practices’ approach, we recommend that MIE issuer’s group its
mortgages into specific segments and provide the recommended
disclosure for each segment within the mortgage portfolio. Issuers
should strive to have smaller segments with narrow ranges of
disclosure instead of large groups with broad ranges of disclosure.
For example, 20% of the mortgages have one year terms and bear
interest at rates between 13 and 15%.
It is also crucial that the audited financial statements included
in an OM reconcile with the mortgage information set out under
Item 2.2 of the OM. In particular, MIE issuers must set out the
mortgages in good standing, mortgages in default, impaired
mortgages and foreclosed mortgages where the lands are now
held by the MIE. We consider it important to also distinguish,
where applicable, between mortgages which are in default and
mortgages which are impaired. Many MIEs classify impaired
mortgages as loans that are in default, that are not fully secured
and where full repayment of the loan is not anticipated. Defaulted
mortgages would not be considered impaired if they are fully
secured and full repayment is anticipated.
Lastly, if an MIE is investing in first, second and third mortgages, the
OM disclosure should set out a percentage range of the overall mortgage
portfolio that is held in the second and third subordinated mortgages.
Lines of Credit and Third Party Mortgages
It is common for MIEs to borrow funds or become obliged
under third party mortgages in a foreclosure. Generally, credit
lines are secured through a general security agreement charging
the assets of the MIE. The nature and scope of the MIE’s assets
charged and the method by which it is registered should be
carefully considered; for example, where the lender’s security
consists of a specific assignment of mortgage loans or otherwise
adversely affects the MIE’s mortgage assets.
In circumstances where the MIE has foreclosed and taken title
of the property but it remains subject to a first mortgage held by a
third party, the MIE will remain obligated to service these mortgage
payments placing addition pressure on the MIE’s cash resources.
In both of these examples, the OM will require additional
disclosure. Specifically, the impact and risk of security taken and
the effect it may have on the priority of payment of funds to the
investors, either through the payment of interest or the return of
capital upon redemption or wind up. Obligations under third party
mortgages will also warrant additional disclosure in the mortgage
portfolio and risk factor disclosure sections of the OM and in the
financial statements included in the OM.
Risk Factor Disclosure
An area that always seems to draw regulatory scrutiny in OMs
is the risk factor disclosure. MIEs must be extremely thorough in
their consideration of the risks specific to an investment in the
MIE’s securities. MIE issuers should avoid boilerplate, generic risk
factors and should identify the MIE’s specific circumstances. For
example, the increased risk due to non-performing mortgages
is a common risk related to the mortgage investment industry.
A ‘best practices’ approach when addressing this risk factor
would be to list the number of mortgages in the MIE’s portfolio
which are impaired or in default as of the date of the OM and the
total amount of any loss provisions taken by the MIE. It would also
be prudent to address what effect the loss provisions may have on
the payment of dividends.
Another common risk factor for MIEs is the risk related to
foreclosure. Such risk factors should not only address the expenses
incurred in the foreclosure process but also set out the ongoing
costs to the MIE of owning the property until it is sold, including:
property taxes, capital repair and replacement costs, maintenance
costs, insurance costs and third party mortgage payments.
The negative impact on the MIE’s ability to invest in new mortgages
and meet redemptions should also be address sed.
Finally, MIE issuers should take care to specify in its risk factors,
the potential risks associated with the subordinated mortgages it
may hold in its portfolio, particularly if the portfolio is heavily weighted
with second or third mortgages. This risk factor may also identify that
a MIE’s priority under its mortgage security may be altered by a court
under certain insolvency/bankruptcy proceedings.
Development of Business
Item 2.3 of the F2 requires that issuers disclose the general
development of their business over at least the two most
recently completed financial years. Although the F2 states that
this disclosure can be made in one or two paragraphs, this is
the absolute minimum and in practice, much more disclosure
is typically required. For example, although a two year period is
specified, if a MIE is being impacted by events that occurred prior
to the two most recent years, then such disclosure should go back
and describe such prior events and how such events continue to
impact the MIE.
A ‘best practices’ approach when disclosing significant
events for the most recent fiscal year should address changes in
the MIE’s financial circumstances (both positive or negative) as
disclosed in the financial statements included in the OM. This
disclosure should not only discuss the factors leading up to those
changes but also the impact of such changes and how the MIE will
address any adverse financial circumstances.
There are a number of unique disclosure concerns related
to MIEs which must be considered when drafting OMs, including
the items discussed above. An MIE cannot simply follow the F2 or
another MIE’s OM precedent. It is imperative that attention is paid to
the specific circumstances of each MIE for compliant OM disclosure.
MIE issuers should strive to achieve ‘best practices’ disclosure in
OMs so as to provide a comprehensive and accurate description of
the MIE’s business and risk factors for the benefit of investors.
The information provided in this article is not meant as legal advice.
Viewers are cautioned not to act on information provided in this article
without seeking specific legal advice with respect to their specific
For more information contact: