The mortgage investment corporation that have the most success as public companies always had great success when they were private. At a minimum, you should gather information about the history of the MIC in its previous incarnation. REUTERS/Mike Cassese
In the spring of 2009, as the financial markets began to extricate themselves from the grip of the financial crisis, it was clear investors would eschew the public equity markets in favour of investments with stable valuations and the provision of predictable, consistent yield.
In a truly ironic twist, after months of research, our firm determined that mortgage funds — the very instruments of destruction that received much of the blame for bringing the entire global financial system to the brink of extinction — could well be the instruments to assist weary investors at such a precarious time.
Mortgage funds are neither new nor particularly complex. For years, investors have enjoyed the steady cash flows of these funds whose simple model is to aggregate investor capital, underwrite, originate and administer a pool of mortgages, and pay the interest out to investors net of fees collected by the managers.
In Canada, many of these funds are structured as mortgage investment corporations, or MICs, flow-through vehicles that relieve the burden of taxation at the corporate level, resulting in taxation of interest income only in the hands of investors.
When we started our research (which ended up producing an amazing list of 360 MICs across Canada), the vast majority of MICs were private, with shares available only to “qualified” high net-worth investors. There were a handful of publicly-traded MICs, such as Timbercreek Mortgage Investment Corp. (TMC/TSX), but they were few and far between.
Although the majority of the MICs we researched were, in our opinion, inappropriate for large-scale consumption (too small, too new, unprofessional, lack of brand-name auditors and legal representatives), we were able to identify a handful that we deemed suitable investment.
Our investors profited handsomely at a time when yield was either very low or required the assumption of significant risk to achieve.
Eventually, the unknown world of MICs became the plat du jour of many investment advisors, and it was time for this hitherto little-known investment to have its time in the sun.
Today, there are numerous publicly traded MICs vying for investors’ capital. Luckily for the investing public, most of these MICs are run by experienced, reputable, professional management teams. Still, there is a lot more to consider than just projected returns when deciding which MIC to invest in. Here is a short list of important items we recommend be considered.
1. Experience and expertise. In a “hope for the best, but plan for the worst” world, it is imperative you know on the way in that your managers can handle difficult situations. The MIC model is simple, but not easy to execute. It is critical the management team of an MIC have vast experience in all quarters of the mortgage space. This includes underwriting, ongoing monitoring, and
the ability to work out mortgages in default.
2. Lending fees. Sometimes referred to as “origination fees” or “administrative fees,” many mortgages in the alternative space require upfront fees paid by the borrower at the time of funding. Some managers throw these fees into the pot to be treated as interest that will find its way into investors’ hands. Others keep these fees.
If the fees are kept by the managers, they should be transparent, capped and considered part of the management fees. Even where these fees are shared with investors, they should be added to the face rate of the loans in question when using interest rates as a proxy for the risk attached to any loan.
3. Investment committees matter. When an MIC is faced with a prospective loan, the loan is usually passed through an investment committee for verification and confirmation. This committee should act in the best interests of shareholders, which requires that at least some of the members of the committee be independent of management.
Just as you would look to the independence of a public company’s board of directors, so, too, should you investigate the degree to which you believe the investment committee of an MIC “has your back” when key decisions are being made that affect both your returns and your capital.
4. Public company experience. Although distinct in many ways from other public companies, publicly-traded MICs are subject to the same challenges and regulatory requirements as other listed entities. It is therefore important that the managers of these MICs have the expertise and experience to do their primary job of finding suitable mortgages for the funds, but also have a deep knowledge and experience in navigating public markets.
5. MICs aren’t good investments. Good MICs are good investments. Just because your advisor calls you with the name of an MIC that is going public doesn’t mean you should be writing a ticket. The MICs that have the most success as public companies always had great success when they were private. At a minimum, you should gather information about the history of the MIC in its previous incarnation. The more professionally it was run before it chose to raise capital through the public markets, the higher the chances that it will continue to excel once it is public.
In the almost four years that have passed since we started studying MICs, the demand for alternative mortgage investments has dramatically grown. So, too, has the supply. We are still very bullish on this space as a provider of attractive risk-adjusted returns.
Being bullish, however, is not due diligence. Do a little of your own and you’ll quickly discover that not all MICs are created equal. With such a plentiful supply of publicly traded MICs available, you should be able to identify the few that are best-in-class. Invest in them and prosper.
David Kaufman is president of Westcourt Capital Corp. a portfolio manager specializing in traditional and alternative asset classes and investment strategies