Spotting the Red Flags: Interest Rate Hikes and MIC's

Here's how knowledge of interest rate changes helped me uncover some some irregularities in a private mortgage investment corporation. This is also a lesson in why if you have questions - you should put up your hand and ask them...even if no one else is asking the question.

Last year I attended a presentation from a mortgage investment corporation (MIC). MIC's are an investment vehicle where they take your funds and lend them out as mortgages. They are usually lending to entities who can't get a mortgage from the bank so yields are higher. This private MIC (as many alternative asset managers do) bragged about the stability of their fund.

The returns were basically a straight line. The higher yield (historically about 6%) made it a great addition to the portfolio - especially as a bond replacement. (Their words).

This presentation was in 2023 after the run up in interest rates. Their forward looking expected yield increased from 6% to 8% over the next few years. This was odd to me so I asked the question: "Interest rates have gone up more than 4% - why is the expected yield only going up 2%?"

Their answer: "It takes time for loans to mature so it will be a while for the rates to increase." Seems plausible. Until the next person asked about NAV stability and they said "oh our loans are very safe and very short term. In fact all our loans are under 2 years right now".

I felt uncomfortable doing it but my hand shot back up. My question: "I don't understand. If your loans are under 2 years then by 2026 shouldn't the interest rate hikes be fully realized in your expected yield?

"Them: Well to be honest..."

(What comes next is WILD).

It turns out that many of these loans are underwater. They buildings were lent at 70% loan to value but the real estate in those areas has dropped more than 30%.

If they forced owners to renew - the increased rates may cause defaults and potentially owners walking away from the property and the loan. Instead - they chose to "extend and pretend". They would leave the loans at original rates & owners continue to pay.

Because it's not "technically" a default and private mortgages don't have a value on the open market...The MIC get's to keep pretending everything's fine.

The key takeaway? Do your due diligence. Understand what you are buying and how the mechanics work. If you don't understand? Ask the questions. You owe it to yourself and your clients to do the work.

Video with a few more notes here: https://www.dhirubhai.net/posts/sithamparapillai_a-little-due-diligence-and-industry-knowledge-activity-7220895937865375744-6noJ?utm_source=share&utm_medium=member_desktop

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