Pic-A-MIC

Pic-A-MIC

With investors flocking to safer investments such as quality CANADIAN real estate property and mortgages secured by CANADIAN real estate, interest in the Mortgage Investment Corporation ( MIC ) has grown significantly. Professional well-managed MICs are generally debt-free and deliver reasonable consistent dividends in the 5% to 7% range. They are not equity (stock and mutual fund) plays that tend to fluctuate dramatically in value, but are income and growth investments (you can either take your dividends in cash for income or you can reinvest your dividends for growth). Most MICs qualify for various Canadian Registered Savings and Registered Pension plan investment. Fisgard MIC for example, qualifies for the

  • TFSA – Tax Free Savings Account
  • RRSP – Registered Retirement Savings Plan
  • RRIF – Registered Retirement Income Fund
  • RESP – Registered Education Savings Plan
  • LIF – Life Income Fund
  • LRIF – Locked-In Retirement Income Fund
  • LIRA – Locked-In Retirement Account
  • IPP – Individual Pension Plan
  • RDSP – Registered Disability Savings Plan

When considering a MIC investment the following are important:

1) Track Record and Longevity

Consider MICs that have good track records and have been in business for a long time, at least 12 years. At a minimum they should have experienced at least two business cycles and have experienced the highs and lows of the real estate and mortgage market.

2) Consistency of Dividends

Consider MICs that have produced dividends without interruption for several years. Be wary of MICs that have had to suspend dividends and redemptions, rendering the investor unable to get income or cash out of his or her investment. This indicates portfolio or management problems.

3) Predictability of Dividends

Consider MICs that are consistent in the amount of dividends paid to you, not high one quarter and low the next. Look for a predictable pattern of dividend returns.

4) Mortgage Portfolio Performance

Insist on proof of mortgage portfolio performance. Ask about the number and dollar volume of impaired mortgages in relation to the total mortgage portfolio, over time, and make sure you are satisfied with that level of performance. Get clear answers as to the amount of investment ‘capital’ the MIC has lost over time.

5) Concentration of Mortgage Investments

Concentration is very important. Ask management about its largest mortgages and what percentage they make up of the entire portfolio. High concentration translates into high risk. Be wary of MICs that have a high concentration of mortgage money with a particular borrower (or a particular group of related borrowers). Also be wary of MICs that have a high concentration of mortgages in a particular type of mortgage, i.e. land development, construction, etc. as opposed to safer finished real estate products such as single family homes. Also be wary of MICs that have a high concentration of mortgages in a particular geographical area, i.e. a high percentage of mortgages in small rural communities that do not demonstrate growth and economic stability.

6) Management Experience and Qualifications

You must be comfortable that there is plenty of professional experience and qualification within the MIC management and staff. Ask for credentials. Are management and staff properly licensed? Are they registered with the appropriate regulatory authorities? Do they have sufficient depth of real estate valuation and mortgage financing experience? How many years have they been practicing?

7) Better Business Bureau and references

Is the MIC a member of the Better Business Bureau? If not, why not? Call the BBB for information on the record of the company, complaints, etc. Ask MIC management for business references, including investors and borrowers, and follow up on them.

8) Redemption (cash out) Provisions

MICs vary in terms of cash out provisions. Be clear as to the date on which you can redeem (cash out) your investment. Avoid investing in a MIC that is vague or open-ended in terms of when you can get your money out.  If it is not clear as to when you can get your money out, then don’t put it in.

9) Regulatory Compliance

You should invest only in MICs that fully comply with all regulations, including being properly registered and licensed with appropriate provincial securities commissions and mortgage authorities. This compliance information is public knowledge, and there is no reason why a MIC cannot provide full information on its compliance regime. Compliance, licensing and registrations are generally available on the internet.

10) Types of Mortgage Investments

Ask about the types of mortgages in the MIC’s portfolio. Section 130.1 of the Income Tax Act specifies that at least 50% of the MIC’s investments must be in a combination of CDIC insured deposits and/or mortgages secured by residential real estate property as opposed to commercial property, otherwise the MIC is offside of the Income Tax Act, resulting in what could be serious adverse income tax consequences. Preference should be given to MICs that have a high proportion of residential compared to commercial mortgages. Of course, you must insist on receiving current year audited financial statements.

11) Geographical Location of Mortgage Investments

Be careful of investing in MICs that lend against property located in areas that do not have economies that demonstrate growth and stability. Often this information can be gleaned from Stats Canada, which has a very comprehensive website.

