $200,000 in assets as actual collateral. You guessed it, the good ole Ponzi scheme! I was told that this MIC operator not only spent all the investor capital on himself, but he cheated his friends, immediate family, in-laws, and many other close acquaintances as well. (NB: These statements are “alleged”, are definite heresy, and I have no actual proof to substantiate my acquaintance’s claims. All I know is that he is pretty devastated financially, and this investment is the cause).
- Direct Sellers– Generally there are two ways you can purchase a MIC: Directly or through an investment dealer (such as an exempt market dealer). With a dealer, the MIC has a better chance of being “vetted” with a thorough due diligence process. In addition, there should be a licensed representative available, who can speak to the pros and cons of the MIC, and assist in determining if the product is suitable for you. The problem with purchasing direct is that there is a huge potential conflict of interest. Yes, you will be speaking with someone who is licensed. However, if they only have the one product to provide you, are they truly going to be objective? Are they going to fully discuss risks with you, and even recommend against buying their only product? Or are they going to tell you about all of the wonderful things about their product, gloss over the risks, and sometimes try and fit a “round peg into a square hole”, in order to make a sale? My guess is it is more likely the latter than not.
Now That You Know The Facts, Here is What You Should Do
The statement “If it sounds too good to be true…” has been beaten to death, in nuclear fashion, a million times over. However, as far as a MIC is concerned, this statement is bang on. Yes, a MIC can form a small part of a well-diversified portfolio, and can prove to be very complementary to other investments. Be extremely aware of your temptation to “load up” on MIC investments, and please, I beg of you, resist that temptation. There are too many other high-quality investment opportunities to purchase to fall into the “MIC Overload Trap”. For examples of how smart people make investment decisions, read this article.
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