Private Matters Today - Fall 2017

ISSUE 06 • FALL 2017

AUDIT SURVIVAL

Rosenwig McRae Thorpe LLP takes you through the path to a painless MIC audit PAGE 24

investor confidence How changes in alternative institutional lending have impacted investor confidence PAGE 20

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How title insurance helps avoid fraud and increase private lender transactions PAGE 18

The impact of OSFI proposed changes from an industry perspective PAGE 12

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CONTENTS

CONTENTS FALL 2017 EDITION 06 EDITOR’S NOTE With the events that have recently unfolded in the Canadian alternative mortgage market, we explore the importance of rules, regulations and investor confidence.

12 COVER STORY Private Matters Today caught up with key industry players who weigh in on the impact of OSFI proposed changes.

08 MIC MANAGEMENT Shannon Dolphin of Dolphin Enterprises Ltd. discusses the nuances of raising and managing MIC investments.

16 RISK MANAGEMENT LMS ProLink’s Derrick Leue guides you through D&O insurance for alternative lenders in his quarterly feature “From Derrick’s Desk”.

24 THE PATH TO A PAINLESS AUDIT »»p.16

»»p.22

4 • PRIVATE MATTERS TODAY • WWW.PMTODAY.CA

A professional accountant’s insights on Mortgage Investment Corporations’ audits.

»»p.20

FEATURES 18 TITLE INSURANCE LETS YOU REST EASY Avoid fraud, errors and inconsistences with the advice of Chicago Title Insurance Company Canada.

20 INVESTOR CONFIDENCE UPDATE »»p.12

Chris Cheng of RESCO MIC comments on the changes to alternative lending and the impact on investors.

22 PRIVATE LENDING & THE LAW SOCIETY Alessandra Ocampo of Indigoblue Legal Group discusses investor/ lender disclosure forms.

26 AD INDEX Get a snapshot of our advertising partners in this edition.

»»p.18

WWW.PMTODAY.CA • PRIVATE MATTERS TODAY • 5

EDITORIAL

EDITOR’S NOTE PRIVATE LENDING IS THE NEW NORM Regulatory changes, supported by the Conservatives and Liberals respectively, to slow down the level of consumer borrowing while dampening the real estate market activity simultaneously seem to be achieving the desired effect. Although the impact on the consumer debt to income ratios will understandably be delayed but the real estate activity has markedly slowed down in the targeted GTA market. The cumulative effect of the regulatory measures in combination with temporary but significant impact of liquidity erosion vis-a-vie investor confidence for significant Alternative Institutional lenders resulted in a tremendous opportunity for private lenders and well capitalized MICs. Indeed, many MICs reported a significant surge in demand for first mortgages. The regulatory framework that Federally Regulated Financial Institutions (FRFI) now must deal with will continue to shift mortgage business over to the private lending side.

‘‘

The regulatory framework that Federally Regulated Financial Institutions now must deal with will continue to shift mortgage business over to the private lending side.

In addition, the proposed changes to the B-20 guideline which includes qualifying conventional business at Bank of Canada benchmark rate will further exacerbate the shift of business from Alternative Institutional lenders to private lenders and MICs. In this issue, we have closely examined the impact of the proposed change by OSFI and interviewed key players across the industry to get various perspectives.

While the impact of regulatory changes made and also those being contemplated has been and will be clear, the important question remains; would the MICs and private lenders be positioned to fully capitalize on opportunities that will be presented to them? Private Matters Today will continue to gather, analyze and highlight opportunities while sharing information about best practices in our on-going commitment to providing timely and relevant content to our readers.

WWW.PMTODAY.CA ISSUE 06 • FALL 2017 EDITORIAL

CONTRIBUTORS

Editor Harry Singh

Benjamin Sammut Chris Cheng Chris Humeniuk Derrick Leue Jessey Touchette John Rider Maria Alessandra B. Ocampo Shannon Dolphin Yale Ren

ART & PRODUCTION Creative Director & Publisher Kayla Patullo

EDITORIAL & ADVERTISING INQUIRIES

tel: +1 416 400 3977 tf: +1 877 219 3138 info@pmtoday.ca Private Matters Today Inc. 1 Greensboro Drive, Suite 301 Toronto, Ontario M9W 1C8

Private Matters Today Inc. is a B2B publishing company that produces a quarterly magazine dedicated to providing educational content surrounding private lending and investing, as it relates to mortgage brokers and agents operating across Canada.

Happy reading!

Copyright is reserved throughout. No part of this publication can be reproduced in whole or part without the express permission of the editor. Contributors are invited, but copies of work should be kept, as the magazine can accept no responsibility for loss.

- Harry Singh

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MIC MANAGEMENT

RAISE AND MANAGE MIC INVESTMENTS

WHILE MEETING CANADIAN COMPLIANCE REGULATIONS

Mortgage Investment Corporations (MICs) are equity vehicles that finance private mortgages as an alternative mortgage financing from traditional banks. In order to be a successful, MIC Managers will underwrite and manage good mortgages. However, another important requirement for creating and managing a MIC is the ability to raise and manage investments while continuing to meet Canadian compliance regulations.

MIC Managers must maintain compliance for investments according to each provincial security regulators, be able to report to your investors, maintain real time accounting, maintain ongoing transactions such as dividends or interest payments and correctly report to regulatory bodies including issuing T5s for the CRA. MIC Managers should have a team in place that is versed in Investor regulations such as a Compliance Officer, corporate lawyer, accountant and ideally a software administration system robust and versed it the regulations of MIC investors to ensure growth but most importantly to maintain corporate compliance.

PROVINCIAL SECURITY REGULATIONS, EXEMPTIONS & NATI ONAL INSTRUMENT 45-106 When raising capital, MICs fall under each provincial security regulator as well as under an exception under securities law.

Reliance on an exemption to raise monies (in most cases) requires a report to the provincial commission depending on where the investor is located and the same report in the province the MIC is located.

MIC Managers can raise money under an Exemption defined under the provincial securities act, regulations and national instruments.

For example, National Instrument 45-106 provides for the details in which a company can raise money under an exemption from prospectus and dealer registration.

