Spotlight on Syndicated Mortgages

Syndicated mortgages are mortgages in which two or more persons participate, directly or indirectly, as lenders in the debt obligation that is secured by the mortgage. Some of these investments fund commercial and large-scale residential real estate developments in their early stages, and projects include condominium, office and retail complexes.

According to the Financial Services Commission (FSCO)’s figures, the syndicated mortgage market grew rapidly between 2014 and 2016, from $3.7 billion to $6 billion. But the growing sector has attracted several lawsuits, which contain claims that investors were put into developments that were far riskier than they were led to believe. The claims allege investors were misled about where their money was going, who had priority on returns and what recourse they had if the development ran into trouble.

In February 2018, eight participants in Canada’s syndicated mortgage market were sanctioned by FSCO as part of a $1.1-million settlement that saw several lose their broker licences. The eight parties, which includes four individual brokers and four brokerages, were involved in the distribution of syndicated mortgage investments for projects linked to Fortress Real Developments Inc., an Ontario-based real estate development company and consultant that partners with builders and developers in five provinces.

In addition to the lawsuits and sanctions, there has been other renewed attention by regulators.

CSA Request for Comments

On March 18, 2018, the Canadian Securities Administrators (CSA) published for a 90-day comment period (ending June 6,2018) proposed changes to National Instruments 45-106 Prospectus Exemptions and National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations related to Syndicated Mortgages, (2018) 41 OSCB 1873.

The purpose of the proposed amendments is to “introduce additional investor protections” and “increase harmonization” of requirements across Canada.

The CSA noted that the significant increase in the offering of syndicated mortgages raises the following concerns, particularly for retail investors:

• Use for seed financing before mortgages acquired
• Sold based on projected values
• Not fully secured against real property
• Subordinate to future financings
• Offered with by issuers with no source of income identified
• Subject to the risk of delay and increased costs inherent to real estate development.

CSA Proposed Changes

The proposed changes would remove the specific prospectus and registration exemption for syndicated mortgages in Newfoundland, the Northwest Territories, Nova Scotia, Nunavut, Ontario, Prince Edward Island and Yukon (Changing Provinces), to make the approach consistent with the remaining provinces.

The current syndicated mortgages exemption in the Changing Provinces would be removed and alternative prospectus exemptions such as the accredited investor or offering memorandum exemption would be available instead. Also, the Private Issuer Exemption would be unavailable for the distribution of syndicated mortgages. This would have the impact of requiring in most cases a dealer to be involved in the sale of the securities.

Additional requirements are also being proposed for the use of the OM exemption for syndicated mortgages. An appraisal of the current fair market value of the property by a qualified appraiser must be included. Other additional proposed disclosure includes: development risks, prior obligations secured against the real property and the price paid by the developer to acquire the real property, and information about the borrower. A mortgage broker involved in the distribution of a syndicated mortgage under the OM Exemption would also be required to provide a certificate that the OM does not contain a misrepresentation as to matters within the mortgage brokers knowledge and it has made best efforts to ensure that matters that are not within its knowledge do not contain a representation.

Specific Questions raised by the CSA for Comment[1]

CSA staff has asked specific questions regarding:

• Appraisals and whether there should be exceptions to the requirement;
• Mortgage Broker certificate and whether there should be exceptions to the requirement or if the scope of the certification should be changed;
• Exclusion from Private Issuer exemption; and
• Alternative exemptions to be adopted.

Other Regulatory Changes

In its fall economic statement on November 14, 2017, the Ontario government reiterated its plans to transfer regulatory responsibilities for the oversight of syndicated mortgage investments from FSCO to the Ontario Securities Commission (OSC). This is consistent with how syndicated mortgage investments are regulated in other provinces.

Prior to the transfer, the government stated it would strengthen protections for syndicated mortgage investors by creating new regulations that establish investment limits, expand requirements for mortgage brokerages to ensure investors are aware of the potential risks, and require mortgage brokerages to document suitability assessments.

To implement these interim measures, the Ministry of Finance posted proposed amendments to the Mortgage Brokerages: Standards of Practice Regulation (O. Reg. 188/08), under the Mortgage Brokerages, Lenders and Administrators Act, 2006. Consultation closed on October 13, 2017. Feedback is under review and next steps are being validated.

The proposed changes include:

• Requiring mortgage brokerages to report complaints relating to a syndicated mortgage transaction to FSCO’s Superintendent of Financial Services (“the Superintendent”) within 10 business days of receiving it.
• Requiring the collection of specific information to ensure that the mortgage brokerage understands the investor’s/lender’s investment needs and risk tolerances. This information is to be recorded in a form approved by the Superintendent and signed by the lender or investor to attest to the accuracy of its contents.
• Requiring that the mortgage brokerage undertake a suitability assessment for each lender or investor in a syndicated mortgage, recording this information in a form that has been approved by the Superintendent and providing a copy to the lender or investor.
• Placing an annual $25,000 investment limit on lenders or investors in syndicated mortgage investments.
• Clarify and enumerate requirements relating to documents that are to be disclosed to lenders or investors in relation to a syndicated mortgage, including requirements relating to appraisals and the financial statements of the borrower.

MIE vs. Syndicated Mortgage

A mortgage investment entity (MIE) is an issuer which proposes to invest its assets in a pool of mortgages. MIEs can vary in structure (mortgage investment corporation, limited partnership, etc.) but the underlying investment premise is the same. The MIE can do a public offering using a prospectus or through a prospectus exemption. If an exemption is used, exempt market dealers may be engaged to do a suitability assessment.

The proposed changes to syndicated mortgages make the treatment of MIEs and syndicated mortgages more similar for purposes of securities law, but in some cases such as when an OM is used the new requirements put MIEs at an advantage.

Impact of Proposed Changes

The question that remains is whether the new proposed changes will decrease the number of syndicated mortgages and encourage the use of other vehicles to raise money for real estate development.

By: Randee Pavalow and Michael Bluestein

[1] Comments may be addressed to: The Secretary, Ontario Securities Commission, 20 Queen Street West, Toronto, Ontario M5H 3S8, [email protected]