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Fostering a Culture of Transparency in the Exempt Market Industry
April 26, 2012
William McNarland, CFA Senior Analyst [email protected]
Barry MacIsaac Research Analyst [email protected]
Suite 1903, 246 Stewart Green SW Calgary, AB, Canada T3H 3C8
Frontenac Mortgage Investment Corporation
QUICK FACTS
Type Mortgage Investment Corporation
(“MIC”) Risk Rating M1 – ‘Low Risk’
Expected Internal
Rate of Return
Ideal Case – 9.00%
Optimistic Case – 7.25%
Base Case – 5.50%
Pessimistic Case – 3.50%
Unsatisfactory Case – 1.75%
Head Office
The Simonett Building,
208 – 14,216 Road #38
Sharbot Lake, Ontario K0H 2P0
Minimum Client
Purchase $5,000
Price Per
Unit/Share $30 per common share.
Deferred Plan
Eligibility Yes.
Expected Issue
Closing Date Continuous offering.
Reporting Issuer
Frontenac MIC issues reports for
investors via the Internet at
http://www.sedar.com/.
Approximate Time
to Exit Continuous offering.
Auditor Raymond Chabot Grant Thornton LLP
Legal Torkin Manes LLP
Jurisdiction BC, AB, SK, MB, ON
Website http://www.fmic.ca/
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REPORT
STRUCTURE
1. Introduction
2. Key People
3. Key Partners
4. Strategy
5. Key Due Diligence Considerations
6. Structure Costs
7. Investment Structure and Entities
8. Management Fees
9. Valuation Considerations
10. Liabilities
11. Redemption Options
12. Return Expectations
13. Exit Strategy
14. Key Risks
15. Voting Structure
16. Financial Safety Mechanisms
17. Investor Liability
18. Potential Conflicts or Concerns
19. Similarity Between Offering Documents and Marketing
Representations
20. Bankruptcy and Regulatory History
21. Historical Corporate Changes
22. Litigation
23. Securities Registration
24. Suitability
25. Rating
26. Disclaimers
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INTRODUCTION
Frontenac Mortgage Investment Corporation is a prospectus-offered
fund that qualifies as a Mortgage Investment Corporation (“MIC”) under the Canadian Tax Act. Through its predecessor trust,
Frontenac has been investing in mortgages in Ontario for over 22
years. Frontenac is managed by W.A. Robinson & Associates, an
investment fund management firm that has been operating for over
30 years. The objective of Frontenac MIC is to generate income by
investing in mortgages that large financial institutions typically do
not service. As a mortgage investment corporation, Frontenac
expects to derive its earnings principally from the receipt of
mortgage interest payments.
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KEY PEOPLE
Wayne Robinson, CFA – Chief Executive Officer
Wayne Robinson has been a director and the president of Pillar
Financial Services, Frontenac’s mortgage broker, since September 30, 1986. He has also been the secretary of Pillar Financial
Services since November 6, 2003. Wayne is the founder, director,
and president of W.A. Robinson & Associates, which serves as the
financial adviser, investment counsel, and portfolio manager of
Frontenac MIC. Wayne Robinson has an extensive financial
education, and is a Chartered Financial Analyst.
Kevin Cruickshank, CA – Chief Financial Officer
Kevin Cruickshank has been the chief financial officer of Pillar
Financial Services and W.A. Robinson & Associates since 2006.
Kevin has been a partner in public accounting firm Seeds &
Company LLP Chartered Accountants since 2008. Kevin is also a
partner in the Loon’s Call Campground & Cottage Resort, and was the chief financial officer of the Hanley Group of Companies from
2000 to 2004. Kevin Cruickshank has an extensive financial
education, and is a Chartered Accountant.
Frontenac Board Members
In addition to the management team, there are six independent
board members. The name, position, and a brief overview is
provided for each board member in the summaries below.
Colleen Allison – Chair
Colleen Allison is a retired teacher and has been a director of
Frontenac since 1996. Formerly, she was chair of Mortgage
Investment Corporation of Eastern Ontario (“MICEO”), which is another MIC operated and managed by W.A. Robinson &
Associates.
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Robert Barnes – Director
Robert Barnes is the general manager at Robinson Solutions Inc., a
buildings systems solution provider, since February 2008. He was
also the managing director of Axis Database Marketing Inc. from
1997 to 2008, and Compliance Marketing Services, Inc., an
integrated marketing and technology services company, since 1997.
William Calvert – Director
William Calvert is a retired senior municipal and provincial civil
servant, as well as a consultant to various municipalities and
provincial ministries.
Eric Dinelle – Director
Eric Dinelle is the owner of Environmental Contracting Services. He
has also been the senior project manager for the City of Kingston
since 2009, and was the senior project manager in the planning
department for the Kingston General Hospital from 2003 to 2009.
Margaret Kelk – Director
Margaret Kelk is a retired teacher and artist. She has owned and
managed various farming and real property rental operating
companies for over 40 years.
Rosemarie Bowick – Director
Rosemarie Bowick is retired from the corporate office at Nortel
Networks. She has also been the chair of the board of directors of
the Mortgage Investment Corporation of Eastern Ontario since
2006.
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KEY PARTNERS
Raymond Chabot Grant Thornton LLP
Grant Thornton LLP and Raymond Chabot Grant Thornton LLP form
the Canadian member firms of Grant Thornton International. Grant
Thornton International is a global organization of accounting and
consulting firms that provide privately held business, assurance, tax,
and advisory services to private, public interest, and public
companies. Grant Thornton Ltd. is a non-profit, non-practicing,
international umbrella membership entity that was organized as a
private company with no share capital and is limited by guarantee.