12) Mortgage Approval Process

Ask management how it selects mortgages. Does the MIC have a credit committee? What is management’s mortgage lending criteria? Does management assess property value itself or does it commission outside bonded/insured professional appraisers? Choose MICs that not only have the depth of experience in management and staff to evaluate property themselves but, as a matter of caution, contract property valuation to third-party professionals, basically A.A.C.I. bonded/insured appraisers.

13) Early Redemption Privileges

Like most financial investments, early redemption (cashing out before maturity) comes at a cost. Few MICs are simply redeemable on demand. It’s hard for a MIC to function that way as its mortgages are rarely, if ever, payable “on demand”. Just make sure you are satisfied with the MIC’s early redemption policy and the cost associated with early redemption. An example of an early redemption feature is Fisgard’s Compassionate Early Redemption provision. This particular feature allows an investor, upon the death of a spouse or partner, to cash in the investment prior to the maturity date without penalty. Look for these types of early redemption features in the MIC you are considering.

14) Dividend Statements

Ask for a sample of the MIC’s Dividend Statement, and be satisfied that it is clear and easy to read. There is no reason for a MIC to have a confusing or complicated dividend statement. A MIC is a relatively straight-forward investment (mortgages secured by Canadian real estate property), so its dividend statement should be quite simple.

15) Liquidation Value

If the MIC under your consideration were to be liquidated today, what would its share value be? Good thing to ask. If it is less than what you paid for the share, then ask how you are going to get all of your capital back.

16) Related Funds

A number of MIC managers handle more than one MIC. Some manage several MIC funds under one roof. Is this an advantage or disadvantage to the investor? Is it an unnecessary complication? When mortgage opportunities come to the manager, which fund is the mortgage placed in – and why? What conflicts may arise from this type of situation?  Good question to ask.

17) Investment by Principals

Are the founders, directors, officers, employees, etc, invested in the fund? If so, how much? If not, why not? Do their shares have special rights or priviledges that other investors’ shares do not have?

18) Loans to Insiders and Related Parties

Does the MIC lend to its managers, directors, officers, employees or related parties? This may not be illegal, but is not a good practice, even though it may be disclosed in the Offering Memorandum or Prospectus. Definitely something to ask about, and watch carefully.

19) Relationships of MIC fund to MIC Management

Some MICs have internal management, but most have external management. Directors and officers are often the owners of the MIC’s management company as well as the controlling shareholders of the MIC fund itself. This is not necessarily a bad situation, and can even be a good situation. It is just something to be aware of.

20) Conflict Possibilities

Sometimes the MIC’s manager collects fees – finders fees or broker fees – from its mortgage borrowers while at the same time getting paid by the investors for managing their MIC investment. In short, the manager is being paid by the borrower for finding the mortgage and being paid by the investors for managing their MIC investment all at the same time. This should raise some important questions in terms of conflicts of interest.

The higher the risk represented by a particular mortgage, the higher the finders/brokers fee will be. Ask why a manager should be paid a fee by a borrower (a fee based on the level of risk) at the same time as the manager is being paid by the investors to manage their money, keeping it as secure as possible. Is this a conflict of interest? Why don’t finders fees and brokerage fees go directly to the MIC fund for the benefit of the investors?

There are a number of fees that managers collect on a mortgage. Here are some:

  • mortgage application fees
  • processing and administrative fees
  • mortgage renewal fees
  • late payment fees
  • NSF fees
  • mortgage discharge fees
  • lender fees
  • finders (brokerage) fees
  • demand notice fees
  • foreclosure processing fees

Why should MIC investors be put at greater risk because the MIC manager collects a larger fee from a mortgage that poses higher risk? It’s a question you should ask – and insist be clearly answered.

[At Fisgard, for example, all of the above fees go to the investors – not to the manager.  This is part of Fisgard’s conflict avoidance policy.]

21) General and Specific Reserves

A well-managed MIC should maintain reserves for doubtful accounts and bad debts. The MIC should have SPECIFIC RESERVES set against each of its impaired mortgages and GENERAL RESERVES to cover potential losses against the whole mortgage portfolio. A reserve program is a prudent businesslike way of accounting for possible losses. You should not invest in a MIC that does not have a reserve program. With MICs that do have a reserve program, you must check and be satisfied with the adequacy of the amount in both the specific and general reserves.

22) Liquidity and Cash Flow

Some MICs are involved in mortgages on construction and development projects. These mortgages involve progressive performance advances which are amounts advanced against the construction or development from time to time as the project progresses. These periodic performance advances are called draws, and a well-managed MIC always has adequate capital available to fund these draws as they come due. If the MIC doesn’t have this capital you should be careful about investing. When researching MICs for possible investment make sure the manager proves to you that the MIC has sufficient capital resources – either cash on hand or readily available through an operating line – to fund all draw obligations. If it is not clear that the MIC can meet its draw obligations, do not invest. A MIC that cannot meet its draw obligations is in the precarious position of being sued by its borrowers.