MICs fall under the Common Prospectus Exemptions which Include: • Accredited Investor: Those investors who are sophisticated or deemed to be, such as institutions, governments, persons or companies who meet an income

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•

• • • •

and asset test. Please refer to KYC or Know Your Client regulations.

“Private Issuer” or Closely-held Issuer Exemption: The shares are all subject to restrictions on transfer found in the Articles of Incorporation, and all the shares cannot be owned by more than 50 persons, not including employees, former employees, or corporate affiliates. The purchasers must be a director/officer/employee of the MIC or Affiliate of the MIC, or close family, friends and business associates of those individuals, or an accredited investor. Except when selling to an accredited investor, no commissions or finder’s fees can be paid to the director/ officer/employee of the MIC. Family, Friends and business associates: Except in Ontario and modified in Saskatchewan, the definition is pretty broad and are limited to 50 shareholders in total.

Founder, control person and family: Applies only in Ontario and much narrower definition of the Family, Friends and Business associates.

Offering memorandum.

Minimum amount investment: The purchase price for the shares is at least $150,000 in total paid in full at the time of distribution.

EMD AND KYC AND FORM 45-106 According to the Ontario Securities Commission, “if a MIC is found to be actively in the business of raising monies as a private nonpublic (not listed on an exchange) corporation continually relying on an exemption, the MIC may also be required to register as an exempt market dealer (“EMD”) or only raise funds through the use of an EMD. Registering as an EMD will also mean strict governance and substantial errors and omissions insurance among other compliance requirements regulated by the applicable provincial commission such as the Ontario Securities Commission (OSC).”

KYC or Know your Clients is a vetting process by MIC Managers to ensure that their investor is risk tolerant to MIC investment. Most MIC Managers will create and maintain their unique process and will generally involve a workflow of qualification (income verification for instance).

OSC states that “companies and underwriters must report certain exempt distributions to the OSC by completing and filing Form 45-106F1 Report of Exempt Distribution (Form 45-106F1) through the OSC’s Electronic Filing Portal Portal and pay the applicable filing fee. Form 45-106F1 must be filed no later than 10 days after the distribution. Investment funds relying on certain prospectus exemptions have the option of filing Form 45-106F1 on an annual basis, within 30 days of the end of the calendar year.”

Form 45-106F1 must be filed electronically for distributions under: • section 73.3(2) of the Securities Act (Ontario) [Accredited investor] • section 73.5(2) of the Securities Act (Ontario) [Government incentive security] • certain prospectus exemptions in National Instrument 45106 Prospectus Exemptions • Multilateral Instrument 45-108 Crowdfunding A new Form 45-106F1 Report of Exempt Distribution came into force on June 30, 2016 and MIC Managers should ideally have an electronic system in place to produce the supporting documents including the detailed excel report required attachment.

REPORTING REQUIREMENTS MICs under the The Client Relationship Model - Phase 2 (CRM2) amendments to NI 31-103 that came into effect on July 15, 2013 define new requirements for reporting to clients about the costs and performance of their investments, and the content of their accounts.

According to OSC, “an account statement has two principal elements: transactional information and account position information.

Transactional information is specific to the securities involved and is required in almost all circumstances where there has been a transaction. Account position information is a snap-shot of the whole account and is required only where the firm holds client assets.”

MIC Managers should have a robust system in place to maintain records on both the original investment with a certificate as well as the related transactions such as deposits, dividends, transfers and redemptions. A system should integrate all the MIC certificate investments to the investor account rather than having separate accounts for each investment. Reports include cost disclosure, performance reporting and client statements such as Quarterly Statements and Statement of Holdings.

TYPES OF INVESTMENTS MIC Managers can raise private equity though investors both from individuals, trusts, joint accounts, registered accounts, nonregistered, agents and corporate investments.

Types of Investment can be in Cash (individual, joint, trustee or corporate) as well as registered capital with a Trustee. MIC capital can also be raised through third party including EMD (exempt market dealers) and financial advisors. Some MICs also raise capital from Investors residing outside of Canada (non-resident) but will must comply with non-resident compliance, taxes and reporting.

REGISTERED ACCOUNTS An excellent source of capital for MICs is registered funds held at a Trustee. With the Trustees approval for holding the investments of a MIC, MICs now have an excellent source of investors capital while investors can receive a more substantial return than conservative WWW.PMTODAY.CA • PRIVATE MATTERS TODAY • 9

MIC MANAGEMENT investments held within a registered account. For new MICs it is recommended to contact Olympia Trust, Canadian Western Trust and Community Trust for more detail.

In order for a MIC to have registered accounts they must comply to the rules set by the Trustee after they have been approved by the Trustee. Once approved, MICs will generally be able to accept all registered accounts including RRSP, RRIF, LIRA and TFSA. MIC Managers will be required to report to Trustees in the method determined by the Trustee. For example, Olympia Trust recently changed their policy for MICs to submit a global certificate as opposed to the 100s of individual certificates. Similarly, Trustees will require the correct reports for cash distributions for dividends and any changes in the registered account.

THIRD PARTY Some MICs are using third party sources to raise capital such as financial agents and through 3rd party firms such as Fundserve.

Although agencies such as Fundserve will provide exposure to different potential investor segments, these options are costly on a monthly basis and could be prohibitive for growing and smaller MICs. MICs with over 50 investors can also advertise in publication and trade show to publicly promote investor opportunities. Internet based investor raising (crowd funding) can be of value and MIC Managers can always contact technology and software suppliers for more detail.

MANAGING INVESTORS Once a MIC raises the capital, they will need to manage their investors transactions. The primary transactions for MIC investors are redemptions, transfers and most importantly dividend calculations and distributions. Having a system in place for dividend calculations and distributions will save days of administration time and significantly reduce errors. Similarly, a system for distributions will allow MIC Manager to send EFT payments directly to investors, calculate and manage Trustee distributions, maintain compliance and create and send investor reports by mail, email and for online statements.

