Residential mortgage credit has expanded in recent years, experiencing an increase of approximately 7.1% year-over-year, as of the fourth quarter of 2020, and 9.4% in 20211. This expansion is cited as being the product of record low interest rates and a strong desire by many to make changes to their housing arrangements.2 In a market where the majority of mortgage lending is facilitated by large banks and credit unions, mortgage investment corporations (MICs or MIC) offer an attractive alternative lending source as they generally are able to offer more creative financing terms. MICs are also attractive as they are able to facilitate a direct flow-through of net income to investors. This article provides an overview of MICs and the corresponding market.
The MIC was first introduced by the Government of Canada under the Residential Mortgage Financing Act in 1973. The MIC was primarily introduced to: (i) encourage private lending; and (ii) make investments in residential mortgages and real estate more accessible to smaller investors. MICs are now primarily regulated and governed by the Income Tax Act (the ITA), which sets out rules applicable to MICs and their shareholders. These rules, along with other governing legislation, will be highlighted in this article.
Nature of the investment
Generally, a MIC pools investments through the issuance of shares to investors and invests in a portfolio of mortgages which generates income through interest and fees charged to borrowers. Typically, income generated by the MIC, net of fees, loan interest and other operational expenses, is then paid out in the form of dividends to investors.
The real estate-secured loans provided by MICs are often short-term (6 to 36 months). As a result, mortgage portfolios are continuously managed with newly invested share capital and the proceeds from mortgages to fund new mortgages. In many cases, these portfolios are managed externally, and involve the sourcing, acquiring and administering of mortgages for a management fee. Since MICs are not necessarily subject to the strict lending guidelines required for traditional lenders, they allow for flexibility in lending terms and avoid lengthy due diligence processes. This flexibility enables MICs to provide individually-tailored loans which are capable of meeting quick capital needs. Further, MICs often lend to borrowers that do not qualify for traditional loans. Accordingly, MICs are generally able to charge higher interest rates than traditional lenders.
Overview of the market
In October 2021, the Canadian Mortgage Housing Corporation released its annual Residential Mortgage Industry Report, which provides insight into the Canadian residential mortgage industry in connection with MICs:
- In 2020, the total Canadian market of mortgage debt held by MICs was estimated to be between $13 billion and $14 billion.
- In 2020, MICs’ share of all outstanding Canadian mortgages continued to comprise approximately 1% to 2% of the entire Canadian mortgage market.
- The average loan-to-value ratio in the alternative lending sector remained stable over 2019 and 2020, at 59% for MICs with over $100 million in assets under management and 64% for MICs with less than $100 million in assets under management.
Despite the uncertainty introduced by the COVID-19 pandemic in 2020 and 2021, the above-noted data suggests that MICs remained relatively unaffected, continuing to account for approximately 1% of the overall Canadian mortgage market (similar data from 2019 was released by the Bank of Canada in March of 2021).
Regulation of MICs
The capital structure of a MIC and its operations are dictated by Section 130.1 of the ITA. Generally, to maintain status as a MIC, a corporation must have complied with the following criteria throughout the taxation year:
- It was a Canadian corporation;
- Its only undertaking was the investing of funds of the corporation and it did not manage or develop any real or immovable property;
- None of the property of the corporation consisted of:
- debts owing to the corporation that were secured on real or immovable property situated outside Canada;
- debts owing to the corporation by non-resident persons, except any such debts that were secured on real or immovable property situated in Canada;
- shares of the capital stock of corporations not resident in Canada; or
- real or immovable property situated outside Canada;
- There were a minimum of 20 shareholders of the corporation and no shareholder, solely or together with related persons, owned more than 25% of the total outstanding shares at any time, whether such shares are held by the shareholder or related person directly or through a trust or partnership;
- After payment to preferred shareholders of any preferred dividends and payment of dividends in a like amount per share to the common shareholders, preferred shareholders are entitled to dividends pari passu with the common shareholders in any further payment of dividends;
- At least 50% of the corporation’s cost amount of all of its property consisted of any combination of:
- debts owing to the corporation that were secured on “houses” or property included within a “housing project”; and
- deposits standing to the corporation’s credit in the records of a bank or credit union;
- The cost amount to the corporation of all real or immovable property, including leasehold interests, does not exceed 25% of the corporation’s cost amount of all of its property; and
- The corporation’s liabilities did not exceed the thresholds set out in the ITA.
Provided that a MIC’s income is distributed in accordance with the rules set out in the ITA, a MIC itself would not pay any income tax. Instead, the MIC would act as a flow-through entity, such that 100% of its taxable income would be paid to its shareholders in the form of dividends. In the hands of the shareholders of the MIC, the dividends are treated as interest income. Generally, provided the MIC does not hold any indebtedness (whether by way of a mortgage or otherwise) of the annuitant under the plan or any person who does not deal at arm’s length with the annuitant, investors may be able to purchase MIC shares through a self-directed registered retirement savings plan or a self-directed registered retirement income fund, allowing them to defer tax until the funds are ultimately withdrawn.
Further, MICs which intend to raise money through an offering are required to be cognizant of Canadian securities laws, including the prospectus and registration requirements. To offer securities to investors, a MIC will need to either file a prospectus or rely on a prospectus exemption in every province and territory where its investors are located. A MIC may also need to be registered as a dealer, rely on an exemption from registration or sell its shares through a registered dealer. In Ontario, these rules are set out under the Ontario Securities Act. MICs may be able to rely on an exemption to the prospectus requirements under securities legislation, such as the accredited investor exemption under National Instrument 45-106.
In addition, if a MIC arranges mortgages for other lenders or manages mortgage monies through the administration of loan advances on behalf of other lenders, the MIC may be considered to be dealing in mortgages or to be an administrator, respectively, as defined under the Ontario Mortgage Brokerages, Lenders and Administrators Act. As a result, the MIC would be regulated by the Financial Services Commission of Ontario, imposing requirements such as licensing as a mortgage brokerage or a mortgage administrator.
Since at least 50% of a MIC’s portfolio must be invested in residential real estate loans or on deposit at a bank or credit union, the performance of a MIC is heavily dependent on the performance of the Canadian housing market. Based on this, it will be interesting to continue to follow this market after its strong performance in recent years especially given a number of headwinds that appear to be gaining momentum – such as rising interest rates.
We wish to thank Cindy Qi, articling student in Toronto, for her assistance with this article.
1 “Semi-Annual State of The Housing Market” (March 2022), Mortgage Professionals Canada.
2 Will Dunning, “Annual State of the Residential Housing Market in Canada” (2021), Mortgage Professionals Canada.