How a policy quirk has moved MICs down the risk chain

A study of policy is a study of unintended consequences. One decision made in the halls of government or a corporate boardroom could result in a completely different set of outcomes, creating new winners and losers. In the case of Canadian mortgage lending, policy changes on income reasonability introduced in recent years resulted in an unusual outcome: banks lent to fewer Canadians, and borrowers with good credit were left to borrow from alternative lenders.

But why does that matter to investment managers? Because many of these borrowers who had good credit but lacked provable income — whether due to a cash job or a different set of circumstances — ended up getting their mortgage through a mortgage investment corporation (MIC). The result, according to one MIC CEO, has been a relative de-risking of these high yield assets. He argues that this quirk of policy, combined with the ongoing interest rate cutting cycle, may make MICs an appealing asset class once again.

“We’ve seen an influx of billions of dollars into the MIC space in the last five years from investors, and its turned smaller MICs into very large players. It’s pushing quality mortgages into the private lending space,” says George Moutsouroufis, CEO of M12 Capital. “Even with rates easing off now we’re seeing private mortgages at around seven or eight per cent plus closing costs.”

The trend towards these slightly less risky borrowers, combined with those high yields, brought about a boom in MIC investment — especially before the interest rate hiking cycle began in 2022. At the same time, a combination of lending policy and internal underwriting decisions have resulted in a careful approach to borrower risk among many MIC lenders. While these loans are secured against houses, Moutsouroufis notes that lenders like him have become very careful about balancing loan to values to protect against weaknesses in the housing market. Lenders are looking at neighbourhood data, property particularities, and market movements to fully grasp the risk they’re taking on.

Despite these steps — and those less-risky borrowers — Moutsouroufis says that the whole MIC industry saw a steady decline in capital flows when rates began increasing in 2022. When cash was paying close to five per cent, effectively risk-free, many of the yield-hungry investors who flocked to MICs under a zero interest rate policy left the space. He notes, however, that the ongoing decline in interest rates — especially in Canada — has seen capital move back into the MIC space. He adds that the increase in the capital gains inclusion rate has also incentivized MIC investing as the yields are paid as simple interest.

While many advisors may have stepped away from MICs as an asset class during that interest rate hiking cycle, Moutsouroufis says he is seeing many return to MICs. As they begin to explore the assets again he highlights a few notable changes in the landscape. First and foremost he emphasizes the idea that we are at or near the bottom of the real estate market, which should help with risk management as properties are unlikely to depreciate further. He adds too that the yields from MICs have become more attractive relative to other income paying assets. He cites his own MIC funds which target 9.5 per cent yields.

While somewhat limited as an exempt market product, Moutsouroufis believes there is an opportunity for advisors who can take on these products to discuss what MICs can do now for clients with higher risk tolerances and longer time horizons. In those conversations, Moutsouroufis believes advisors need to drive home the changes in lending rules that underpin MICs resurgence.

“There is definitely going to be a resurgence of this type of private asset,” Moutsouroufis says. “We’re already seeing a significant increase in activity, in deals coming in, because of all these rule changes with the banks, and I don't think the rules are ever going to be back to what they were.”