23) Borrowings (Leverage) and Cash Management

Invest only in MICs that clearly demonstrate a long history of prudent cash management. Cash flow is everything in a MIC. It is not unusual for a MIC to have a bank Line-of-Credit (operating line), but there is a material difference between a MIC that uses its LOC for leverage and a MIC that uses its LOC for short-term purposes, such as being able to forward-commit to mortgage investment opportunities. Ideally a well-run MIC should have 100% of its capital working (earning interest on mortgage investments) and have very little in the bank, just enough for day to day operations. The MIC should have an operating line that allows it to commit to mortgage opportunities even though it may not have the money in the bank at the time. This type of borrowing is prudent, but should be used only on a short-term basis.

On the other hand a MIC that uses leverage (the spread between the rate a MIC can borrow at and the rate it can achieve on its mortgage investments) to generate its revenue should be watched very carefully, and avoided if leverage is excessive. A bank can withdraw its Line-of-Credit facility at moment’s notice, causing instant and serious cash-flow problems in a MIC that depends on the LOC for revenue purposes. Borrowing at one rate to invest at another – playing the spread – is a dangerous game, a bad gamble. One need only look at the on-going global economic crisis to witness the carnage resulting from excessive borrowing (leverage). Avoid investing in MICs that use excessive leverage for revenue purposes. It’s deadly.

24) 1st and 2nd Mortgages

Junior (2nd) mortgages are lucrative investments, but carry greater risk and require specialized experience to be selected and managed properly. Exercise caution when considering investing in a MIC that has a high percentage of the dollar volume of its mortgage portfolio in 2nd mortgages. I stress dollar volume as a MIC may have a relatively small percentage of the number of its mortgages in 2nd mortgages, but that small number may represent a disproportionately high percentage of the MICs overall portfolio dollar volume. Be careful of that type of portfolio. A well-run secure MIC will always have a high percentage of its mortgage investments in quality 1st (senior) mortgage securities. It’s just safer.

 

25) Redemption Rights

Be wary of investing in a MIC that is not permitted to redeem your investment in full at any time at its discretion. This right will be spelled out in the MIC charter and Offering Memorandum or Prospectus. If a MIC finds itself in a position of having too much money and too few mortgage investments, it is better for the MIC to redeem shares (pay back your money) than for the MIC to be forced to retain excessive ‘un-invested capital’, which could be a substantial cost to the MIC, hence reducing your security and lowering your dividend return.

26) Insured Mortgages and Title Insurance

When selecting a MIC as a potential investment you should enquire as to whether some or all of the MIC’s mortgage investments are insured by Canada Mortgage and Housing Corporation (CMHC), Canada Guarantee or Genworth. These are the three insurance companies that provide mortgage insurance, CMHC being a Federal crown corporation. It is unusual for MICs to carry mortgage insurance, but certain MICs may carry insurance on some of the mortgages in their portfolios.

You should also enquire as to whether the MIC in question carries Title Insurance, such as that provided by First Canadian Title or other title insurers. Very few MICs have such an arrangement, but certain MICs may have a contract with a title insurance company. It’s a good arrangement to have.

27) Registered Plan Trustee Fees

If you are considering investing in a MIC through one or another of Canada’s Registered Plans such as the RRSP, RRIF, TFSA, RESP, LIF, LRIF, LIRA, IPP or RDSP, be sure to confirm the trustee costs of maintaining the Plans. Some MICs offer more economical plans than others. For example, the RRSP or RRIF in a particular plan may cost $125 to open the Plan, a certain fee per contribution, and $125 to close the Plan, whereas in other MICs the trustee costs could be higher or lower. In the case of an investment such as the Tax Free Savings Account ( TFSA ) which is limited to a $5,000 contribution per year, or a regular (most often monthly) limited contribution investment such as a Registered Education Savings Plan ( RESP ) or the Registered Disability Savings Plan ( RDSP ) the trustee costs can be prohibitive. Be sure to examine these costs carefully before investing.

[Fisgard’s RRSP/RRIF costs $100+tax per year for the primary plan-holder and $75+tax per year for the secondary plan-holder (such as the Spousal RRSP or Spousal RRIF). Fisgard’s RESP costs $24 per year, and its TFSA costs $36 per year, with no set-up and closing-out fees. Fisgard’s RESP and TFSA costs are very low compared to the vast majority of MICs in Canada.]

Fisgard Asset