An Overview of Syndicated Mortgages
If you’re looking to make money by investing in mortgages, you’re far from alone. Canada has a number of markets – notably Vancouver and Toronto – that are red-hot right now, and there are ways to make money as a lender. For people who don’t live in one of the hot markets, you can still make money by investing in homes that could be all the way across Canada from you.
If you have Googled ways to make money in mortgage investment, you have likely seen websites pop up for organizations that want to educate you about investigating in a syndicated mortgage. However, there are some aspects that you need to know about before you send off a check, particularly in such areas as investing in mortgages across provincial lines.
There are many different ways to take part in a syndicated mortgage, but for the most part, they generally take one of two forms:
- Indirect participation on a mortgage pool, through the purchase of units or shares in a private or non-publicly traded mortgage investment consortium
- Direct or indirect participation in a particular mortgage through a syndicated mortgage interest
The purpose of this article is to provide an in-depth look at syndicated mortgage interests.
If you are joining a program that involves direct participation, each individual in the syndicate becomes a co-lender of their own particular share, known as a pro rata share, or syndicated interest. Every co-lender enters an obligation under a loan agreement to fund a particular committed amount. This also entitles each co-lender to its own pro rata share of income from payments or benefits should the borrower go into default.
In many cases, the co-lenders will select one from among them, or choose a third party agent, to represent the co-lenders as a sort of administrator to manage the loan and interact with the borrower over the term of the note.
The security for the mortgage loan consists of the mortgage and may also have one or more promissory notes, an assignment of purchase, sale contracts, assignment of leases and rents and a general security agreements. The co-lenders enter the security as joint parties in some cases, which creates a direct contractual relationship between the borrower and each co-lender, or in other cases, the administrator is the only one to enter a direct relationship on behalf of the co-lenders.
It is also possible to participate directly in a syndicated mortgage after the initial closing; a co-lender can sell some or all of its pro rata share, either through the administrator or directly, to one or more parties interested in investing in the loan. Either an assignment and assumption agreement or an assignment and acceptance agreement will document this change, and as a result, each incoming lender receives the particular interest from the selling lender in both the loan and in the security.
In instances involving indirect participation, co-lenders enter an agreement with the originator or arranging lender (but not the borrower) to purchase syndicated or undivided interests in the mortgage loan and the security that the borrower will issue. This leads to a funding obligation and an agreement to reimburse the lender for expenses that are associated with originating the loan. The co-lenders may receive participation certificates to serve as evidence of their interests, or they may not, depending on the agreement.
Indirect lenders are not parties to the mortgage loan security at the loan’s initial closing and do not have any contractual relationship with the borrower of a direct nature. Borrowers may not know all of the indirect lenders attached to their mortgage and may not even know that the mortgage has been syndicated.
It is possible to participate indirectly in a mortgage after closing, just like with direct participation.
There are some syndicated loan structures that are hybrids of direct and indirect, with different priority levels among the various lenders with regard to receiving payment and carrying out a variety of remedies in case of default.
Remember – Syndicated Mortgages Are Securities
All of these types of syndicated mortgages come with different issues about securities law for lenders and borrowers, as well as any intermediaries or advisors involved in the process. It is worth stopping at this point to note that a mortgage is a security. Also, a syndicated mortgage is a mortgage in which at least two persons participate, directly or indirectly, as a lender within a debt that the mortgage secures. It is true that both dealer registration and prospectus exemptions can be obtained by licensed mortgage brokers, those exemptions require special qualification in Alberta and British Columbia.
So a borrower or arranging lender who offers the opportunity for direct participation (or an arranging lender offering indirect participation) to private investors in Alberta or BC may have to fulfill special criteria for those provinces. Ontario, in contract, permits dealer registration and prospectus exemptions for licensed mortgage brokers, when syndicated mortgages are involved, and the Financial Services Commission of Ontario (FSCO) has very specific guidelines for investor solicitation and the dissemination of information.
Dealing Syndicated Mortgages
If you are a borrower with an active business outsides the securities field and you only occasionally issue syndicated mortgage interests in one particular loan directly to private investors, you should not have to register as a dealer or need a dealer registration exemption in order to do this, because these issues are just a way to finance your business (which is not involved in securities) instead of trying to build a trade in securities. However, you would need a prospectus exemption for each transaction.
However, if you are an arranging lender/originator or a mortgage broker, and you take part in this sort of a transaction on a regular basis, and the purpose of these transactions is to benefit a business that deals in securities, you would need to register as a dealer as an exempt market dealer (EMD) unless you have an exemption. Typical examples of exemptions are the Minimum Amount Investment Exemption or the Northwestern Exemption. Both of these work in BC and Alberta.
In Alberta, the intermediary must have a mortgage broker license from the Real Estate Council of Alberta (RECA) unless there is an exemption. In BC, the intermediary must hold a mortgage broker license from the Office of the Registrar of Mortgage Brokers at the Financial Institutions Commission (FICOM) unless you hold an exemption.
