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When investors first hear about Mortgage Investment Corporations (MIC), often, there’s an inclination to reference Mortgage Backed Securities (MBS).
There are some similar elements to the two models, but there are some major fundamental differences that should be noted for those interested in investing.
Let’s discuss the similarities first:
Both Mortgage Investment Corporations and Mortgage Backed Securities:
- Provide an avenue for investors to invest in mortgages without requiring any mortgage lending knowledge or administration by converting mortgage loans into tradeable (or redeemable) securities whereby interest payments are paid back to investors.
- Focus on residential housing (single family, multi-family etc)
- Can be held in registered accounts.
How they are different:
An MBS in Canada is secured by mortgages that qualify under the National Housing Act (NHA) and the Canada Mortgage Bond (CMB) programs. Financial Institutions (Often the Big 6 Banks) use these pools of funds to both meet funding needs and regulatory liquidity requirements by holding these assets on their books.
NHA MBS offer two options – a pre-payable mortgage pool where mortgage borrowers have the option of paying more of the principle than originally agreed which provides for less predicative streams of returned principle, or a non-pre-payable mortgage pool that does not permit these extra or lump sum, un-scheduled payments. The principle payments create a need for reinvestment, and so, require active management by lender and investor.
MBS pricing fluctuates with changing interest rates. The pricing of NHA MBSs are also adjusted for the amount of principal that has been repaid during the holding period.
The CMB program was created in 2001 to increase the flow of cost efficient funds from investors to borrowers through FIs (Financial Institutions) by creating steady, reliable payments investors could depend on. The CMB is attractive to investors due to lessened management requirements because, unlike NHA MBS, they do not pay back portions of principle which require re-investment. NHA MBSs are often packed by (approved) sellers and sold to the CMB program through the Canada Housing Trust which then disperses them to investors. A CMB MBS pays a steady stream of interest income like a bond and the full principle is returned upon maturity. These MBS Bonds, like conventional bonds can be held to their maturity date or sold prior to their maturity in the secondary market.
The pools generate capital for FIs that can be used in their everyday mortgage lending activities if certain requirements are met. Canada Mortgage and Housing Corporation (CMHC), a crown corporation, is responsible for issuing MBSs, and insuring and guaranteeing the timely interest payments and return of principle to investors.
MBSs consist of mortgage loans that CMHC considers to be high quality borrowers and properties and are deemed to be “AAA” instruments like government of Canada bonds. These loans are often packaged into varying tranches (slices/portions) of loans previously administered and re-sold to the market. Due to the high quality of the loans and the guarantee provided, the returns generally match the little risk taken by the investor.
Residential mortgage securitization has been a large part of the Canadian housing system, and increasingly so over the last 15 years with the introduction of the CMB program. CMHC plays a key role in stimulating the housing market and encouraging home ownership while attempting to mitigate the government’s overall liability at the same time. NHA and CMB bonds take up over $400 billion of the entire mortgage market in Canada. (As of June 2015, per the BoC Financial System Review). With an estimated $1.4 trillion of outstanding mortgage debt in Canada, CMHC has capped it’s limit on issuing MBS’s at $600 billion to manage housing market risks and Government’s exposure to the housing sector.
The Mortgage Investment Corporation was introduced in 1973 by the Government of Canada through the Residential Mortgage Financing Act to make it easier for small investors to participate in the residential mortgage and real estate markets.
MICs are secured by mortgages selected by independent management & administration companies and their holding requirements are defined under the income tax act. (i.e 50% must be held in residential, must be Canadian property, etc.)
MICs raise capital through their management company and lend the pooled investor funds out through the administration company, often through a network of mortgage brokers within Canada.
A MIC is treated more like an investment fund or operating company under the eyes of provincial securities regulators. They are considered a “flow through” vehicle for investors to participate in the private mortgage market, while providing capital to areas, people or properties that larger financial institutions will not or cannot lend to.
Shares of MICs are often offered by an OM (offering memorandum) with a select few offered through prospectus, most of which are listed on the TSX. Those listed on the TSX experience a fluctuation in share value due to market activity whereas those not listed generally maintain a consistent share price as 100% of net income is distributed to shareholders.
The management company of the MIC raises capital in the retail or institutional markets from investors that meet the criteria of their OM or Prospectus offering. A MIC investor invests into the pool of mortgages that have been underwritten by the administrator of the fund. Generally speaking, the administrator sees out these mortgages from funding stage to payout stage and, in most cases these mortgages are not packaged or sold to third parties.
MICs offer no guarantees and are most impacted by management decisions and strategy. Longer running MICs with consistent returns generally offer more comfort for investors. The attractive returns match the added risk for not being ‘guaranteed’.
Redemptions in MICs can often be made on an annual basis or as deemed suitable by the management company.
MICs are said to take up approximately 2% of the total market. There are numerous MICs across the country run by varying management teams with varied strategies. The number of MICs over the last 10 years has risen dramatically, a reflection of CMHC’s cap on issuing MBSs, increased underwriting restrictions and general tightening by FIs. This tightening opens lending opportunity for MICs that command higher interests rates on their loans and attract investors looking for higher fixed-income returns.
A MIC’s return does not fluctuate with changing market interest rates because of the alternative market that they serve. Pricing decisions are based solely by the management company. With that said, the returns can fluctuate due to other market conditions and overall performance.
As you can see, although a similar concept, the two entities are quite different operationally and serve diverse purposes for both investors and the end borrowers while impacting the overall mortgage landscape on a dissimilar scale.