Judging from recent pronouncements by the chair of the U.S. Federal Reserve Board, interest rates are likely to remain low in the U.S., and inevitably Canada, for at least another three years. With the best five-year guaranteed investment certificates (GICs) yielding barely more than the inflation rate, what's an income-seeking investor to do?
For higher yields, investors must climb the risk ladder. This usually means turning to corporate bonds, preferred shares, real estate investment trusts (REITs) and dividend-paying stocks. Another lesser known investment for fixed income is the mortgage investment corporation.
MICs were created in 1973 to make it easier for small investors to participate in the residential mortgage and real-estate markets. These corporations pool investors' funds and lend the proceeds for mortgages secured by real estate. At least 50% of an MIC's assets must be residential mortgages and/or deposits, the latter insured by the Canada Deposit Insurance Corp. MICs can usually be held in registered accounts.
MICs, which are governed by section 130(1) of the Income Tax Act, pay no corporate tax. All net income is paid to investors and taxed in their hands as interest income. This translates into regular distributions that are several percentage points above the yield of a five-year GIC. Some MICs, such as CareVest First Mortgage Investment Corp., have posted 10-year returns of 9% or more. In recent years, yields have been trending lower with the general decline in interest rates. (Disclosure: I own shares of CareVest MIC.)
These relatively high returns come with the risk of losing some or all of the capital invested. MICs tend to specialize in higher-risk lending, often financing real-estate purchases that don't qualify for regular mortgages offered by financial institutions.
A borrower might be a home buyer who is self-employed or has a poor credit history, or a business seeking funds for construction, property development or other special-situation financing. Some of these borrowers will default and the MIC may be unable to recover its money. Another factor that heightens the risk of MIC investing is that these corporations are allowed to borrow money to invest in mortgages.
Some MICs are public companies. Firm Capital Mortgage Investment Corp. FC, Timbercreek Mortgage Investment Corp. (TMC/TSX) and MCAN Mortgage Corp. MKP trade on the Toronto Stock Exchange and, as such, are governed by the exchange's listing requirements and rules. They currently pay shareholders regular distributions in the 7% to 7.5% range. (I also own shares of Timbercreek Mortgage.)
At current prices, anyone with a brokerage account can invest in a publicly traded MIC for under $1,500 for 100 shares. Purchases or sales are as quick as trading any stock. The value of the investment will fluctuate with the share price.
Other MICs are not listed on the stock exchange. They sell securities by private placement. In most provinces, these MICs or their sales representatives must be registered as exempt market dealers under securities legislation.
Jeremy Farr, a partner at Borden Ladner Gervais LLP in Ottawa, is well versed in the intricacies of MIC regulation. He says that provincial securities law determines whether an individual residing in that province can buy shares in a non-listed MIC. Ontario is the most stringent. A person must be an accredited investor -- essentially a high-net-worth individual -- or initially purchase at least $150,000 worth of shares.
In British Columbia, New Brunswick, Nova Scotia, and Newfoundland and Labrador, the purchaser need only receive an offering memorandum and risk-disclosure statement. In the other provinces and territories, which also have memorandum and disclosure requirements, individual purchases are restricted to less than $10,000 per transaction unless high-net-worth criteria are met.
The capital needed to invest in some private MICs, such as B.C.-based V.W.R. Capital Corp., is minimal. Others require a substantial investment. For example, an initial subscription in Magenta Mortgage Corp.'s Class A participating shares is at least $150,000.
Private MICs frequently have minimum holding periods of a year or more. Share redemptions are not immediate and could take several weeks. Early redemptions may be possible if an administration fee is paid.
There is no standard reporting of the total costs that MIC investors pay. Management compensation may include a percentage of total mortgage assets, bonus payments and various fees associated with the mortgage business. Other costs charged to the MIC range from mortgage licensing and securities fees to all the usual costs of running a business.
When choosing a MIC, consider:
- What is the track record of the MIC? Have investors ever lost their investment capital?
- Who are the managers and how are they compensated?
- What costs are charged to the corporation?
- What kinds of properties are mortgaged and what is their geographic distribution?
- How are mortgages chosen? What maximum loan-to-value ratio is used?
- What is the mortgage impairment rate? What happens if a borrower defaults?
- Is leverage used?
- What risk-management policies are in place? What is the capital reserve?
- What are the redemption procedures?
Fisgard Capital Corp.'s PIC-A-MIC sets out in detail the most important factors to evaluate.
MICs provide individual fixed-income investors with higher-risk, higher-reward returns. As with any risky investment, due diligence is essential.
