Canadian alternative lenders hit a funding hurdle

Following Bank of Canada's quick rate increase, investors sought out higher-yielding, safer assets

Canadian alternative lenders hit a funding hurdle

Canadian mortgage investment corporations (MICs), alternative lenders that provide riskier mortgage loans and modest construction finance, are finding it difficult to get investors, which firms and analysts say might put more pressure on them and lead to industry consolidation.

The historic lows in interest rates over recent years drew investors eager for large returns to these alternative lenders, which account for around 1.5% of Canada's mortgage market, according to Reuters.

But as a result of this year's Bank of Canada tightening cycle, rates rose quickly, prompting investors to look for safer, higher-yielding assets.

Despite the sustained high demand from borrowers, worries about a property market that is quickly cooling and a potential recession have depleted enthusiasm.

“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,” Dean Koeller, president of Calvert Home MIC and chairman of the Canadian Alternative Mortgage Lenders Association, told Reuters.

MICs pool loans made to small real estate developers and borrowers who are ineligible for residential mortgages from banks, which they then sell to investors. Most of these loans have floating rates, which means that payments rise in tandem with interest rates.

Even though the direct effects of the sector's problems are minimal due to its small scale, the Bank of Canada warned in a staff note that MICs and other private lenders' problems could indirectly increase the financial system's vulnerabilities. However, any tremors experienced by MICs may have an impact on larger lenders, from which MICs borrow money.

Rob Colangelo, senior credit officer at Moody's Investors Service, noted that while rising interest rates benefit lenders since they increase margins, that’s being offset by investors' demands for larger returns.

He warned that any potential increase in unemployment may force debtors into default, worsening the situation for all parties, if MICs increased the cost of loans to entice investors.

As smaller MICs, who traditionally have a harder time accessing bank finance, fail to acquire enough money to survive, current conditions might also result in an increase in bankruptcies or consolidation in the industry, according to Colangelo.

The slowdown occurs as the demand for loans from MICs continues to be high, with larger banks tightening lending requirements and driving more borrowers to alternative lenders.

In a perfect scenario, a MIC might get enough equity from investors to cover all of its mortgage commitments.

It is an "expensive proposition," according to Moody's Colangelo, to use credit to fund loans, which increases business risk in a market where housing prices are down.