There are over 2,600 member firm partners and more than 30,000
personnel operating in over 100 countries within Grant Thornton.
Although many of the firms carry the name, they are all not
members of one international partnership. Each member firm is a
separate national entity that independently governs itself and
manages its own administrative matters. Quebec-based Raymond
Chabot Grant Thornton LLP has been rated A+ with the Better
Business Bureau since 2002, and when combined with Grant
Thornton LLP, they have over 4,000 professionals in 110 offices
across Canada, and report over $450 million in revenue.
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STRATEGY
Frontenac’s business strategy consists of lending money to individuals for the purposes of acquiring real property, against the
security of a mortgage issued by the corporation. The purchase of
common shares allows an investor to participate with other investors
in a common fund holding a variety of mortgages.
Frontenac works closely with retail mortgage brokers throughout
Ontario in order to market itself as a lender of choice in the non-
prime mortgage market segment. Frontenac expects to be well
positioned to receive referrals on mortgage lending opportunities
that do not meet the criteria of major lending institutions in Canada.
Other lending opportunities involve borrowers in rural areas that
typically are not serviced by major lenders. As a result, Frontenac’s investments in mortgages are expected to earn a higher rate of
interest than what is generally obtainable through traditional
mortgage lending activities.
Frontenac MIC has adapted the following strategies for lending
mortgages:
- Frontenac will make loans of up to 80% of the fair market
value of the subject property for terms of up to five years, but
generally within two years.
- Frontenac may engage in bridge financing activities, albeit
rarely, including the financing of new home construction.
- Frontenac intends that at least 70% of the mortgages held
will be first mortgages, and no more than 30% of the
mortgages held will be second mortgages.
- Frontenac will allow for up to 49% of the mortgages to be for
commercial properties.
- Frontenac intends to generally invest in fixed-rate of interest
mortgages.
- Frontenac intends to hold a cash position equal to 5% of its
total assets.
- Frontenac will not buy or sell mortgages in the secondary
market, hold a fractional interest in a mortgage, or participate
in mortgage syndications other than those with Mortgage
Investment Corporation of Eastern Ontario (“MICEO”), which is another MIC with the same management team and
administrator as Frontenac.
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KEY DUE DILIGENCE
CONSIDERATIONS
The following topics are primary due diligence considerations for
institutions or individuals investing in Frontenac MIC:
1. Mortgage Investment Corporations
2. Frontenac MIC Portfolio
3. Financial Performance
4. Historic Returns and Return Stability
5. Frontenac MIC Lending Area
6. Mortgage Considerations
Mortgage Investment Corporations
Mortgage investment corporations were introduced in Canada in
1973 by the enactment of the Residential Mortgage Financing Act.
One of the stated objectives of this statute was the improvement of
the flow of mortgage funds for middle- and moderate-income home
buyers, a necessary step in order to reach national housing targets.
MICs were intended to encourage and facilitate the investment of
private capital into residential mortgages by providing a vehicle
through which smaller, non-institutional investors could place
investment funds into mortgages. Recognizing that mortgages are
not as liquid as other securities, such as stocks and bonds, and not
as easy to buy, sell or divide into fractional interests so as to
facilitate portfolio diversification, the government of the day elected
to allow for the creation of corporate entities permitting the pooling
of mortgages. The shareholder of these entities would, similarly to
mutual fund investors, own a part of the corporation's total portfolio
corresponding to his or her own investment and enjoy the benefits
of expert advice. The tax treatment of MICs would be comparable to
that of direct investments in mortgages.
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A Mortgage Investment Corporation or “MIC” is an investment and
lending company designed specifically for mortgage lending in
Canada. Owning shares in a MIC enables you to invest in a
company that manages a diversified and secured pool of
mortgages. Shares of a MIC are qualified as deferred plan
investments under the Canadian Income Tax Act. MICs are
generally provincially registered and licensed, with the management
of the mortgage fund under the direction of provincially licensed
mortgage brokers and real estate agents.
A MIC mortgage portfolio can include everything from small second
mortgages on residential property to commercial and development
mortgages on new projects. Every investment is typically based on
a thorough investigation of the property. A typical MIC loan should
never exceed a specified percentage of the current value of the
property. Compare this to a conventional bank’s willingness to routinely loan 80% of the value of the property and sometimes even
100%. MIC investment strategies vary considerably, as do the rates
of return on invested capital.
MICs are organized for investing in pools of mortgages. Profits
generated by MICs are distributed to its shareholders according to
their proportional interest. The mortgages are secured on real
property, often in conjunction with other forms of security, such as
personal and corporate guarantees, general security agreements,
and assignments of material contracts such as insurance policies.
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To qualify as a MIC, the following criteria must be met:
1. A MIC must have at least 20 shareholders.
2. A MIC is generally widely held. No shareholder may hold
more than 25% of the MIC’s total capital.
3. At least 50% of a MIC’s assets must be residential mortgages, or cash and insured deposits.
4. A MIC may invest up to 25% of its assets directly in real
estate, but may not develop land or engage in construction.
This ceiling on real estate holdings does not include real
estate acquired as a result of mortgage default.
5. A MIC is a flow-through investment vehicle, and distributes
100% of its net income to its shareholders.
6. All MIC investments must be in Canada, but a MIC may
accept investment capital from outside of Canada.
7. A MIC is a tax-exempt corporation.
8. Dividends received with respect to directly held shares are
taxed as interest income in the shareholder’s hands. Dividends may be received in the form of cash, or additional
shares.
9. A MIC’s annual financial statements must be audited.
10. A MIC may employ financial leverage by using debt to
partially fund assets.