T5S MIC Managers will need to issue T5s to the investors. Many MICs will not issue T5s to registered accounts as the Trustees manage registered investors directly. For a MIC with over 50 investors, MIC Managers must submit T5s electronically direct to CRA and thus need to ensure the information is accurate and complete.

GENERAL MIC COMPLIANCE 1. A financial audit (completed by a qualified firm CA or CPA firm, does not need to be IFRS, as MICs are not automatically considered reporting issuers even though they are deemed “public companies” under the Canadian Income Tax Act); 2. Annual resolutions to approve the financial statements; 3. Annual resolutions to declare dividends, and possibly to catch up for dividends declared throughout the year on a monthly or quarterly basis; 4. Annual resolutions to declare any bonuses to the officers and managers;

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5. Resolutions to effect any issuance of shares to new investors, and possibly to catch up for shares issued throughout the year to investors; 6. Reporting Requirement for Exempt Distributions (i.e. for issuing shares to investors under an exemption such as the “Accredited Investor”), in the jurisdiction where the distribution/issuance takes place (e.g. Ontario) a form 45-106F1 for Investment Funds (e.g. a MIC can be considered an Investment Fund if it does not exhibit any control over the private companies it invests in that are in addition to the mortgages invested in or directly funded), is required to be filed with the provincial securities commission within 30 days after the MIC’s financial year-end if the exemption used was either an Accredited Investor, Minimum Amount or Additional Investment in Investment Funds, otherwise (i.e. not considered an investment fund and has not distributed/issued shares to investors under the previously mentioned exemptions) it needs to be filed within 10 days after the distribution/ issuance.

7. MIC Managers will need to file the Form 45-106 based on managed certificates within 10 days of share purchases Raising Capital for MICs is essential for maintaining a MIC. When creating a MIC, having the correct contracts such as a subscription agreement are the first step. Recognizing various different sources of capital such as registered funds will also provide growth. Most importantly, having a system to comply to regulations and each provincial security regulation is vital as any errors are extremely costly and can cost the MIC their business. MIC Management on the Investor component is just as important as ensuring the MIC is underwriting the best loans. ________ Shannon Dolphin is CEO of Dolphin Enterprises Ltd. and has been working with MICs for over 14 years. Dolphin and its new Underwriting and MIC Manager software solution is the only software to provide administration for MICs from the application of the loan to the back-end transaction based Chart of Accounts/Accounting system. For more information contact info@dolphinent.com or call 604-685-6721 or visit www.dolphinent.com

COVER STORY

THE IMPACT OF OSFI PROPOSED CHANGES FROM THE PERSPECTIVES OF A REALTOR, BROKER & LENDER The Office of the Superintendent of Financial Institutions (OSFI) released various proposals in July of 2017 to further tighten mortgage underwriting standards at federally regulated lenders.

The biggest change is the implementation of a stress test for all uninsured mortgages (those with a down payment of more than 20%). Under current banking rules, only insured mortgages, variable rates and fixed mortgages less than five years must be qualified at a higher rate. That rate is the Bank of Canada’s posted rate, currently 4.84%. Going forward, it will be replaced by a 200-basis-point buffer above the borrower’s contract rate.

How do you think the proposed changes will affect your direct industry and your business as a realtor?

The other proposed changes include: • Requiring that loan-to-value measurements remain dynamic and adjust for local conditions when used to qualify borrowers; and • Prohibiting bundled mortgages that are meant to circumvent regulatory requirements. The practice of bundling a second mortgage with a regulated lender’s first mortgage is often used to get around the 80%+ loan-tovalue limit on uninsured mortgages.

How do you foresee these changes impacting borrowers?

The extension of stress testing to all uninsured mortgages would have a far greater impact. Private Matters Today caught up with industry professionals to gain their insights on the impact of further tightening on conventional mortgages.

A REALTOR PERSPECTIVE: JESSEY TOUCHETTE, SALES REPRESENTATIVE OF ANDREW IPEKIAN REAL ESTATE GROUP, KELLER WILLIAMS Do you believe that the changes to Guideline B-20 proposed in July 2017 by the Office of the Superintendent of Financial Institutions (OSFI) will have a positive or negative (or both) effect on the Canadian housing market?

A . I believe the impacts by the changes will be positive and negative. Overall the proposed changes are going to protect Canadian’s from taking on too much debt which is to prevent a market crash and ensure sustainability. With interests rates rising they are trying to ensure you will be able to afford your mortgage payment when they do rise. Initially I do not think it will sit well with people as they are going to qualify for much less, however down the line they may be thanking the banks for these “stress tests”.

12 • PRIVATE MATTERS TODAY • WWW.PMTODAY.CA

A. The best comparison would be when they introduced the stress test for insured mortgages last year, many of my clients who were putting 5% down then were rushing to get a firm deal prior to the set date. I think there will be some similarities in that aspect, however I don’t see it affecting as many people in overall.

As business goes I think you may see a small spike in sales from now until the date is announced and implemented.

A. As far as affordability it will certainly affect a lot of individuals and families, some upwards of 15-25% Currently to purchase a $1M dollar home you need to have an income of $125,000 with little to no debt. Once these changes are implemented it will rise to $145,000 to buy the same house. Plan ahead if you are looking to purchase a home or investment property.

How can you adapt as a real estate professional to assist borrowers (buyers) that are being pushed out of the market due to these changes?

A. As a real estate professional my first piece of advice is to speak to your bank, or mortgage broker etc.. Get clear on how this is going to affect you financially. If you are being pushed out of the market we need to work fast to find you a home before these changes are implemented. Don’t wait for them to announce a date because it will either be a short window or the market will go into a frenzy. You should be actively looking now. If you are too late, we need to adjust your expectations and criteria if this does significantly affect you.

What suggestions would you give OSFI as an alternative to increasing the qualifying interest rate?

A. I do agree with their proposed changes, they see interest rates are on the rise and are trying to ensure Canadians can afford their homes 5, 10 and 15 years from now. An alternative would be larger tax or land transfer tax breaks for first time home buyers.

Our market is only getting more difficult to get into and for many these new changes are only going to increase the difficulty.

