MICs In Your Mix

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Image by Nattanan Kanchanaprat from Pixabay

Investing in units of a Mortgage Investment Corporation (MIC) is a way to bolster the yield of the fixed income portion of your asset mix. The current 1.7% yield on a diversified portfolio of Canadian bonds remains low by historical standards. In the meantime, the likely transitory bump in inflation has seen the core inflation rate rise to 2.7%, implying a negative inflation adjusted return on bonds. So, let’s mix things up and look at how MICs may be one solution to boost your fixed income returns.

MIC Mechanics

Let’s use the source of everything housing related in Canada, the CMHC, to understand MICs:

  • Enabled by federal laws passed in 1973 to increase the “flow of mortgage funds” and provide a channel for small investors to participate in private lending for housing
  • A pooled investment fund with mortgages backed by real estate collateral
  • All interests in real property must be in Canada
  • Must have at least 50% of their assets in residential mortgages, cash, and insured deposits
  • Typically provide shorter-term mortgages at higher fees and rates to borrowers who have difficulty qualifying with banks and credit unions
  • They define their own underwriting criteria for lending
  • Borrowers are often self-employed, entrepreneurs, and real estate investors with short term cash needs
  • Most are externally managed through a separate management company which originates and manages the mortgages in return for fees which are typically 2% or more
  • Overseen as investment vehicles by provincial securities legislation
  • As they do not pay corporate tax, all income is paid out as dividends to shareholders
  • Eligible for government deferred and tax-sheltered plans such as RRSPs, RRIFs, and TSFAs

CMHC estimated the size of the MIC market at $14-$15 billion in 2019. While that sounds big it is only 1% of all outstanding mortgages in Canada. MIC lending is concentrated in large urban centres. They employ leverage, typically loans from banks, to increase the size of their mortgage portfolio. In turn, due to the higher rate of the MIC’s mortgage rate compared to the rate on the bank loan, dividends to investors can be increased. Chart 1 below shows how MICs are structured.

Chart 1

Source: CMHC

MIC Merits

There are several attributes to look for in a MIC:

  • A record of stable monthly income flows
  • Attractive historical yields and returns versus bonds or GICs
  • Historically low loss rates
  • A strong management team and effective operational and compliance controls
  • Regular and sufficient investor information provided
  • Low average term to maturity of the mortgages (this reduces exposure to interest rate risk and to fluctuating real estate prices)
  • Mortgages diversified across provinces (reduces geographic risk)
  • Mortgages that are concentrated in owner-occupied properties in major urban centers (more marketable in event of default)
  • High proportion of first mortgages and low loan to values (decreases risk of loss from defaults)
  • Reasonable redemption features
  • Low volatility of monthly returns (typical for private MICs given stable unit prices)
  • Significant investment by the managers and insiders (aligns interest with investors)
  • Independent board guidance or oversight

MIC Minuses

These are the main risks for MICs that come along with the potential for earning higher returns:

  • The lower credit quality of MIC borrowers
  • A significant and sustained downturn in the housing markets, and if applicable commercial real estate markets (this will reduce the value of the collateral against the mortgages and may make the properties more difficult to sell in the event of default)
  • The impact of a sudden increase in the rates on the MICs bank loans or the withdrawal of the bank financing
  • Private MICs are illiquid and have restrictions on redeeming units
  • Public MICs’ monthly returns can be as volatile as other publicly traded stocks

MIC Markets

CHMC estimates there are over 200 private MICs. However, only accredited investors[1] can buy units in them. Fortunately, anybody with a brokerage account can choose from four large publicly trades MICs on the Toronto Stock Exchange. These are Atrium MIC, Firm Capital MIC, Timbercreek Financial Corporation, and MCAN Mortgage Corporation.

Table 1 compares three of the public MICs. Atrium (ticker AI) and Firm Capital (ticker FC) are structured the same as most private MICs. I have also included Timbercreek Financial Corp. (ticker TF). It is a little different as it has assets other than direct mortgages, has a larger portion of commercial mortgages, and has much higher leverage (debt/equity). I have not included MCAN (ticker MKP) for several reasons. Its business model involves securitizing a substantial portion of their mortgages. It is also registered as a Loan Company under the Trust and Loan Companies Act (Canada) as it funds a substantial portion of its portfolio through short term deposits from investors. Finally, compared to the other companies it is highly levered.

Table 1

Sources: Morningstar, company reports

As you can see from the table, Atrium has the highest percentage of residential mortgages and Timbercreek the lowest. While Firm Capital has the highest amount of riskier second mortgages this is mitigated by having the lowest loan to value on its mortgages and the lowest leverage. Timbercreek has the highest percentage of first mortgages, and on the flip side, the lowest number of loans, the highest loan to value, and substantially higher leverage.

MIC Mapping

Table 2 below shows the geographic concentration of the three public MICs. Atrium and Firm Capital are highly concentrated in Ontario, while Timbercreek is more balanced among BC, Alberta, Ontario, and Quebec.

Table 2

Sources: Company reports

MIC Money

Given the lack of data for private MICs, let’s look at the yields and returns on the three public MICs from Tables 1 and 2. Chart 2 shows the trailing 12-month yields, calculated monthly over the last 5 years. You can see how the yields are extremely attractive, and all three have averaged over 7%. The spike in yields in early 2020 was during the big Covid-related stock market selloff. This dropped the prices of the MICs by 40%-50%. Since the monthly dividend distributions remained constant, the yields temporarily shot up. As prices recovered and the dividends remained the same, the yields fell to the current levels of 6.2% for Atrium, 6.4% for Firm Capital, and 7.3% for Timbercreek (due to its much higher leverage). Compared to 1.7% for a diversified bond fund or 0.6% for a 3-year GIC from the major banks these yields are still attractive .

Chart 2

Source: yahoo!finance

MICs look even better from a historical return perspective. In Chart 3 the three public MICs easily outperformed the annualized return from bonds by a minimum of 4% to a maximum of 7% over the three-year and five-year periods. In fact, over the last three years Atrium and Firm Capital had returns closer to equities. There were two trends that boosted MIC returns significantly above their trailing 12 month yields. First, their share prices benefited from falling rates on competing products. Second, rising real estate prices increased the value of the collateral securing the mortgages.

Chart 3

Source: Morningstar

MIC Manifesto

MICs make sense in your mix if you have the appetite and capacity. You can increase the yield of your fixed income portfolio with an investment that is backed by real estate assets and offers an attractive yield for the risk and liquidity. There are many private MICs that you can compare to the data for the three public MICs structures in the tables and charts. You may find all the “MIC Merits” in one MIC or you may find that investing in a few might achieve better diversification. Of course, remember there is no free lunch, so make sure you understand the “Mic Minuses” as well.

Invest Wisely,

Dave Schaffner, CFA

Principal, Wayfairer Capital Management Ltd.

[1] To qualify as an accredited investor you must meet one of the following criteria: you alone or jointly with your spouse must have net assets (not including equity in your primary residence) greater than $5M; your income must be greater than $200,000/year, or joint salary of $300,000/year, in each of the last 2 years and you expect to reasonably keep the same level of income; you have aggregate financial assets alone or jointly (for example cash, stocks, and bonds) of at least $1M.