On June 5, 2024, the Bank of Canada (BoC) reduced its key interest rate by 0.25% to 4.75%, becoming the first major central bank in the G7 to shift course on monetary policy. Encouraged by slowing inflation, the BoC signaled that further rate cuts are expected this year.
The BoC’s shift has major implications for millions of homeowners who will be renewing their mortgages over the next two years. Investors with exposure to the mortgage market, including those who invest in Mortgage Investment Corporations (MICs), are also affected by the BoC’s actions.
The following article aims to provide MIC investors with actionable insights and strategies to adjust their investments and maintain high returns during anticipated rate cuts in 2024 and beyond. The article will cover the implications of rate cuts on MIC funds, strategies for adjusting investment portfolios, risk management techniques, and expert commentary on expected changes in monetary policy.
Understanding the 2024 Rate Cuts
Like other central banks, the BoC uses monetary policy to promote economic well-being and price stability in Canada. One of the BoC’s core mandates is to keep inflation “low, stable, and predictable.” In response to surging inflation following the COVID-19 pandemic, the central bank hiked interest rates aggressively in 2022 and 2023, eventually setting the benchmark rate at a 22-year high of 4.75%.
Elevated interest rates curbed borrowing and consumption across Canada, pushing inflation back within the BoC’s target range of 1% to 3%. In April, the annual Consumer Price Index (CPI) was 2.7%, the lowest in three years. Although annual CPI inched up to 2.9% in May, it remained well below the mid-2022 peak of 8.1%. Policymakers remain confident that inflation will continue to moderate in 2024 and 2025, and eventually settle at the mid-point of the BoC’s target range.
According to economists at TD Bank and CIBC Capital Markets, the BoC will likely cut interest rates at least two more times this year. This aligns with the BoC’s forecast that inflation will moderate to 2.5% this year before easing further in 2025.
Impact of Rate Cuts on MIC Funds
Central bank policy indirectly influences the mortgage market. Rate changes can stimulate or dampen borrowing demand as traditional lenders adjust their rates accordingly, passing on interest rate savings or higher costs to borrowers. Lower borrowing costs generally lead to an increase in mortgage applications and higher demand for mortgage lending, which can potentially benefit mortgage investment corporations (MICs) through higher refinancing activities.
While lower rates could compress interest rate margins of mortgage investments, MICs operate in the private lending market where interest rates are often much higher than those offered by major banks. This is because private lenders provide highly customizable loans that can be extended to a diverse range of borrowers more quickly and efficiently than major banks, regardless of the policy environment. Recent trends in mortgage financing suggest borrowers value this flexibility and aren’t deterred by higher rates charged by private lenders. According to the Canada Mortgage and Housing Corporation, private mortgages accounted for 8% of new residential mortgage financing as of 2023, up from 5.3% two years earlier.
In Canada, MICs can invest in both commercial and residential mortgages, which can include first and second mortgages. However, the focus tends to vary based on the specific MIC. Canadian homeowners have a strong history of paying their mortgages, even during challenging times. As a result, MICs that focus on residential mortgages have a strong track record of providing attractive returns to investors while maintaining a relatively conservative risk profile. This foundation is further strengthened through careful loan selection, diversification, and active portfolio management. These factors keep MIC investments highly competitive in the face of rate cuts. In fact, MICs continue to attract investors seeking higher yields than traditional fixed-income securities, such as Guaranteed Investment Certificates and government bonds. A rate cut can lead to lower returns on traditional savings and fixed-income assets, making MICs more attractive to investors.
Adjusting Investment Portfolios
Rebalancing a portfolio to include mortgage investment corporations (MICs) can be an effective way for investors to diversify, reduce volatility and enhance their returns through higher-yielding mortgage investments. Investors who want to invest in private mortgages should evaluate their current portfolio allocation and determine their risk tolerance for incorporating a new asset class.
Investors should then research the available MIC offerings and evaluate their options before investing. This includes evaluating each MIC’s management team, track record, fees, liquidity, geographic focus and diversification strategy. MICs with a focus on geographic diversification are better positioned to capitalize on regional opportunities and ensure that their yields aren’t suppressed by growing competition in major urban centres. The most lucrative MIC opportunities are offered by established non-bank financial service providers with a proven track record of investing in residential mortgages and delivering targeted returns to investors.
The rebalancing process involves selling a portion of existing portfolio assets to free up capital for investing in a MIC that achieves the target allocation. The proceeds can be used to purchase shares in the selected MIC(s). This can often be done through a brokerage account or directly with a MIC provider. The new mortgage investments should be monitored regularly with periodic rebalancing, as necessary, to maintain the desired asset allocation.
Risk Management Techniques
Like any other asset class, risk management plays an important role in mortgage investing. Asset diversification, geographic diversification and proper asset allocation are essential for navigating a complex interest rate environment.
For MIC investors, much of the risk management process is handled by the mortgage corporation that’s managing the mortgage portfolio. Mortgage corporations are responsible for the entire mortgage selection, adjudication and management process, including maintaining adequate liquidity, adjusting their investment strategy and maintaining appropriate loan-to-value ratios across all their loans.
Leading MIC providers lend across geographic regions and employ stringent underwriting guidelines focusing on high-quality borrowers who are less likely to default. t. These providers focus on risk-adjusted lending, continuously monitoring the market to ensure their lending criteria appropriately reflect prevailing conditions. For example, at CMI, we’ve adopted a more conservative approach to loan-to-value (LTV) ratios in certain markets and shortened appraisal timelines to ensure the most accurate and updated values. We have also placed a stronger focus on income and affordability to ensure prudent lending decisions during economic downturns.
Capitalizing on Opportunities
Leading mortgage investment corporation (MIC) providers leverage technology and data analytics to measure and monitor a borrower’s credit risk, enhance operations, identify opportunities and improve investment strategies. Data and predictive analytics can be used to more accurately assess each borrower’s creditworthiness, optimize the loan origination process, enhance the due diligence process, and improve investment reporting.
MICs also employ an in-house team of mortgage experts who stay informed about market trends and regulatory changes. This allows the mortgage company to maintain a proactive approach to managing risks and ensuring regulatory compliance. It also enables providers to target regional opportunities based on local economic factors, like population and job market trends.
What the Experts Say
Economists continue to expect the Bank of Canada to reduce interest rates in 2024 and 2025. According to Andrew Grantham, senior economist at CIBC Capital Markets, “We continue to forecast a further 25 bp reduction at the next meeting in July, and a total of 4 cuts […] by the end of the year.”
“We expect the BoC isn’t done,” said TD Economist James Orlando. “We have the central bank cutting twice more in 2024, before continuing the cutting cycle throughout 2025.”
The anticipated rate cuts are expected to relieve mortgage holders and increase demand for mortgage financing, which could benefit Mortgage Investment Corporations. Investors looking to make private mortgage investing part of their strategy should work with a non-bank financial service provider with a proven record of meeting their yield targets.
Conclusion
Like any investment strategy, MIC investing requires a balanced approach to managing risks and navigating changes to monetary policy. Investors should view MICs as one of several investment pillars of a well-balanced portfolio.
CMI Financial Group is one of Canada’s fastest-growing private mortgage lenders, having facilitated nearly $3 billion in successful mortgage placements. Our family of MIC Funds provides direct access to Canada’s residential mortgage market with options tailored to investors’ goals and risk tolerance. To learn more about CMI MIC Funds, explore our fund offerings.
You can also contact CMI to learn more about our MIC Funds.