A BROKER PERSPECTIVE: BEN SAMMUT, MORTGAGE BROKER OF MORTGAGE GATE AND FOUNDER OF MILLENNIAL MORTGAGES

How can you adapt as a mortgage professional to assist borrowers (buyers) that are being pushed out of the market due to these changes?

Do you believe that the changes to Guideline B-20 proposed in July 2017 by the Office of the Superintendent of Financial Institutions (OSFI) will have a positive or negative (or both) effect on the Canadian housing market?

A. Moving forward there will be an even greater need for alternative and private financing to bridge the gap between available A-money and what clients actually need. As a broker, I think having a strong network of private funds and a better understanding of the alternative space is going to be a huge asset.

A . I think the results will be negative. The federal liberals changed things so drastically before that any further policy changes would likely do more harm than good. It’s nice to see that government is taking action from a public confidence standpoint, but the policies themselves are too harsh and were implemented too quickly in my opinion.

How do you think the proposed changes will affect your direct industry and your business as a broker?

A . It’s nice that they want to even the playing field between bulk-insured monolines and the balance sheet lenders by making everyone play by the same rules, essentially. This may very well increase the broker share of business as monolines will become more relevant again. But as a whole, I think volumes will decrease as these policy changes exclude even more buyers/property owners looking to refinance.

How do you foresee these changes impacting borrowers?

A . I think we’re going to see conventional buyers’ affordability decrease by roughly 20% like we saw with high-ratio buyers last year. Meanwhile, I’d like to think that we won’t see rates of fraud increase. But if these changes are implemented with the swiftness we’ve seen in the past and without grandfathering anyone in, people are going to be forced into some unfortunate situations and I would worry some clients and unscrupulous members of the broker community would commit fraud as a means of navigating the changes.

What suggestions would you give OSFI as an alternative to increasing the qualifying interest rate?

A. I think that nearly doubling the contract rate for qualification is excessive, especially in the conventional space because the exposure to risk on behalf of the lender is relatively small. Instead, they could focus more on a client-specific risk assessment that may lower allowable GDS/TDS ratios or require higher net worth/ cash deposits for any given client for example.

As a broker, I think having a strong network of private funds and a better understanding of the alternative space is going to be a huge asset.”

- Ben Sammut, Mortgage Gate

WWW.PMTODAY.CA • PRIVATE MATTERS TODAY • 13

COVER STORY A LENDER PERSPECTIVE: CHRIS HUMENIUK, PRESIDENT AND CHIEF EXECUTIVE OFFICER OF COMMUNITY TRUST Do you believe that the changes to Guideline B-20 proposed in July 2017 by the Office of the Superintendent of Financial Institutions (OSFI) will have a positive or negative (or both) effect on the Canadian housing market?

A . When asked about the changes to Guideline B-20 proposed by the Office of the Superintendent of Financial Institutions (OSFI) in July, Chris Humeniuk, President and CEO of Community Trust Company had this to say: “I believe that certain changes are necessary to ensure long-term viability in the Canadian housing market, but we should be careful not to create a crisis where one may not exist” – suggesting that the recent CMHC changes and proposed changes from OFSI are too close together. “The effect of these types of changes don’t happen overnight, and the market hasn’t even had time to adjust to the changes imposed by CMHC in late 2016 and other provincial legislation aimed to cool the Toronto and Vancouver markets earlier this year.”

How do you think the proposed changes will affect alternative lenders?

A . Humeniuk also suggests that the new rules will have the largest impact on Alt-A lenders, placing them and their borrowers at a greater disadvantage. “The changes imposed to bulk insurance eligibility by CMHC in 2016 essentially carved out and handed our prime, uninsured borrowers to the big banks. And with the additional changes proposed by OSFI, Alt-A lenders are estimating that as many as 25% of their existing borrowers will no longer qualify, forcing them into the private market”, a move that Humeniuk suggest may limit transparency with their borrowers.

How do you foresee these changes impacting borrowers?

A. “We have already seen natural challenges to affordability with the increase in market value, which in turn has led to an increase in falsified income documents” says Humeniuk. “The latest restrictions on co-lending relationships will only encourage an increase in this type of behaviour in the sense that borrowers may not disclose when a 2nd mortgage is placed behind us.”

Ultimately, he and his team would rather know if a second is being placed behind them at the time of origination so they can have a chance to underwrite the entire financing arrangement to their own risk grading.

What suggestions would you give OSFI as an alternative to increasing the qualifying interest rate?

A. While Humeniuk agrees with the principle behind the qualifying interest rate, he suggests that perhaps a tiered approach would be more appropriate. “I agree that the stress test is a prudent approach, but 200bps in all situations is too high” he states. “I believe the qualifying interest rate should reflect the risk grading of the individual application, rather than an all-in-one approach” suggesting that shorter term mortgages and stronger borrower covenants should be factored in to the amount applied to the stress test. _____ The proposals are just the latest in a long line of changes to how mortgages are written in Canada. The government began its regulatory tightening campaign nearly nine years ago to “reduce the risk of a U.S.-style housing bubble developing in Canada.”

(Those were the words of the Department of Finance in 2008.)

Private Matters Today.

A brief history of key mortgage rule changes: January 1, 2017: OSFI imposed onerous capital requirements on default insurers, thus disadvantaging many bank competitors (and consumers) by jacking up rates substantially on low-ratio insured mortgages.

February, 2016: The Department of Finance announced it was increasing the minimum down payment from 5% to 10% on the portion of a home’s price that’s above $500,000.

November 30, 2016: New stress test regulations were extended to include insured mortgages with 20% equity or more. It also banned certain mortgage types from being insured, including refinances, extended amortizations and single-unit rentals.

November, 2014: OSFI releases its B-21 guidelines, which set out insurer restrictions on everything from debt-ratio calculations and self-employment evaluation to borrowed down payments and cash-back mortgages.

October 17, 2016: The federal government introduced a stress test to be used in approving all high-ratio insured mortgages with terms of five years or more. It required such borrowers to prove they can handle payments at the Bank of Canada’s posted 5-year rate (currently 4.64%).

