Example letter to shareholders on deferring dividends from your MIC until year-end
This letter is to inform you that we are deferring the regularly scheduled dividend until the financials for the year end are completed and audited, which we expect to be on or around {date}, in order to accurately manage the MICs cash flows with its income for the current fiscal year. As part of the International Financial Reporting Standards (IFRS) the MIC is required to implement an expected credit loss (ECL) framework, with a provision for same in the financial statements. In order to accurately and legitimately provide for an ECL in the financial statements we must measure the MIC’s financial assets and liabilities to account for apparent losses taking into account past events, current conditions and forecast information of each asset, mortgage, borrower, and property to reflect changes in an asset’s credit risk.
Under IFRS 9, financial assets are classified according to the business model for managing them and their cash flow characteristics. In essence, if (a) a financial asset is a simple debt instrument such as a loan or mortgage, (b) the objective of the MIC’s business model in which it is held is to collect its contractual cash flows (and generally not to sell the asset) and (c) those contractual cash flows represent solely payments of principal and interest or just interest, then the financial asset is held at amortized cost. The ECL framework is applied to those assets and any others that are subject to IFRS 9’s impairment accounting, a group that includes lease receivables, loan commitments and financial guarantee contracts. By way of an example we must consider and provide for the following in our financial statements as follows:
Impairment of loans is recognized – on an individual or collective basis – in three stages under IFRS 9:
Stage 1 –
When a loan is originated or purchased, ECLs resulting from default events that are possible within the next 12 months are recognized (12-month ECL) and a loss allowance is established. On subsequent reporting dates, 12-month ECL also applies to existing loans with no significant increase in credit risk since their initial recognition. Interest revenue is calculated on the loan’s gross carrying amount (that is, without deduction for ECLs). In determining whether a significant increase in credit risk has occurred since initial recognition, a lender is to assess the change, if any, in the risk of default over the expected life of the loan (that is, the change in the probability of default, as opposed to the amount of ECLs).
Stage 2 –
If a loan’s credit risk has increased significantly since initial recognition and is not considered low, lifetime ECLs are recognized. The calculation of interest revenue is the same as for Stage 1.
Stage 3 –
If the loan’s credit risk increases to the point where it is considered credit-impaired, interest revenue is calculated based on the loan’s amortized cost (that is, the gross carrying amount less the loss allowance). Lifetime ECLs are recognized, as in Stage 2.
Thus in order to accurately match our cash out-flows by way of a dividend with our actual income as reported in our financial statements, we require careful consideration and analysis so as not to have distributed more than the MIC’s minimum requirement to have on hand and meet its solvency requirements under law and accounting standards; and most importantly to ensure that retained earnings (net income) is distributed as dividends and not capital. Overall, the ECL will reflect the MIC’s management’s expectations of shortfalls in the collection of the mortgage’s contractual cash flows.
Finally, twelve-month ECL is the portion of lifetime ECLs associated with the possibility of a mortgage loan defaulting in the next 12 months. It is not the expected cash shortfalls over the next 12 months but the effect of the entire credit loss on a mortgage loan over its lifetime, weighted by the probability that this loss will occur in the next 12 months. It is also not the credit losses on mortgage loans that are forecast to actually default in the next 12 months. If the MIC can identify such loans or a portfolio of such loans that are expected to have increased significantly in credit risk since initial recognition, lifetime ECLs are recognized. Lifetime ECLs are an expected present value measure of losses that arise if a borrower defaults on its obligation throughout the life of the mortgage loan. They are the weighted average credit losses with the probability of default as the weight. Because ECLs also factor in the timing of payments, a credit loss (or cash shortfall) arises even if the MIC expects to be paid in full but later than when contractually due.
We hope this clarifies some of the questions you may have, and please do send us any others.
Finally, during this same period we will be gating any redemptions. This means, until the MIC’s audited financial statements are finalized, we will be suspending any redemption requests. This is important so as to ensure we have met our qualification requirements as a mortgage investment corporation throughout the fiscal year, and to enjoy the benefits as a MIC classified under the Income Tax Act of Canada.