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Frontenac MIC Portfolio
Mortgages in Frontenac’s investment portfolio have maturity dates ranging from one to two years. The portfolio contains 203
mortgages that are mainly first and second mortgages secured by
residential and commercial real estate. Approximately 77% of
Frontenac’s mortgages are residential, 16% are commercial, 4% are vacant land, and 3% are cash or liquid assets.
The majority of mortgage investments made by Frontenac are in the
$200,000 to $250,000 range, on average, with interest rates
between 10% and 12%. Mortgages are issued with either one or
two-year terms, have fixed rates and can be paid in full before the
maturity date without being subject to an early redemption fee. The
weighted average interest rate of the mortgages at 2011 year-end
was 10.80%, compared to 10.82% at the end of 2010. If interest
rates rise or fall at any given time throughout the year, interest
income will not be affected due to Frontenac’s policy of issuing fixed rates.
Number of Mortgages
Interest Rate Fair Value Average
2 8% $95,417 $47,709
19 9% $6,620,662 $348,456
67 10% $16,325,914 $243,670
30 11% $5,481,856 $182,729
84 12% $16,353,882 $194,689
1 13% $48,178 $48,178
203 10.8% $44,925,909 $221,310
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Diversification
A larger amount of mortgages provides larger diversification.
Traditionally, many small MICs have fewer than twenty mortgages,
in which case a large terminal loss on a mortgage can become a
material event to a small fund. On December 31 2011, Frontenac
held 203 mortgages, which is over 25% higher than on December
31, 2010. The high number of mortgages in Frontenac’s portfolio provides significant diversification and lowers risk. In addition, it is
wise to consider whether a fund contains any large mortgages that
provide for a lack of diversification. The tables below show the
significance of the largest mortgages in relationship to the size of
Frontenac’s net asset value.
The largest mortgage in Frontenac’s portfolio is 6.1% of the net asset value, which is relatively unchanged from 2010. However, the
largest three mortgages and the largest five mortgages are 3%
lower than the ratio of net assets in 2010, and the largest ten
mortgages are 5% lower than the ratio of net assets in 2010. The
outcome of the analysis of the number and size of the mortgages
provides the comfort of diversification to investors.
Statistic Percentage of NAV
Largest Mortgage 6.1%
Largest Three Mortgages 13.2%
Largest Five Mortgages 18.2%
Largest Ten Mortgages 26.4%
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Loan to Value
The loan to value (LTV) is the mortgage amount divided by the
appraised value of the asset. A lower LTV provides incentive for
borrowers to not default on their loans. To get a sense of this, it is
wise to consider not only the average LTV of the portfolio, but also
the median LTV and the average LTV at mortgage origination. It is
possible that the average LTV could be artificially low. Consider an
MIC that has total assets of $15 million and has issued a first
mortgage of $100,000 on a property that has been appraised at
$400,000:
If the LTV of the first mortgage was calculated using the total value
of the asset, this low LTV mortgage could lower the MIC’s LTV by 25% in real terms. An MIC manager could manipulate the LTV by
soliciting this type of business. In this case, it would be more
appropriate to calculate an average mortgage LTV or median
mortgage LTV. The table below provides the median and average
LTV for Frontenac.
The Portfolio Average LTV being 8.58% lower than the Origination
LTV shows stability in the mortgagors’ paying their principal and interest obligations. The Median LTV is also in reasonable proximity
to the Average LTV. These three analyses of LTV demonstrate low
risk characteristics due to the amount of equity that the mortgagor
has in the properties.
First Mortgage $100,000
Appraised Value $400,000
LTV of First Mortgage 25%
Second Mortgage $200,000
LTV of Total Mortgages 75%
Real LTV of First Mortgage 50%
Statistic LTV
Average LTV of Portfolio 53.7% Median LTV of Portfolio 54.3% Average of LTV at Origination 60.68% (2010)
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Ratio of First to Second Mortgages
Traditionally, first mortgages are less risky than second mortgages
except in the rare circumstance that a second mortgage has an
extremely low LTV. The ratio of first mortgages to second
mortgages for Frontenac is below, and demonstrates low-risk
characteristics.
Appraisal Data
With the exception of cases in which the manager knows that a
property has increased in value and the mortgage balance has
declined, it is preferred to have recent appraisal data. Below is a
breakdown of the year the mortgages in the portfolio were last
appraised.
The majority of the mortgages have recent appraisal dates, which
creates fewer discrepancies between the book and fair market
values.
Mortgage Position Percentage
First Mortgages 96.8%
Second Mortgages 3.2%
Appraisal Year Number of Mortgages
2011 48
2010 56
2009 28
2008 17
2007 13
2006 10
2005 6
2004 2
2003 2
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Terminal Losses
There can be much discussion about mortgage defaults and losses.
The key consideration should be terminal losses and not default.
For example, if a mortgagor defaults on interest for four months and
a power of sale is exercised, fees and costs are often recoverable
from the borrower directly or through this process. The concern is
about the fees or costs that are not recovered and become terminal
losses. The terminal losses of the past are accounted for in the
audited historic return data. For example, in 2011 the write-offs in
the Fund were $271,336, compared with $326,199 in 2010, or
1.01% of the Fund’s assets and interest paid to investors in 2011 compared with 0.56% in 2010. Given the data from 2011, an annual
1% write-off would be considered conservative for Frontenac,
whereas many other MICs would consider 5% or higher a
conservative figure.
Interest Rate Risk
Traditionally, with fixed income investments, there is concern that
increases in interest rates can cause capital losses. Frontenac’s returns are positively correlated to Bank of Canada interest rate
increases due to Frontenac charging higher interest rates in rate-
increasing environments.