14 • PRIVATE MATTERS TODAY • WWW.PMTODAY.CA

July 9, 2012: The government reduced the maximum amortization period to 25 years for high-ratio insured mortgages, limited the gross debt service and total debt service ratios permitted to 39% and 44%, respectively, banned mortgage insurance on properties over $1 million and implemented a maximum 80% LTV for refinances.

March 18, 2011: Regulators introduced a 30-year maximum amortization on insured mortgages over 80% LTV, an 85% loanto-value limit on insured refinances and eliminated government insurance on secured lines of credit (e.g., HELOCs).

April 19, 2010: The government introduced stress testing for insured mortgages using the Bank of Canada’s 5-year posted rate.

Other key changes included a 90% LTV max. on refinances (down from 95%), and an 80% LTV maximum for rental financing.

October 15, 2008: The first mortgage rule changes announced by the government eliminated 40-year amortizations (dropping them to 35), raised the minimum insured credit score, added a new maximum total debt service ratio of 45% and additional loan documentation standards.

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RISK MANAGEMENT

FROM DERRICK’S DESK

PROTECTING THE PUBLIC INCREASES YOUR EXPOSURE

The overarching mandate for the Provincial Regulatory regimes is to protect the public. The recent investigation of Home Capital Group demonstrated that attempting to protect Canadians can have unintended consequences for the public in many different ways. The OSC’s investigation lead to the loss of: 1. more than $400 million in shareholder value for investors; 2. dozens of quality jobs at alternative lenders; 3. confidence in alternative lenders as a strong investment class and; 4. capital available to Canadians seeking the dream of home ownership. It was members of the Canadian public who were negatively impacted under each of these four scenarios.

The directors and officers of Mortgage Funds (i.e., MICs, Trusts, and Publicly Traded Funds) represent the individuals that the regulators want to oversee in order to protect the public. The exposure facing directors and officers of alternative lenders increases with greater regulatory oversight. The risk of a regulatory investigation or lawsuit brought against the entity or its directors and officers is higher under securities law. Plaintiff lawyers are experienced in launching class action lawsuits against companies allegedly violating securities laws.

Securities regulators set the bar higher than many other regulatory bodies in Canada. If you are raising capital from investors and are registered with a Provincial Securities Commission then the compliance requirements will be significant. Investigations by the Securities Commission leading to sanctions against the directors and officers will attract litigation from eager plaintiff lawyers.

Alternative lenders who are not publicly traded should not assume that their organization or directors and officers can “fly under the radar”. Directors and officers should expect investor scrutiny if the Securities Commission levies any sanctions or penalties as a result of their investigation of your organization. It will not matter if you are raising capital in the public markets or through an Exempt Market Dealer.

PROTECTION TIPS

Transparent disclosure was at the root of the allegations raised by the OSC against Home Capital. This is a good lesson and reminder that full disclosure to investors and prospective investors is critical. Mortgage Funds should retain the services of accounting firms and law firms who are experienced with the disclosure requirements under Securities law.

16 • PRIVATE MATTERS TODAY • WWW.PMTODAY.CA

Outsource capital raising activities to an experienced Exempt Market Dealer. Raising capital for your Mortgage Funds through a third party EMD will reduce your liability exposure; however, it will not eliminate the risk. If investors feel they suffered a financial loss as a result of your fund’s performance then you can be certain that your Fund and its directors and officers will be named in the lawsuit along with your EMD. Purchase a Directors & Officers (“D&O”) Liability policy. There are a limited number of insurers in Canada who can properly underwrite and insure Alternative Lenders. There are significant differences between D&O policies offered to alternative lenders in Canada. Lenders with a manager that is registered as an EMD, Investment Fund Manager and/or Restricted Portfolio Manager will have greater exposure and should consider Professional Liability coverage for investment fund management services. A few of the D&O policies will provide additional coverage for expenses incurred by the policyholder to mitigate the reputational risk and harm they experience as a result of an investigation by a regulatory body. The D&O insurers have a panel of law firms on retainer with significant experience defending clients under securities law in Canada and the US. The D&O policy will cover your legal expenses to defend allegations and cover damages paid to the third parties claiming against you as a result of a settlement or liability assigned by the courts.

Protecting the public is a noble and important goal in society.

However, directors and officers of Alternative Lenders must realize that your exposure only increases with greater regulatory oversight. _____

Derrick Leue is the President of PROLINK Insurance. Please contact PROLINK Insurance to learn more about their Directors & Officers Liability Insurance program for lenders.

1-800-663-6828 or DerrickL@prolink.insure

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FEATURE

TITLE INSURANCE ALLOWS YOU TO SLEEP AT NIGHT There was a time local bank branch managers held a lot of sway in deciding what real estate properties their clients could afford. Those days are now gone.

The real estate recessions of the 80’s and 90’s forced the banks to diversify and the market then opened up to alternative lenders. Lenders like credit unions and trust companies did very well in this environment.

The rise and fall of the real estate market led to even broader lending practices.

Families, associations and other groups started to amass large amounts of capital.

They realized that there was money to be made in private lending - and it was game on. As private lending, and the number of private lenders, has continued to expand across Canada, greater risks have arisen for both the lenders and the borrowers, particularly in the residential space.

More lenders means fewer and different processes, different standards of underwriting and funding, and more opportunity for shenanigans in the process.

This has resulted in a perfect environment for fraud, forgery and mismanagement of funds, especially during The Great Recession of the late 2000’s/early 2010’s.

It has also revealed that a lot of the defects in these loans had occurred prior to the recession, demonstrating the existence of flaws in the processes of a number of private lenders and their counsel.

The feeding frenzy in the market since the recession ended has also created opportunities for those trying to take advantage to step in and play fast and loose with the information they provide to lenders, or “completely loose” in the outright frauds of lenders. These are the times when title insurance has been able to bridge the gap in ensuring deals are being closed properly and insuring lenders (and borrowers) when things go wrong.

In the last several crazed market years, title insurance companies have been able to provide certainty to private lenders that

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closing their deals is safe and secure. Fake identification, uncertain valuations, the increase in quick closings, and the difficulty in being able to confirm the bona fides of foreign buyers, (due to language, distance and time zone issues) has made it more and more difficult for lenders to ensure they are on solid ground. Title insurance provides certainty that the borrowers are “who they say they are” and do have the capacity to enter the loan with the lender.

