Economic downturn hits alternative lending industry

A home for sale on Sumach St. in the Cabbagetown neighborhood of Toronto, pictured May 21, 2020.Fred Lum/The Globe and Mail

The coronavirus pandemic is hitting alternative lenders hard, with a substantial drop in business, a handful of mortgage investment firms preventing investors from redeeming their funds and others trying to offload their home loan portfolios.

In Ontario, mortgage registrations by private lenders fell 26 per cent in June from the same month last year, according to Teranet, which operates the province’s electronic land registration system. This follows a 45% drop in May and a 29% drop in April, when property sales tumbled and private lenders halted lending to gauge the economic rout.

Industry experts say the slowdown will reveal where the sector’s weaknesses lie.

“The tide is going down right now. We’ll see very quickly who’s been naked all this time in the world of private mortgages,” said Dustin Van Der Hout, investment adviser at Richardson GMP Ltd.

In contrast, banks, credit unions, trusts and insurance companies suffered more moderate declines over the same period. Mortgage registrations with major Canadian banks fell 3% in June compared to the same month last year. This follows single-digit percent declines in May and double-digit gains in April, according to Teranet. (Mortgage loans are registered after the lender has granted the loan to the owner.)

Alternative lenders include Mortgage Investment Companies, or MICs, which pool funds from investors to provide mortgages. They lend to the self-employed and a high-risk segment of the population, as well as homeowners facing an unfortunate turn of events like sudden job loss, divorce, or health issues.

They have risen rapidly over the past decade as house prices jumped and policymakers tightened mortgage rules to keep homeowners out of debt, putting traditional mortgages out of reach for some borrowers.

But when the pandemic hit in March and millions of Canadians lost income, it put pressure on lenders.

Banks have set aside more funds to cover loan losses and have seen a steady increase in demand for mortgage deferrals. By the end of June, banks were offering mortgage deferrals of up to six months to more than 760,000 homeowners. That’s about 16% of their residential loan portfolio, up from 10% in April, according to their industry group, the Canadian Bankers Association.

Meanwhile, weakness is surfacing among private lenders and MICs, where the loan interest rate can be three times that of the bank.

“If the bank sees 16% arrears on quality mortgages that pay 2% to 3% interest, what is the arrears rate for someone paying 12% to 15% through a private lender?” says Mr. Van Der Hout.

Unlike banks, private and alternative lenders generally do not defer payments.

As a result, some face headwinds from their borrowers, investors, or both, i.e. homeowners who have lost income and cannot make their mortgage payments and investors who wish to withdraw their money from the fund.

Westboro Mortgage Investment LP and Morrison Laurier Mortgage Corp. halted redemptions at the start of the pandemic.

At the time, Westboro told its investors, “It has been determined that the temporary suspension will protect the long-term interests of all unitholders during this period of economic uncertainty and limit the effects of the pandemic.” Morrison Laurier said he “has no choice but to suspend dividends, redemptions and new purchases at this time for a period of 90 days”. The two did not respond to a request for comment.

Meanwhile, smaller, struggling alternative lenders have tried to offload their mortgage portfolios to more established counterparts, such as RiverRock Mortgage Investment Corp.

“A lot of these people have no experience in lending. They weren’t lenders before they started this business. They don’t have any institutional or executive lending experience,” said Nick Kyprianou, managing director of RiverRock, which has agreed to buy some of their portfolios. “They have all been around for 10 years. But the problem is that for the last 10 years the market has been very good and corrected all the mistakes you made. You don’t even know you made the mistake,” he said.

Mr Kyprianou said some PRIs often do not fully understand the risks associated with giving a borrower a second or third mortgage. The most recent data available shows that the largest PRIs have increased their exposure to these second and third mortgages, according to the Canada Mortgage and Housing Corporation. .

The exact size of the alternative lending market is unclear. CMHC estimates there are around 200 MICs in the country, although some mortgage brokers say there could be hundreds more. The federal housing agency estimates it represents about 1% of the total national mortgage market, which was between $13 billion and $14 billion in 2018, down from $8 billion to $10 billion in 2016. (However, that only covers the two dozen largest PRIs. There is no comparable data for 2019.)

In Ontario, MICs and private lenders play a larger role, with a market share of 6.7% in 2018, compared to 4.4% in 2012, according to the latest available data from Teranet. In the province’s eight largest cities, private lenders held 7.2% of the mortgage market in 2018, and in Toronto they held 8.9% of the market.

The default rate for private borrowers is not available, but it was heading up before the pandemic. The MIC default rate was 3.12% in the third quarter of last year, compared to 2.79% in the second quarter, according to a CMHC spokeswoman. By comparison, the bank default rate was 0.24% in February.

Economists and housing experts predict more difficulties in the market as the pandemic continues. The country’s household debt was already at an all-time high, and mortgage holders were spending a higher share of their income after just interest on their debt when the economy was strong.

Although jobs have started to return and economies are reopening, the unemployment rate is at 12.3%, businesses continue to suffer and many government programs are set to expire in the fall. In addition, banks’ mortgage deferral programs are expected to end soon.

“We are in a state of total illusion, an economy that is having a psychotic episode,” said Ron Butler, director of his family business Butler Mortgage, which has been negotiating mortgages for more than two decades. “There is no doubt that there are problems on MIC land. It’s really opaque right now that will have the most problems.

There is a dearth of timely, regular, national data on the entire mortgage market, especially alternative mortgages. CMHC and Statistics Canada have recently started publishing reports on alternative mortgages, but most of the data is inconsistent and lags at least six months.

Although there is no known default rate for alternative lenders, lenders have seen a slight increase.

Mr Butler said more and more landlords have defaulted since the pandemic began. Its brokerage also helps facilitate certain private loans between investors and borrowers. Over the past year, he said no one has defaulted on their payment obligations. Now there are default values. “There are more people struggling to make payments today,” he said.

Fundamental Research Corp., which provides CMHC with data on MICs, said the largest MICs collected more than 90% of their revenue from their borrowers at the start of the pandemic.

For now, the housing market rebound in many major cities means that even if homeowners default and lenders sell their homes, high prices will protect lenders. The real problem for them will come if property prices fall in major markets.

“As soon as the borrower stops payments, the MICs can recover the asset. If the property [prices] drop 30%, that’s when they’re going to start having trouble,” said Siddharth Rajeev, who heads up Fundamental’s research department.

But the research firm said: “We remain cautious about the long-term impact of the pandemic, as a prolonged period of high unemployment will spell disaster for the property market.”

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