The global financial crisis of 2008/2009 brought about tremendous change in the world insofar as the banking and financial services sectors were concerned. As most economies around the world struggled, the global monetary policy response was to maintain interest rates as low as possible. This allowed businesses to borrow at low rates in order to invest, creating more jobs and momentum for their respective economies. Canadian monetary policy reflected the same sentiment and sought to achieve the same desired effect. While the rest of the world dealt with a deep recession, Canada fared generally better and recovered a lot sooner. With the cost of borrowing at historical lows, Canadian consumer debt levels have been hovering well over $150 for every $100 an average Canadian makes in income. This metric has been closely monitored by policymakers over the last 10 years. The easiest solution to putting the brakes on high levels of consumer borrowing would be to raise the interest rates. However, with the global economy struggling to recover and the slow pace of recovery in the United States, Canada’s largest trade partner, raising the interest rates could put the Canadian economy at risk of falling back into a recession.

The Minister of Finance, in conjunction with the Bank of Canada, chose to deal with the rising levels of consumer debts by tightening the availability of credit. The Government of Canada, through its regulator, the Office of Superintendent of Financial Institutions (OSFI), mandated federally regulated financial institutions such as banks, trust and, default, insurance company to tighten their lending criteria with a view to slowing down the availability of credit to residential borrowers. The domino effect of such tightening has given the alternative mortgage market in Canada a tremendous boost over the last eight years.

Canada’s alternative mortgage market is comprised of two categories of lenders: institutional alternative lenders and private lenders. Institutional alternative lenders are generally trust companies or banks that raise capital by selling guaranteed investment certificates (GICs) that pay slightly more than the competition and in turn lend to alternative borrowers. The Canadian GIC is an investment offering a guaranteed rate of return over a fixed period of time at a relatively low risk level. Alternative borrowers typically fall into one of the four categories: business for self, New Immigrants, Investors and Credit Challenged. Traditionally an alternative mortgage portfolio would carry primarily credit challenged borrowers followed by the other three categories. As OSFI introduced regulations, namely B-20 and B-21, to tighten the availability of credit in the mortgage market, many borrowers who previously would have qualified with a traditional bank or financial institution at favorable interest rate, found themselves in the position of approaching an alternative lender who may have more flexibility in what it will view as income.

For example, a business for self-borrower will have to provide two years tax returns to establish track record and net income to a traditional lender to get the best rate, which would average around 2.49 percent. For better or worse, most business for self-borrowers is guided by their accountants to minimize their taxable income by writing off business expenses. This practice of minimizing income taxes has the unfortunate consequence of the prospective business for self-borrower not being able to qualify at a traditional lender that would insist on taxable income and make very few concessions. An institutional alternative lender on the other hand would look at cashflow to establish income which would be favorable to a profitable business. The cost of borrowing of course, would be 1 to 2 percent higher. The result of tightening credit has shifted significant business from traditional lenders over to institutional alternative lenders. However, the institutional alternative lenders are also regulated by OSFI and have in turn been advised to clamp down on their lending guidelines essentially kicking out business that they previously would have funded over to the second category of alternative lenders in Canada, namely private lenders.

Private lenders are organized in two categories: Mortgage Investment Corporations and individual private lenders. Mortgage Investment Corporations or MICs raise capital from investors who desire consistent high returns on their investments and lend to borrowers who fall outside the rigid/set guidelines of traditional and institutional alternative lenders. Individual private lenders on the other hand lend to the same segment but lend their own money or pooled money with like-minded investors.

While traditionally the size of the private mortgage market has been very insignificant, these changes have significantly increased the level of activity in the alternative mortgage market. Institutional alternative lenders have experienced significant growth, but the market has been dominated by two major players: Home Trust and Equitable Bank, with Home Trust being the market leader. Unfortunately, Home Trust recently has come under scrutiny with the regulators and investor confidence has been shaken. Both institutional alternative players have noticed a run on their deposits and have worked in restoring investor confidence. In the interim, MICs and private lenders have experienced tremendous increase in activity at the expense of institutional alternative players intentionally slowing down to build up their balance sheets.

Fundamentally, the two major institutional alternative lenders have managed their books judiciously. Their fundamentals, average loan to values, reserves, geographic distributions and impaired loan reserves, have been very prudently managed. Thus, it is a matter of time before both institutions regain investor confidence. However, the broader regulations that went into effect to slow down the level of borrowing to cool down the housing and the related mortgage markets are here to stay. As a result, alternative (private) lending will continue to flourish in Canada.