Most title companies consider a private lender to be any lender that is not a Chartered Bank, Trust Company, Credit Union, Insurance Company or Finance Company. Chicago Title considers lenders on CMHC’s list of approved lenders not to be private. If they fit within the definition and do not appear on the list, we treat them as private lenders.

The Great Recession resulted in a large number of claims for title insurers. This caused some tightening of underwriting and the imposing of additional fees to ensure the risk was being properly assessed and covered. At Chicago Title, we have worked to keep these conditions and fees to a minimum. We have the lowest additional charges and the safest but least intrusive underwriting in the Canadian industry.

We want to be your partners in creating safe and secure deals, helping you keep the risk low. We have had a number of incidents where we have been able to highlight discrepancies to our lender clients and their counsel saving them from future problems or fraud on deals. For example, “A borrower applied for a mortgage loan with a private lender in the amount of $600,000 to purchase a house. The underwriter at Chicago Title noticed that the address of the borrower was different from the mortgaged property and that the person was living in a low income building. This raised a red flag and the fraudulent transaction was avoided.”

From this example, it is no surprise that last minute funding of a deal to non-parties was often a fraud being perpetrated. This has led to changes by title insurers in their approach to refinancing. On all refinance policies an exception is now added that allows a claim to be denied for fraud if funds are disbursed to any party other than a registered owner or a party holding a prior charge or encumbrance. This exception is not included on purchase transactions as generally the funds are going to the vendor’s solicitor and the due diligence is greater, minimizing the risk of fraud. For more details on funding or underwriting restrictions, contact our underwriting group at: info@chicagotitle.ca.

Chicago Title has recently broadened its underwriting for private lenders by extending out the Transaction Protection Endorsement to Private Lender Loan Policies. This endorsement provides coverage for the lender for any error made by their counsel or their counsel’s staff in a transaction. Although the vast majority of lawyers and notaries in Canada are doing a great job in closing real estate and lending transactions, errors can happen or “white lies” can be told by borrowers, resulting in the misdirection of funds. Often you only need one error to make a significant dent in your bottom line and this can impact your ability or willingness to continue to lend. We offer you no fault protection coverage that pays you up front for losses, allowing you to get back to business quickly, leaving any messiness for us to clean up.

Title insurance, especially with the Transaction Protection Endorsement, allows you to sleep at night knowing that frauds, errors and inconsistencies can be covered. ____ John Rider is the Senior Vice President, Retail and Commercial Title Insurance of Chicago Title Insurance Company Canada. For more information email jrider@ctic.ca

FEATURE

DESPITE CHANGES TO ALTERNATIVE LENDING, MIC INVESTORS SHOULDN’T WORRY CHRIS CHENG FROM RESCO MIC, TALKS INVESTOR CONFIDENCE The recent changes in the private lending landscape have many similarities to the 1991 film, The Perfect Storm. Based on a true story about the courageous men and women who risk their lives every working day, pitting their fishing boats and rescue vessels against the capricious force of nature. One unfaithful day, their worst fears were realized at sea, when they are confronted by three raging weather fronts which unexpectedly collide to produce the greatest, fiercest storm in modern history – “The Perfect Storm”.

Much like the characters in this film, an abundance of courageous Canadians invest their hard-earned savings to put towards their retirement fund, knowing the potential of losing their retirement savings is ever looming. Unfortunately, over the years, people do lose their investments in stocks such as the Black Monday in 1987, the Black Friday of 1869, the Dot Com Bubble and the housing market collapse in the U.S., to name a few.

The brewing storm of the private mortgage market began in 2010 when the government introduced the B-20 legislation (the underwriting guidelines for residential mortgages) that Office of the Superintendent of Financial Institutions (OSFI) imposed on all regulated lenders and the Canadian Mortgage and housing Corporation (CMHC). More and more borrowers, even with good credit scores and net worth, are having trouble qualifying for mortgages with traditional lenders such as banks, trusts or credit unions. The government legislation is pushing borrowers to seek mortgage financing from private lenders and Mortgage Investment Corporations (MICs).

On the other hand, today’s low interest rate environment is a challenge to investors, especially with an aging population. Most elderly investors are “starving for yield”, they are searching for investments that will preserve their capital and generate the potential higher rate of returns.

Majority of investors also do not have the appetite for the volatility 20 • PRIVATE MATTERS TODAY • WWW.PMTODAY.CA

of the equity markets. Since private MICs are priced at a point in time, and not continuously traded on a secondary market like TSX, more often the value of a private MIC does not correlate to price changes in the public markets. As a result, participating in private MICs can allow investors to reduce exposure to equity markets, and to retain capital value, even when equity markets are volatile. As a result, alternative investments such as MICs arise as alternatives to the traditional investments such as saving accounts, GICs and bonds. The combination of the demand from both borrowers and investors resulted in the increased popularity of MICs. Newly emerging disruptions to the current lending regime has the potential to create a ‘perfect storm’ which will incite worry to investors. Recently, municipalities in the Greater Toronto Area have seen a sharp drop in sales and prices have declined almost 21.5 per cent from a peak hit in mid-April before the province put in measures such as foreign buyer tax to cool the market in the GTA. Despite the recent decline of housing prices in Toronto, the market might rebound similar to what it did in Vancouver after the B.C. government imposed a foreign buyers tax last summer.

According to Statistics Canada, once again Canada is the fastest growing country in the G7 driven largely by immigration. Population drives the demand for housing, therefore the recent decline of home sales may be more of a short-term bump than a long-term correction.

The value of a home is not the biggest risk when investing in MICs for investors. Imagine the price of your own home declined by more than 10% but would you stop making your mortgage payments?

In fact, Canadians in general are very responsible when it comes to meeting their mortgage obligation. Mortgage delinquency rates are low in Toronto and Vancouver despite hot housing markets that have sent prices soaring. The delinquency rate in Toronto was just 0.12 per cent, and 0.15 per cent in Vancouver, compared to the national average of 0.34 per cent.

