Canadian alternative lenders face funding challenge as investors flee to safer assets

By Nichola Saminather

TORONTO, Aug 17 (Reuters) - Canadian mortgage investment corporations (MICs), alternative lenders that offer riskier home loans and small construction financing, are struggling to attract investors, firms and analysts said, which could increase pressure on them and spur consolidation in the sector.

These alternative lenders, which make up about 1.5% of Canada's mortgage market, drew investors looking for high returns as interest rates hit rock bottom in recent years. But with rates rising rapidly under a Bank of Canada tightening cycle this year, investors have sought higher-yielding, safer assets.

Concerns about a rapidly cooling housing market and a possible recession given the pace of rate increases have also sapped appetite despite continued high demand from borrowers.

"We're going through a period now where investors are more cautious as to how alternative (investments) and, really the overall real estate market, is adjusting to higher interest rates," said Dean Koeller, president of Calvert Home MIC and chairman of the Canadian Alternative Mortgage Lenders Association.

MICs pool loans to small property developers and to borrowers who do not qualify for residential mortgages from banks, and sell them to investors. Most of these are floating-rate loans whose payments increase alongside interest rates.

The struggles of MICs and other private lenders could indirectly contribute to vulnerabilities in the financial system, the Bank of Canada said in a staff note https://www.bankofcanada.ca/2021/03/staff-analytical-note-2021-2/#22-Reassessing-the-size-of-mortgage-investment-corporations last year, although the sector's small size means the direct impact from its troubles is small. Still, any tremors felt by MICs could affect bigger lenders, from whom MICs borrow funds.

While higher interest rates are good for lenders because they lift margins, investors' demand for better returns is eating in to the higher rates MICs are charging on loans, said Moody's Investors Service Senior Credit Officer Rob Colangelo.

If MICs were to make loans even more expensive to attract investors, any potential rise in unemployment could push borrowers into default, leaving all the parties worse off, he said.

Current conditions could also lead to an increase in bankruptcies or consolidation in the industry, as smaller MICs - which typically have a harder time accessing bank debt - fail to raise enough capital to survive, Colangelo said.

The pullback comes as demand for loans from MICs remains strong, with larger banks tightening lending standards and pushing more borrowers to alternative lenders.

Atrium MIC said on Aug. 10 it had record mortgage advances during the second quarter, ending the period with the biggest mortgage portfolio in its history.

In an ideal world, a MIC would be able to raise enough equity from investors to fund all its mortgage commitments. But MICs like Calvert are funding more mortgages with debt, holding them on their own books longer.

Using credit to fund loans is an "expensive proposition," Moody's Colangelo said, which adds to company risk in a falling housing market.

Another MIC, MCAN Mortgage Corp, is relying primarily on capital it raised last year to fund its lending, even though it does have a wealth business that enables it to tap deposits, Chief Executive Karen Weaver said.

"We did have growth last year from two rights offerings ... and until the markets settle down, I expect we'll just be functioning off of our existing capital," she said, adding that MCAN's focus now is on preserving its bottom line rather than expanding its loan book. (Reporting by Nichola Saminather in Toronto Editing by Matthew Lewis)