Repeatable Returns
Traditionally, the first mortgage needs of Canadians have been
provided for by Canadian banks. However, Canadian banks are
restricted by lending criteria that will not allow them to lend to clients
who have a rural property, are self-employed, earn commission
income, are business owners, have distant credit problems, or need
short-term construction financing. Frontenac has been filling this
niche, which has allowed it to earn high interest rates with low levels
of terminal loss. The opportunity has increased in the last few years
as lenders have left the Canadian market and more individuals
require non-traditional mortgages. It is the opinion of the EA Analyst
team that returns in the future will be similar to those of the past.
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Duration
The shorter the duration of the mortgages in an MIC, the lower the
risk is. The duration of the mortgages held by Frontenac is very
short, as shown by the year of maturity of the mortgages in the table
below.
2011 Financial Performance
The following financial statement summaries reflect the performance
of Frontenac in 2011 and compare the results with 2010.
Statement of Operations
.
Maturity Date Number of Mortgages
2012 73
2013 48
2014 4
2015 0
Operating Year 2011 2010
Interest Income $3,771,220 $2,851,989
Expenses
Administration fees $800,627 $639,149
Audit fees $39,180 $26,943
Director fees $36,417 $40,567
General and operating expenses $239,863 $212,508
Interest and bank charges $39,361 $3,788
Legal fees $32,077 $48,249
Custodian fees $11,300 $10,500
Trustee account fees $63,896 $88,904
Total Expenses $1,262,721 $1,070,608
Net Investment Income $2,508,499 $1,781,381
Loss on mortgage investments ($271,336) ($326,119) Unrealized change in value of mortgage investments
$151,000 $15,000
Increase in Net Assets from Operations
$2,388,163 $1,470,262
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In 2011, Frontenac had a substantial increase in interest income.
Management had issued new shares for nearly $14 million and were
able to place capital by finding appropriate borrowers. This resulted
in a 32.2% increase in revenue, a 40.8% increase in income, and a
gross profit margin increase from 62.5% in 2010 to 66.5% in 2011
Changes in Net Assets
In 2010, shareholders reinvested 80.1% of their income back into
common shares. In 2011, shareholders reinvested 86.5% back into
common shares, and Frontenac issued nearly 467,000 shares.
Operating Year 2011 2010
Share Capital Transactions Cash proceeds from issuing common shares
$13,997,592 $2,929,163
Reinvested dividends $2,170,541 $1,425,783
Redeemed common shares ($1,093,192) ($1,534,416)
Common share dividends ($2,388,163) ($1,470,262) Net Assets, Beginning of the Year:
$30,973,376 $28,152,846
Increase in net assets from operations
$2,388,163 $1,470,262
Net Assets, End of the Year: $46,048,317 $30,973,376
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Net Asset Value
Mortgages reflect 97.6% of the net asset value. The remaining 2.4%
is cash and prepaid expenses.
Frontenac increased in size by over 30% in 2011 and increased its
percentage of reinvested dividends, which is a strong indicator that
investor confidence is growing for the Fund.
Shareholder’s Equity
Operating Year 2011 2010 Assets Cash and cash equivalents $1,254,128 $1,279,227 Mortgage investments $44,925,909 $31,067,014 Prepaid expenses $8,517 $8,517 Total Assets $46,188,554 $32,354,758 Liabilities Bank line of credit $0 $1,300,000 Dividends payable $50,189 $7,364 Accounts payable and accrued expenses
$56,238 $62,351
Prepaid mortgage payments $33,810 $11,667
Net Assets, End of the Year: $46,048,317 $30,973,376
Year 2011 2010
Shares Amount Shares Amount Balance, beginning
1,032,446 $30,973,376 938,428 $28,152,846
Shares issued for
cash 466,586 $13,997,592 97,639 $2,929,163
Dividend reinvestment
72,351 $2,170,541 47,526 $1,425,783
Redeemed for cash
(36,440) ($1,093,192) (51,147) ($1,534,416)
Balance, end of year
1,534,943 $46,048,317 1,032,466 $30,973,376
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Historic Returns and Return Stability
The return stability of Frontenac has been very consistent. Since the
duration or length of mortgages in Frontenac is very short, the
expected return will be highly correlated to the Canadian Bank Rate.
The expected return will be the Canadian Bank Rate plus the added
return provided through management skill. Management skill is net
of terminal losses, which is a large factor in determining the
managers’ skill. The table below summarizes the returns.
This analysis demonstrates that the returns are very stable, and
there is strong correlation to the Canadian Bank Rate and manager
skill in determining overall return. The returns have been quite
impressive compared to publicly available mortgage-based mutual
funds.