The Bank of Canada hiked its benchmark interest rate to 0.75% from 0.5%, its first increase in nearly seven years, amid expectations of stronger economic growth this year. There might be further rate hikes in the near future which could have an impact to housing market. Keep in mind that for most borrowers the 25bps rate hike means that their mortgage payment is only going up by less than one specialty coffee per day! I am sure most homeowners would give up coffee to keep their home.

In the eyes of the security regulator such as the Ontario Securities Commission, MICs are considered a high-risk investment, understandably. However, I truly believe that a professionally managed MIC consists of a pool of well diversified mortgages can form a part of a well-diversified portfolio, and can prove to be very complementary to other investments. However, investors need to understand exactly what they are investing, how much they should invest and the risks associated with their investments.

There are a wide range of MICs and each one with unique characteristics suitable for different type of investors. Here are a few basic factors investors should consider when investing in any MICs: 1. Take a look at how much of the portfolio is commercial versus residential where residential could be considered as less risk because of the larger demand.

2. What is the “loan to value” of the portfolio, in other words, what percentage of properties are backed by loans.

3. Look at the mix of first and second mortgages, preferably you want more first mortgages in the portfolio.

4. Are they located in geographic areas that hold value?

5. How much leverage does the MIC have? In other words, how much the MIC borrowed from the bank to fund mortgages?

6. The experience of the management team and do they have independent Directors on the Board to provide guidance and expertise in different areas 7. Other factors such as redemption schedule, management fees, etc. should also be taken into consideration 8. Finally, the statement “Not to put all your eggs in one basket has been beaten to death. However, as far as investment is concerned, this statement is bang on.

Having spent over 25 years in the investment industry with a firm belief of the investment philosophy, “it’s time in the market, not timing the market”, which means that investors make money by being in the market, not by timing the market. To avoid getting lost at sea, investors should seek professional advice from qualified and licenced exempt market representatives. Finding the right mortgage investment corporation that is suitable for individual investment objectives and risk tolerance will ultimately help you achieve your long term financial goals.

Chris Cheng is the Chief Operating Officer of RESCO Mortgage Investment Corporation.

For more information visit www.rescomic.ca

WWW.PMTODAY.CA • PRIVATE MATTERS TODAY • 21

LEGAL

PRIVATE LENDING AND THE LAW SOCIETY

THE ABSENCE OF FORM 1 INVESTOR/ LENDER DISCLOSURE STATEMENT FOR BROKERED TRANSACTIONS AND THE USE OF FORM 9D AND FORM 9E

As more and more Canadians are being turned away from traditional banking institutions in satisfying their mortgage needs, the private lending arena continues to grow.

Borrowers who are new to Canada; borrowers with bruises on their credit; borrowers who are self employed and have a more difficult time to prove their income. These are all types of borrowers who look towards private lenders to help assist in reaching their dreams of home ownership and/or other financial goals.

Currently, in private lending transactions, brokers are required to complete Form 1: Investor/ Lender Disclosure Statement for Brokered Transactions (“Form 1”) provided by the Financial Services Commission of Ontario and pursuant to the Mortgage Brokerages, Lenders and Administrators Act, 2006. Its purpose is to “help increase transparency, enhance consumer protection, and allow investors/ lenders to make more informed investment decisions”.

Form 1 does have its exceptions pursuant to section 31(2) of the Ontario Regulation 188/08 Mortgage Brokerages: Standard of Practice.

In the absence of Form 1 and clear written instructions that a Form 1 is in place, the Law Society of Upper Canada has implemented regulatory forms to be completed by lawyers and their clients.

These forms, Form 9D Investment Authority and Form 9E Report on the Investment, have been developed to ensure clear and concise communication between lawyers, mortgage brokers, and lenders. If the borrower has independent legal representation, only the lender’s lawyer will be responsible for completing these forms.

The Law Society of Upper Canada shares the same goals as the Financial Services Commission of Ontario where it seeks to ensure that the public, potential and actual investors, and lenders have complete disclosure regarding the transaction they are engaging in.

FORM 9D: INVESTMENT AUTHORITY Form 9D is the initiating form that needs to be completed by the lawyer and reviewed and signed by the client, the private lender.

This form sets out the details of the investment that are typically

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found on a standard mortgage commitment. Details such as the principle amount of the mortgage, the amount to be advanced by the lawyer (minus all relevant fees and interest adjustment, etc.), the term of the loan, etc.

Conditions of completing the private lending transaction will also be set forth within this document such as requirements to add the private lender as a second loss payee on fire insurance policies and/or declarations to be signed by the borrower to ensure that the property will not be leased or rented out without the private lenders’ written consent.

FORM 9E: REPORT ON THE INVESTMENT Form 9E is a Report on the Investment, similar to a final reporting document from the lawyer to the client upon closing of the mortgage transaction. This form is similar to Form 9D where the terms of the mortgage commitment will be outlined once again, however, with adjustments made to a change in maturity date and/ or payment dates.

The purpose of these forms are to ensure that the lawyer and the client have clear and concise instructions on the mortgage transaction itself. It seeks to protect not only the lawyer but also the client, the private lender to ensure that the terms of the mortgage are properly noted and registered. These forms have proven to reduce complaints and claims through Lawyers’ Professional Indemnity Company and through the Law Society’s Compensation Fund.

Forms 9D and 9E may seem a bit more tedious for both lawyers and clients however it enhances transparency and cohesion in ensuring that the private lending terms are properly adhered to.

Consequently, a benefit for all parties involved. ______

Maria Alessandra B. Ocampo is the founding lawyer of Indigoblue Legal Group. For more information contact, legal@indigoblue.ca or visit www.lsuc.on.ca

WWW.PMTODAY.CA • PRIVATE MATTERS TODAY • 23

FEATURE

THE PATH TO A PAINLESS AND EFFICIENT MIC AUDIT

A CPA’S INSIGHTS ON AUDITS FOR MORTGAGE INVESTMENT CORPORATIONS It’s Friday afternoon, and instead of being out on a patio enjoying a refreshing drink to close off a productive week, you are instead trying to respond to the latest round of questions from your auditor. They have also notified you that the audit fee is going to be 20% higher than initially expected and in order to meet the compliance deadline next week, they need to schedule a conference call over the weekend.