Distributing Syndicated Mortgages
The Accredited Investor Exemption, the Private Issuer Exemption and the Minimum Amount Investment Exemption are the most common exemptions that borrowers and intermediaries use to distribute interests in syndicated mortgages. Any resale or first trade by a co-lender of any portion of its interest in a mortgage loan that had previously closed is treated as a distribution that requires an exemption. The OM Exemption, or the offering memorandum exemption, can also work, but the investment limits differ between BC and Alberta, so many Alberta co-lenders may find that it does not work for their needs.
Alberta and the OM Exemption
This provision applies when any borrower or issuer distributes syndicated mortgage interests to an investor/lender or resident purchaser in Alberta, or when an issuer/borrower in Alberta makes a similar distribution to any purchaser/lender/investor, in or out of Alberta. There are several requirements:
- The investor/purchaser/private lender buys the interest as principal;
- The cost of acquiring all of the securities (not just the syndicated mortgage interest but also any other investments in distributions by different issuers or from multiple offerings from the same borrower/issuer of the syndicated mortgage interest) in the last twelve months by one individual investor/private lender/purchaser who is:
- A non-eligible investor, is capped at $10,000, or
- An eligible investor, is capped at $30,000, or
- An eligible investor who also received advice from an investment dealer, portfolio manager or exempt market dealer that this is a solid investment, is capped at $100,000;
- Before or simultaneous with the signing of the security purchase agreement by the investor/private lender/purchaser, the originator/arranging lender or the borrower/issuer:
- Secures a signed acknowledgment of risk in the required from the investor/private lender/purchaser, and
- Provides an offering memorandum in the required form to the investor/private lender/purchaser.
An “eligible” investor :
- Has assets as an individual or with a spouse of no less than $400,000;
- Is an individual who has pre-tax net income, either alone or with a spouse, of no less than $125,000 in each of the most recent two calendar years and has a reasonable expectation to exceed that minimum in the present calendar year;
- Is a person pre-tax net income or profit in excess of $75,000 in each of the most recent two calendar years and has a reasonable expectation of exceeding that minimum in the present calendar year;
- Is a person of which most voting securities are in the beneficial ownership of eligible investors, or the majority of the directors consist of eligible investors; and
- Is an accredited investor.
If the individual investor/private lender/purchaser qualifies as an accredited investor or non-individual, such as a partnership or corporation, those investment limits do not apply. A borrower/issuer cannot use the Amended OM Exemption to distribute syndicated mortgage interests to a person that is used or was created just to hold or buy securities through that exemption.
Because of these investment limits, many borrower/issuers will not be likely to use this exemption to distribute syndicated mortgage interests.
BC and the OM Exemption
The exemption rules are virtually the same in British Columbia as they are in Alberta, with the exception that the investment limits do not apply. Also, the form of the offering memorandum is different in BC, and the form must be certified by the mortgage broker.
How Qualified Syndicated Mortgages Work in British Columbia
In British Columbia, Commission Rule 45-501 (BC) Mortgages from the British Columbia Securities Commission (BCSC) supersedes any limitations on prospectus exemptions and dealer registration exemptions when it comes to syndicated mortgages, in cases where distribution of the syndicated mortgage is going to an institution, like a mortgage broker or a registered portfolio manager.
This rule also provides that these requirements do not apply when the transaction involves a qualified syndicated mortgage. To qualify, these conditions must be met:
- The sale must go through a mortgage broker
- The mortgage must secure a debt on property that is solely used for residential purposes and has no more than four separate units
- The mortgage does not secure a debt that will go toward development or construction
- The mortgage cannot lead to debt in excess of 90% of the fair market value of the property, when combined with any other debts that the property secures; and
- The mortgage in question is limited to a single debt obligation.
Distributing Syndicated Mortgages across Provincial Lines
When you are dealing with investors and mortgages in several provinces, the best practice is to follow the laws in the most restrictive province for the entire deal. That way the laws in the province where the issuer is based, for example, will not scuttle a deal that involves a property in a less restrictive part of Canada.
Mortgage Investments Based in Ontario
Ontario does have less restrictive provincial regulations regarding the distribution of syndicated mortgage interests. However, when they do business with entities in other provinces, the laws of Ontario are not sufficient. If an FSCO licensed mortgage broker in Ontario solicits investors/private lenders in BC or Alberta, it is important to keep the following in mind:
- The broker must have registration:
- With FICOM or RECA or retain a broker who is registered in FICOM/RECA (whichever applies) for the transaction, and
- With Alberta or BC (depending on the location of the transaction) as an EMD or retain an EMD with the proper registration to handle the deal; and
- Both parties must be able to utilize one or more of the prospectus exceptions available in Ontario, as well as one available in either BC or Alberta, depending the location of the transaction.
Reporting Distributions of Syndicated Mortgage Interests
If any of the exemptions listed in this article are used for the distribution of syndicated mortgage interests in BC or Alberta, reports of those distributions must be made in the required form with the securities commission of the relevant province. The borrower is responsible for filing the report. Some EMDs have filed the reports as underwriters, but as they are not actual underwriters, that is not appropriate. Borrowers need to maintain control of the filing. In Alberta the SEDAR (System for Electronic Document and Analysis and Retrieval) platform is the appropriate destination for electronic filing. In BC, BCSC eServices is the destination.