Year Bank of
Canada Rate Annual Return
Management Skill
1990 13.90% 11.40% -2.50% 1991 8.91% 12.00% 3.09% 1992 5.91% 12.66% 6.75% 1993 4.79% 14.24% 9.45% 1994 6.92% 12.58% 5.66% 1995 6.97% 12.87% 5.90% 1996 5.00% 9.12% 4.12% 1997 3.25% 8.47% 5.22% 1998 5.00% 7.00% 2.00% 1999 4.75% 7.45% 2.70% 2000 6.00% 7.90% 1.90% 2001 4.75% 5.40% 0.65% 2002 2.75% 6.50% 3.75% 2003 3.25% 7.60% 4.35% 2004 2.25% 6.30% 4.05% 2005 2.50% 5.70% 3.20% 2006 4.25% 5.78% 1.53% 2007 4.50% 7.20% 2.70% 2008 3.25% 6.36% 3.11% 2009 0.50% 5.88% 5.38% 2010 0.50% 5.01% 4.51% 2011 1.00% 6.67% 5.67%
Average 4.59% 8.37% 3.78%
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Large Mortgage Funds’ Best Years from 2004 to 2011
The Globe and Mail
Large Mortgage Funds’ Worst Years from 2004 to 2011
The Globe and Mail
One-year Annualized Returns
The Globe and Mail
Fund Best Year
BMO Mortgage and Short-term Income 5.85%
CI Signature Mortgage 4.59%
Investors Mortgage and Short-term 6.02%
Frontenac MIC 7.20%
National Bank Mortgage 5.50%
Scotia Mortgage Income 5.89%
TD Mortgage 7.36%
Fund Worst Year
BMO Mortgage and Short-term Income 1.53%
CI Signature Mortgage 1.02%
Investors Mortgage and Short-term 1.11%
Frontenac MIC 5.01%
National Bank Mortgage 1.83%
Scotia Mortgage Income 0.99%
TD Mortgage 1.63%
Fund Return
BMO Mortgage and Short-term Income 2.77%
CI Signature Mortgage 2.35%
Investors Mortgage and Short-term 2.12%
Frontenac MIC 6.67%
National Bank Mortgage 3.55%
Scotia Mortgage Income 0.99%
TD Mortgage 2.27%
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Three-year Annualized Returns
Five-year Annualized Returns
Ten-year Annualized Returns
Fund Return
BMO Mortgage and Short-term Income 1.88%
CI Signature Mortgage 2.05%
Investors Mortgage and Short-term 1.94%
Frontenac MIC 5.85%
National Bank Mortgage 2.20%
Scotia Mortgage Income 1.37%
TD Mortgage 2.05%
Fund Return
BMO Mortgage and Short-term Income 2.84%
CI Signature Mortgage 2.31%
Investors Mortgage and Short-term 3.13%
Frontenac MIC 6.20%
National Bank Mortgage 3.05%
Scotia Mortgage Income 2.74%
TD Mortgage 3.44%
Fund Return
BMO Mortgage and Short-term Income 2.67%
CI Signature Mortgage 2.57%
Investors Mortgage and Short-term 2.92%
Frontenac MIC 6.29%
National Bank Mortgage 3.74%
Scotia Mortgage Income 3.05%
TD Mortgage 3.65%
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Frontenac MIC Lending Area
The best areas for mortgage lending have low unemployment, high
family incomes, and reasonable real estate prices. Below is a
comparison of Ottawa with other Canadian major cities.
Overview of Ottawa
Ottawa is the capital of Canada, the second largest city in the
Province of Ontario, and the fourth largest city in Canada. The city is
located on the south bank of the Ottawa River in the eastern portion
of Southern Ontario. Ottawa borders Gatineau, Quebec, located on
the north bank of the Ottawa River; together they form the “National Capital Region.” The 2011 census identified the city’s population as 883,391, and the metropolitan area’s population as 1,236,324. From
1990 to 2000, Ottawa experienced significant population growth that
has continued through today.
Ottawa Dominion Bureau of Statistics
Mercer ranks Ottawa among the top cities for quality of living among
the worlds’ large cities and second in North America. In addition, it
was rated the second cleanest city in Canada and the third cleanest
city in the world. In 2012, for the third consecutive year,
MoneySense ranked Ottawa as the best community in Canada to
live in.
Year Population YOY Change Canada
1950 202,045 - - 1960 268,206 32.7% 30.2% 1970 302,341 12.7% 20.4% 1980 295,163 (2.4%) 13.0% 1990 313,987 6.4% 12.9% 2000 774,072 146.5% 10.7% 2010 883,391 14.1% 7.9%
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Economic Overview
Ottawa’s primary employers are the Government of Canada and the high-tech industry. The city has a high standard of living and a low
unemployment rate. In 2007, Ottawa had the fourth highest growth
rate among major Canadian cities with a 2.7% GDP growth rate,
which exceeded the Canadian average of 2.4%. It is estimated that
the National Capital Region attracts around seven million tourists
annually who spend about $1.3 billion.
Conference Board of Canada
From 2001 to 2006, Ottawa experienced an increase of 40,000 jobs.
While the number of employees in the federal government
stagnated, the high-technology industry grew by 2.4%. The overall
growth of jobs in Ottawa was 1.3% compared with the previous
year, down to sixth place among Canada's largest cities.
The unemployment rate in Ottawa was 5.1% in 2006, which was
below the national average of 6.0%. The economic downturn
resulted in an increase in the unemployment rate in 2009. The table
below compares the unemployment rate among Canadian provinces
in 2012.
Year GDP per Capita
YOY Change
National GDP
YOY Change
2003 35,700 - 37,124 - 2004 36,412 2.0% 37,922 2.1% 2005 37,121 1.9% 38,697 2.0% 2006 38,023 2.4% 39,386 1.8% 2007 38,649 1.6% 39,820 1.1% 2008 38,570 (0.2%) 39,629 (0.5%) 2009 37,550 (2.6%) 38,070 (3.9%) 2010 38,052 1.3% 38,846 2.0% 2011 38,433 1.0% 39,370 1.3%
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The Canadian Press
Among the provinces above, Ontario has a fairly average
unemployment rate. Compared with cities in Ontario, Ottawa has
one of the lowest unemployment rates, which is an indicator that the
city is poised for strong population growth.
The Canadian Press
Canadian Province Unemployment Rate
Newfoundland and Labrador 12.9% Prince Edward Island 10.8% New Brunswick 10.1% Quebec 8.4% Nova Scotia 8.2% Ontario 7.6% British Columbia 6.9% Manitoba 5.6% Saskatchewan 5.0% Alberta 5.0%
National Average 7.4%
Canadian City Unemployment Rate
Windsor 10.7% Peterborough 9.6% Barrie 9.2% Brantford 8.8% Toronto 8.6% London 8.5% Oshawa 7.8% Niagara 7.5% Kingston 7.4% Sudbury 7.2% Kitchener 6.7% Ottawa 6.2% Hamilton 6.0% Guelph 5.4% Thunder Bay 5.3%
Ontario Average 7.6%
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Ottawa has the second highest family income of all major Canadian
cities. The median family income was $90,990 in 2008, which was
much higher than the Ontario and Canada average..
Statistics Canada 2008
The Federal government is Ottawa’s largest employer, employing
over 110,000 individuals from the National Capital Region. In
addition, Ottawa is an important technology center; its 1,800
companies employ approximately 80,000 people. Most of these
companies specialize in telecommunications, software
development, and environmental technology. Large technology
companies such as Nortel, Corel, Mitel, Cognos, and JDS Uniphase
were founded in Ottawa. Ottawa also has regional locations for 3M,
Adobe Systems, Bell Canada, IBM, Alcatel-Lucent, and Hewlett-
Packard. Many of Ottawa’s telecommunications and new technology companies are located in the western part of the city.
Location Median Family Income
Calgary $91,570 Ottawa $90,990 Edmonton $88,190 Oshawa $83,220 Guelph $81,910 Regina $81,480 Sudbury $79,570 Victoria $77,810 Saskatoon $77,740 Alberta $86,080 Ontario $70,910
Saskatchewan $69,800 British Columbia $67,890 Manitoba $64,530 Quebec $63,830
Canada $68,860
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Another major employer is the health sector, which employs over
18,000 people. Nordion and i-Stat, as well as the National Research
Council of Canada and OHRI, are part of a growing life sciences
sector. Business, finance, administration, and sales and service
occupations rank high among types of occupations. Approximately
10% of Ottawa's GDP is derived from the financial services,
insurance, and real estate sectors, whereas employment in goods-
producing industries is only half the national average. The City of
Ottawa is the area’s second largest employer with over 15,000 employees.
Cost of Living
The cost of living in Ottawa is considerably cheaper than most major
Canadian cities. MoneySense evaluated 179 Canadian cities and
Ottawa was ranked in first place due to its low cost of living, strong
economy, low crime rate, and steady population growth. The table
below compares average annual household expenditures by city
based on tax rates, living costs, transportation, food, recreation,
insurance costs, healthcare, entertainment, and education.
Statistics Canada 2011
Among the major Canadian cities listed, Ottawa is the cheapest are
in which to live. Combined with its high median family income,
Ottawa likely experiences more savings, which allows for more
accessible housing. The table below compares the average home
prices of standard two-story houses, single detached houses, and
condominiums.
City Average Household Expenditures
Calgary $82,722 Toronto $73,407 Edmonton $70,216 Vancouver $67,967 Saskatoon $66,584 Halifax $60,636 Winnipeg $58,074 Montreal $56,053
Ottawa $52,796
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RBC 2012
The price for a single detached home in Ottawa is approximately 4.1
times the average family income. Housing in Ottawa is very
affordable when compared to Vancouver, which is at over 10 times
family income and Toronto, which is at over 7 times
CMHC 2012
Newly completed housing in Ottawa is stable compared to
Vancouver and Toronto. In 2009, rapid growth, low interest rates,
and accessible mortgages led to a sharp decline in home prices.
With steady population growth, a low unemployment rate, high
wages, and steady GDP growth, Ottawa is in a position that enables
it to be one of the major cities least affected by a housing downturn.
City Standard 2-
Story Single
Detached Condominium
Vancouver $845,000 $790,000 $403,200 Toronto $602,000 $515,100 $326,400 Calgary $414,700 $423,600 $254,500 Ottawa $379,800 $371,900 $257,000
Edmonton $372,900 $322,900 $199,500 Montreal $365,300 $281,300 $227,200 Saskatoon $344,800 $326,800 $218,500 Winnipeg $282,000 $263,700 $157,700 Halifax $234,300 $209,800 $176,900
City Newly-Completed Single Detached (Average)
Year 2010 2011 Change Vancouver $1,074,943 $1,372,889 27.7% Toronto $667,361 $836,042 25.3% Calgary $534,172 $563,904 5.6% Edmonton $484,937 $480,283 -1.0% Ottawa $416,358 $444,450 6.7%
Winnipeg $427,767 $429,519 0.4% Saskatoon $420,079 $408,326 -2.8% Halifax $358,919 $354,385 -1.3% Montreal $338,097 $327,206 -3.2%
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MLS 2011
The average home in Ottawa sold for $339,041 in 2010 compared
to $304,801 in 2009. This represents an 11.2% increase, the
highest of all major Canadian cities.
City Average Home Sale Price
Year 2009 2010 Change Vancouver $592,441 $653,499 10.3% Toronto $396,154 $435,277 9.9% Calgary $385,882 $399,332 3.5% Montreal $330,056 $355,109 7.6% Ottawa $304,801 $339,041 11.2% Edmonton $320,378 $323,488 1.0% Saskatoon $280,784 $291,056 3.7% Halifax $239,784 $254,949 6.3% Winnipeg $216,012 $227,370 5.3%
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STRUCTURE COSTS
INVESTMENT
STRUCTURE & ENTITIES
Indicated returns are net of management fee, which is 1.0% plus
expenses, and net of mortgage administration fee of 1.0%. Investors
will pay management fees and operating expenses.
The investment structure is a “Mortgage Investment Corporation” as described in the “Key Due Diligence Considerations” sub-heading.
The following entities are associated with Frontenac MIC:
W.A. Robinson & Associates Ltd.
W.A. Robinson & Associates is Frontenac MIC’s manager, portfolio advisor, registrar of common shares, and transfer agent. W.A.
Robinson & Associates is a registered portfolio manager and
investment fund manager retained by Frontenac to manage the
overall business and operations of the corporation and to provide it
with investment advice and portfolio management services in
respect of its investment portfolio. W.A. Robinson & Associates is
majority-owned by Wayne Robinson. Frontenac will pay W.A.
Robinson & Associates an annual fee of 1% of the value of
Frontenac’s total assets, calculated and payable at the end of every month.
Pillar Financial Services Inc.
Pillar Financial Services is a licensed mortgage broker and
mortgage administrator retained by Frontenac to service the
mortgage portfolio, including the sourcing and administration of
mortgages. The Pillar Financial Services is also responsible for the
underwriting and approval of prospective mortgage applications,
collection of payments and, where necessary, commencing
enforcement proceedings against delinquent mortgagors. Pillar
Financial Services is wholly-owned by Wayne Robinson and is an
affiliate of W.A. Robinson & Associates. Frontenac pays Pillar
Financial Services an annual fee of 1% of the total asset value in
consideration for the mortgage brokering and administration
services they provide.
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MANAGEMENT FEE
VALUATION
CONSIDERATIONS
LIABILITIES
REDEMPTION OPTIONS
Pillar Financial Services is the administrator and W.A. Robinson &
Associates is the manager for the Company. Frontenac signed new
contracts for these services in 2008 under which Pillar and W.A.
each charge an annual fee of 1% of the total asset value calculated
on a monthly basis.
Administration and management fees paid under these agreements
were $800,627 for 2011 compared to $639,149 for 2010. The
increase in the dollar value of the administration and management
fees from 2010 is a reflection of the increase in the total net assets
of Frontenac.
The fund values its common shares on a monthly basis. The net
asset value is confirmed by an independent account audit once a
year. Since there has not been a year with a loss, the net asset
value has been constant.
In July 2007, the Board of Directors approved a $3,000,000 line of
credit with the Royal Bank of Canada. The purpose of the line of
credit is to provide liquidity, not to provide leverage. On December
31, 2011, there was no outstanding balance on the line of credit.
Due to the regulatory restrictions placed on an MIC offered by a
prospectus, liquidity is only available each year on November 30.
There is no charge for investors to redeem from FMIC. In the case
of extreme redemptions that cause a liquidity concern for other
investors, the board may restrict redemptions to 25% of the
common shares.
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RETURN
EXPECTATIONS
The base case return for 2011 is based on the following formula:
Expected Canada Bank Rate + Manager Skill = Investors’ Return
The current Bank of Canada rate is 1.00%, and the average historic
management skill has been 3.78%. The Bank of Canada rate is
defined as the upper limit of the Bank of Canada’s operating band. Canadian interest rates are expected to stay low until at least 2014.
This would provide an expected return for FMIC in 2012 of 4.78%.
With Bank of Canada rates at 1.00% and a manager skill rate of
4.50%, the internal rate of return would be 5.50% for the year
ending December 31, 2012.
Scenario Bank of
Canada Rate Manager
Skill Return
Ideal 3.00% 6.00% 9.00%
Optimistic 1.75% 5.50% 7.25%
Base-case 1.00% 4.50% 5.50%
Pessimistic 0.50% 3.00% 3.50%
Unsatisfactory 0.25% 1.50% 1.75%
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EXIT STRATEGY
KEY RISKS
Frontenac is an on-going investment fund. Investors may redeem
their common shares at their discretion, subject to timing and
liquidity restrictions.
Falling Property Values
If real estate properties fall in value, less equity cushion is provided
by the current LTV.
Increase in Terminal Losses
It is possible that terminal losses could increase, which would
reduce income to the point that investors could potentially lose
capital.
Interest Rates
A fall in interest rates would reduce the amounts that FMIC could
charge mortgage holders, which would lower the portfolio’s return.
Manager Skill
If management cannot find mortgage holders to pay higher than
conventional rates of interest, the Fund’s returns would suffer.
Investors receive one vote per shared owned. A quorum for a
meeting of shareholders shall be the holders of at least 25% of the
shares entitled to vote at a meeting of shareholders, whether
present in person or represented by proxy.
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FINANCIAL SAFETY MECHANISMS
INVESTOR LIABILITY
POTENTIAL CONFLICTS OR CONCERNS
SIMILARITY BETWEEN OFFERING DOCUMENTS & MARKETING REPRESENTATIONS
Frontenac MIC has the following financial safety mechanisms in
place:
1. Clients will often use an intimidator like TD Waterhouse or
RBC Dominion Securities.
2. The custodian of the Fund is Computershare.
3. Frontenac is a public security, so all information is available
independently on SEDAR.
4. Clients receive annual audited financials.
5. In order to provide liquidity to its shareholders, Frontenac is
required to maintain approximately 5% of its net assets in
cash throughout the year. Management regularly monitors its
available cash and credit line facility to ensure that a 5% cash
reserve is maintained.
If the investor remains at arm’s length, and is not involved in any management of the corporation’s operations, there should be no concerns regarding liability.
No potential conflicts or concerns were identified.
There are no discrepancies between the Frontenac MIC offering
documents and its marketing materials.
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BANKRUPTCY & REGULATORY HISTORY
HISTORIC CORPORATE
CHANGES
LITIGATION
SECURITIES REGISTRATION
SUITABILITY
EA analysts have confirmed that no director or member of
management of Frontenac MIC, W. A. Robinson & Associates or
any related parties of the above corporations have been subject to
bankruptcy within the past 10 years. In addition, there have been no
regulatory issues with the Canadian Securities Commission or any
other regulatory committees.