Now that’s a nightmare scenario that every mortgage investment corporation (MIC) wants to avoid! It is certainly an avoidable situation if you understand the compliance requirements and follow best practices to meet those requirements.

FOLLOWING BEST PRACTICES

For most people in the private lending and MIC space, accounting and financial reporting is often an afterthought. However, that kind of approach is what leads to painful audits that run over-budget.

Focusing on the following three areas will go a long way in ensuring that accounting and financial reporting systems are effectively and accurately supporting your primary operations.

1.

A proper management reporting system coupled with an accounting system A MIC’s management reporting system (i.e. the system it uses to track its mortgage portfolio, track its shareholders, and report to management for decision-making) should be tailored to meet the needs of each individual MIC. Spreadsheets can work as an alternative but the common deficiency with spreadsheets is that the

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data is not centralized like it is in Dolphin, resulting in duplicated work and higher likelihood of errors due to human input or improper setup.

2.

Regular and rigorous review process It is important to have a review system in place to ensure the data within the system is accurate. A good review process involves management receiving and reviewing reports from both the management system and the accounting system on a regular basis, and documenting that a review was done. One simple way to document the process is to have the reviewer sign the reports and archive them. Documenting the review process also creates a stronger audit trail and enables the auditor to perform the audit with higher efficiency.

We also find that having a periodic review process in place ensures that management is receiving vital information on a timely basis and that the systems can readily product current financial information.

3.

Having trained accounting personnel onboard MIC management are generally not trained accounting professionals, nor should they be. We recommend having a qualified bookkeeper on the team, either part-time or full-time, depending on the size of the MIC. This setup enable the management to focus on operations while not being bogged down with the accounting details. The bookkeeper should be able to extract the correct information from the management system to ensure that the accounting system properly reflects the operational information and also do this in

a timely manner. In addition, having access to external accounting professionals can help you simplify complex accounting and tax issues and create a positive impact on business.

UNDERSTANDING THE COMPLIANCE REQUIREMENTS Adopting best practices will assist in meeting compliance requirements painlessly and efficiently. The remainder has to do with making sure that the compliance requirements are fully understood. A MIC is subject to compliance requirements from many different fronts. On the financial reporting front, it is important to understand why a MIC needs an audit in the first place. Generally, the structure of a MIC includes the MIC itself plus a second entity known as a mortgage administrator company. Both entities are subject to different financial reporting requirements.

For the MIC itself, the audit requirement usually stems from the desire of the investors to receive audited financial statements. In addition, if the MIC is using an offering memorandum (OM) to raise capital, there is a requirement to include the latest audited financial statements in the OM. When a MIC is just starting up, it may also need an audited opening balance sheet to be included in the first OM. Usually, the timing on the completion of the audit is aligned with the reporting to investors.

For the mortgage administrator, the audit requirement is imposed by the Financial Services Commission of Ontario (FSCO).

FSCO requires the following 3 items to be

delivered to them within 90 days after the fiscal year-end: 1. Audited financial statements 2. A letter from the auditor reporting on the internal controls over the books and records of the mortgage administrator; this is usually called the management letter 3. A copy of the special FSCO audit report on the administrator’s trust account and the assets and liabilities under administration.

Items one and two are standard items that an auditor would include in all audits.

Item three requires the auditor to perform additional audit procedures to meet the FSCO requirements. These procedures are usually designed to follow the compliance checklists provided by FSCO. In addition to these audit requirements, trust companies or investment administrators often require tax opinion letters to be issued to them from the MIC on an annual basis to certify the MIC’s compliance with tax laws. The auditor can issue these letters with minimal additional work by leveraging work already performed as part of the financial statement audits.

CLOSING INSIGHTS FROM AN AUDITOR Being prepared is the key to an efficient and painless audit. The auditor is your friend who can apply their experience to help setup best practices in meeting the compliance requirements surrounding financial reporting. We are glad to help because it makes our job easier too!

We are also more than auditors; we are happy to work and grow with you, which means having a dedicated group of accounting and tax professionals thinking about your business the way you do, and we have a vested interest in your success. _____ Yale Ren is a manager at Rosenswig McRae Thorpe LLP. RMT is a full service accounting firm with extensive experience in real estate. For more information visit us at www.rmtcpa.ca

KEY TAKEAWAYS

in a strong and robust 1. Invest management reporting system

that works with your accounting system.

and follow regular review 2. Create processes to ensure accuracy and timeliness of information.

trained accounting 3. Include professionals in your team and in your network.

understand compliance 4. Fully requirements to avoid headaches down the road.

your accountants’ 5. Leverage expertise to help you grow.

For other compliance requirements not related to financial reporting, it would be best to consult with your legal advisor.

Speaking from experience the most common mistakes are cases where compliance requirements set by the FSCO checklist for the mortgage administrators have not been followed fully. Luckily, most of these errors were spotted early and FSCO is usually understanding of first offences.

However, even in these situations, the auditor’s hands are tied when it comes to the audit reports, and a modified report would be issued if not all the requirements are met.

This results in more work for the auditor and likely a higher audit fee, and of course it would better to have a clean record with FSCO.

WWW.PMTODAY.CA • PRIVATE MATTERS TODAY • 25

ADVERTISERS INDEX

ADVERTISERS INDEX 03 Canadian Mortgages Inc.

15 Indigoblue Mortgage Investment Corporation

18 Chicago Title Insurance Company Canada

26 LMS Prolink

28 Community Trust

02 Mortgage Arena

15 Dolphin Enterprises Ltd.

11 RESCO Mortgage Investment Corporation

27 Autism Ontario

25 Rosenwig McRae Thorpe LLP

17 Indigoblue Legal Group

7

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Community Trust Company does not provide investment advice and does not endorse or promote any investment products. Investors are encouraged to seek independent financial and legal advice before making any investment decisions.