What is a MIC?
The Mortgage Investment Corporation (MIC) structure was created by the federal government in 1973 to offer more funds to the market than banks were willing to allocate, while simultaneously stimulating investments in residential mortgages by the private sector. MICs provide their shareholders with monthly distributions from a portfolio of mortgages that generate steady cash flows on a long-term basis, while providing ownership of the underlying assets to the fund (or shareholders) as security and source of capital preservation.
What does a MIC manager do?
The MIC manager’s job is to gauge ongoing risks on the lending side. However, the manager must also assess the capital-raising aspects to ensure that capital flow is in line with deal flow and investor/borrower expectations at all times. This is a balancing act for only the most experienced managers.
What is leverage?
One might define leverage as the practice of using debt to augment the return on equity within a fund or operating business. In the case of mortgage investment corporations, the manager tries to create greater profits for investors from what they borrow. The spread between what is earned and what is borrowed is the margin of profit from leverage used.
Although the decision to use leverage (and determining the capacity) is a significant portion of the overall strategy to consider for a MIC manager, it is also important that investors understand the risks associated with leverage.
Can leverage impact shareholder value?
Let’s say in the unlikely scenario two similar mortgage portfolios of $200 lose 10% of value…
MIC A raised $200 in equity (no leverage)
MIC B raised $100 in equity and borrowed $100 (levered 1 to 1)
Impact on shareholders through 10% loss in mortgage portfolio:
MIC A shareholders lose 10% ($200 -10% = $180)
MIC B shareholders lose 20% ($200 – 10% = $180 – $100 secured by lender = $80)
In the case of MIC B, the $100 (from source of leverage) is in first position before realizing losses, leaving only $80 leftover for shareholders creating an enlarged loss of 20% overall. The same dollar figure was lost in each scenario but the loss for MIC B is shared amongst a lesser amount of shareholder equity.
The term “capital preservation” often used by MICs is diluted by leverage; as asset values change, liabilities do not, meaning that potential losses would be magnified.
Things to note:
- A high ratio of leverage generally reflects a higher risk profile but also greater potential for higher returns.
- The source of MIC leverage (a bank or otherwise) has the ability to influence the overall operations and lending strategy, impact shareholder value and potentially amend the successful philosophy laid out by founders.
- Today’s low interest rate environment makes it very tempting to borrow and lever; one must remember that rates will eventually rise.
Does Frontenac use leverage?
As managers, we have taken the strategy of truly putting “capital preservation” first, with a reasonable return second. This means we have chosen NOT to use leverage. Instead, we use real equity raised from a diverse group of investors to fund residential mortgage opportunities that our equally diverse group of mortgage brokers provides us on a daily basis.
How does Frontenac generate a reasonable return?
In our case, when leverage is not used, the cost of capital is generally higher. Investors provide the capital to get a return that matches the risk they think they are taking. In our situation, the only way to generate the return is to do so through assets (interest payments through security on real property). This means we need to continually seek out opportunities that will generate the yield desired by investors while functioning within the mandate of the MIC structure. Finding equity and using it prudently so it is not sitting by idly is a constant matching game.
In order to alleviate some risks associated with not levering, we spend a great deal of energy and intelligence developing systems, processes and relationships to work towards keeping investor capital working at or near 100% at all times.
“When considering any investment product, particularly a MIC, make sure that you scrutinize the management, its experience, and how much time that team has been in the marketplace. The biggest risk one can take when choosing any product is the management’s philosophy. It is extremely important to know the market, the risks and the opportunities. The management team needs to have a lot of familiarity and a strong track record with the strategies they employ.”
~ Matthew Robinson
With over three decades of experience in this space, W.A. Robinson Asset Management Ltd. remains true to its philosophy while valuing the mission the federal government intended with MICs in Canada: Making funds available to those who need it while providing capital preservation to investors with a reasonable return through the residential real estate market.
