In the landscape of Canadian mortgage financing, while traditional lenders hold a dominant position, alternative lenders are emerging as significant players by offering creative financing solutions for borrowers unable to secure conventional loans.
Mortgage financing in Canada is dominated by traditional lenders, such as chartered banks and credit unions. There are, however, alternative lenders. For example, mortgage investment entities ("MIEs") pool capital from investors to provide loans to borrowers who are unable to access conventional mortgage financing. Mortgage investment corporations ("MICs") are a sub-category of MIEs that meet certain criteria under the Income Tax Act ("ITA"). In this sense, all MICs are MIEs but not all MIEs are MICs. In this article, we will provide an overview of MICs in Canada.
What are MICs?
MICs are investment and lending companies specifically designed for mortgage lending in Canada. Generally, private MICs raise capital by issuing shares to investors at a fixed dollar amount per share. These funds are then used to invest in a portfolio of mortgages with more creative financing terms than those of traditional lenders. Interest income generated from these mortgages is usually distributed to shareholders as dividends.
Under the ITA, dividends received by MIC shareholders are generally classified as interest income. Capital gains realized by an investor on the shares of a MIC are subject to the normal treatment of capital gains under the ITA – that is, taxed at one-half the rate of tax on ordinary income. It is worth noting that shares of a MIC are "qualified investments" for the purposes of most deferred income tax plans, including RRSPs, RRIFs, TFSAs, RESPs and RDSPs.
Overview of the market
On May 29, 2024, the Canadian Mortgage Housing Corporation released its annual Residential Mortgage Industry Report. The key takeaways are as follows:
- Assets under management of the top 25 MIEs in Canada decreased by 2.1% in the fourth quarter of 2023 (year-over-year), marking the second consecutive quarter of decline;
- During the fourth quarter of 2023, the alternative lender risk portfolio increased (year-over-year) as evidenced by higher defaults and foreclosures in both the single family and multi-family segments;
- The proportion of first lien mortgages decreased, thereby heightening MIEs' vulnerability to amplified losses in the event of default; and
- The share price of publicly traded MIEs has risen in 2024, suggesting a shift in investors' appetite toward high-yielding funds/stocks.
Benefits of becoming a MIC
MICs are not subject to the strict lending guidelines required for traditional lenders and, as a result, offer flexibility in lending terms. This flexibility ultimately enables MICs to provide individually-tailored loans. Because MICs often lend to borrowers that do not qualify for traditional loans, they are able to charge higher interest rates than traditional lenders. A major benefit of becoming a MIC is that their mortgage portfolios are continuously managed with newly invested share capital because of the short-term nature of the loans.
Capital structure of MICs
The typical structure of a MIC is a business corporation with one class of common shares and one or more classes of non-voting, preferred shares. Common shares usually carry the right to vote and are held by persons close with the manager of the MIC. Preferred shares, on the other hand, typically receive all the economic benefit of the MIC assets and are offered to passive investors.
Regulation of MICs
Section 130.1 of the ITA sets out the criteria to qualify as a MIC. The key conditions that must be satisfied throughout the applicable tax year are:
- The corporation must be a Canadian corporation;
- The corporation's only undertaking is the investing of its funds. A MIC cannot be actively managing or developing real property;
- Debts must be secured by real property located within Canada;
- The corporation must have at least 20 shareholders. No one shareholder, together with related persons, may own at any time, directly or indirectly, more than 25% of the issued shares of any class or series of the corporation;
- The corporation is required to hold at least 50% of its assets in the form of money or debts secured on residential property; and
- In addition to the 50% asset test referred to above, the corporation must maintain a prescribed debt to equity ratio and must limit holdings in real property to under 25% of the cost amount of all of its property.
Specific to British Columbia
Under the British Columbia Mortgage Brokers Act ("MBA"), B.C.-based MICs must register with the BC Financial Services Authority as a "mortgage broker." The definition of mortgage broker under the MBA captures any legal person who lends money secured by land in or outside of B.C. In addition, each MIC must have at least one "sub mortgage broker." This is any person in B.C. who actively engages in any activities of the mortgage broker as an employee, director or partner.
In the province, the MBA has always regulated the brokering and lending activities of MICs. Prior to 2019, however, the province was an outlier when it came to distributions of MIC securities and the dealer registration requirement. Before changes in 2019, B.C. found that it was not "contrary to the public interest" that MICs were able to distribute their securities to the public without registration as a dealer or through intermediation of a dealer.
Now, to offer securities to investors in B.C., MICs must either file a prospectus or rely on a prospectus exemption in every province and territory where its investors are located. A common exemption that is utilized by MICs is the offering memorandum exemption. This exemption allows MICs to provide a detailed offering memorandum to potential investors, outlining the investment strategy, risk factors and financial performance, thereby ensuring transparency while streamlining the fundraising process.
By utilizing this exemption, MICs can efficiently access a broader pool of investors, facilitating the growth of their mortgage portfolios and enhancing liquidity in the real estate market. This approach not only reduces regulatory burdens related to fundraising but also fosters an investment environment that can be more agile and responsive to market conditions. In addition, MICs must use exempt market dealers ("EMDs") to raise capital. EMDs are companies registered with the British Columbia Securities Commission and authorized to trade in exempt market products, such as MIC preferred shares.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.