EA analysts are unaware of any historic corporate changes
regarding Frontenac MIC or any of the corporation’s affiliates.
EA analysts are unaware of any acts of litigation against Frontenac
MIC, W.A. Robinson & Associates, any related parties, or any
members of management or directors of the above-mentioned
corporations.
W.A. Robinson & Associates is a registered exempt market dealer
and portfolio manager in British Columbia, Alberta, Saskatchewan,
and Manitoba, a registered portfolio manager in Quebec, and a
registered limited market dealer in Ontario.
An investment in Frontenac MIC common shares is considered risky
and should be undertaken only by sophisticated investors of
adequate financial means who can bear the risks associated with
the offering. Individuals who are eligible or accredited investors and
who reside in British Columbia, Alberta, Saskatchewan, Manitoba,
or Ontario may participate in the offering.
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RATING
The EA Analyst team has rated Frontenac “M-1” on the MIC risk
rating schedule of M-1 to M-7. M-1 is the lowest risk rating, which is
reserved for MICs with long track records of consistent positive
returns. Other factors that lead to this rating are:
1. Frontenac has a high level of diversification.
2. Frontenac has a low Loan-to-value ratio.
3. In the analyst’s opinion, areas in Eastern Ontario, notably Ottawa, are considered to be desirable economic lending
areas for MICs.
4. The ratio of first to second mortgages is favourably high in
Frontenac’s investment portfolio. 5. Mortgages in Frontenac’s portfolio have recent appraisal
data.
6. Frontenac has experienced minimal terminal losses.
7. There is low interest rate risk due to fixed rate mortgages.
8. Returns have been steady over a substantial amount of time,
demonstrating management’s ability to weather economic storms.
9. Mortgages in Frontenac’s portfolio have short maturity dates. This policy management has enacted is key to preventing
terminal losses.
Rating Definition
M-1 Very Low Risk M-2 Low Risk M-3 Low-to-Average Risk M-4 Average Risk M-5 Average-to-High Risk M-6 High Risk M-7 Very High Risk
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Rating Definition
M-1
Mortgage Investment Corporations rated M-1 have the highest level
of stability and sustainability of distributions per unit. Corporations
with this rating have a superior combination of the following factors:
good history of operating performance, outstanding financial
flexibility, high quality assets, good diversification, large size in
terms of breadth and scale of operations, and a strong industry
structure. The corporation is likely to have strong sponsors or
owners or specific structural or contractual elements that eliminate
or mitigate risks or other potentially negative factors.
M-2
Mortgage Investment Corporations rated M-2 have very good
distributions per unit stability and sustainability. The corporation
exhibits performance that is only slightly below the M-1 level,
typically shows above-average strength in areas of consideration,
and possesses levels of distributable income per unit that are not
likely to be significantly negatively affected by foreseeable events.
The corporation’s performance is above average in many, if not most, areas of consideration.
M-3
Mortgage Investment Corporations rated at M-3 have good
distributions per unit stability and sustainability, but performance
may be more sensitive to economic factors, have greater cyclical
tendencies, and may not be as well diversified as an M-2 firm,
resulting in some potential for distributions per unit to fluctuate. The
corporation will not be above average in all areas of consideration,
but will tend to outperform in many areas. M-3 is usually the highest
rating category for a new and smaller corporation and often
represents a ceiling for some of the better commodity-oriented
corporations.
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M-4
Mortgage Investment Corporations rated at M-4 have adequate
distributions per unit stability and sustainability, but distributions per
unit are affected by one or more factors such as cyclicality,
seasonality, and commodity price fluctuations, and economic cycles
have a comparatively greater influence over performance compared
to first in the higher rating categories. Concentration and lack of
diversity may affect stability.
M-5
Mortgage Investment Corporations rated at M-5 have weak
distributions per unit stability and sustainability. The corporation is
subject to many of the same cyclical, seasonal, and economic
factors as those in the M-4 rating category, but the lack of
diversification is generally more pronounced, and the corporation’s performance will tend to fall below average in several areas.
M-6
Mortgage Investment Corporations rated at M-6 have very weak
distributions per unit stability and sustainability. The corporation will
tend toward below average performance in many areas of
consideration. There may be a high degree of volatility associated
with current levels of distributions per unit, and the ongoing
operational performance and financial flexibility of the corporation
are weak. The corporation may also be relatively new and small,
and have limited sponsor support.
M-7
Mortgage Investment Corporations rated at M-7 have poor
distributions per unit in terms of stability and sustainability. The
corporation performs below average in most areas of consideration.
There is a high degree of volatility associated with current levels of
distributions per unit. In addition, depending upon the specific
circumstances, this category may also contain those Mortgage
Investment Corporations that have ceased distributions.
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DISCLAIMERS
General
ExemptAnalyst is a fully-owned trademark of Mount Fortress Capital
Inc., which is registered in the Province of Alberta. The particulars
contained in this report were obtained from sources we believe to be
reliable, but they are not guaranteed and may be incomplete. The
opinions found in this report are the analysts’ and are not to be construed as a solicitation or offer to buy the securities analyzed in
the report.
Research Analysts
The research analysts who prepared the report certify that it
accurately reflects their opinions and that their compensation is not
directly or indirectly derived from the rating assigned in the report.
Compensation
Fees have been paid to the analysts to write this report, which help
to offset the high cost of research. ExemptAnalyst must abide by the
CFA Institute Code of Ethics and Standards of Professional
Conduct.
Liability
Mount Fortress Capital Inc. and ExemptAnalyst do not make any
warranties, expressed or implied, as to the risk or results from
investing in any exempt market security. Anyone reading this report
assumes full responsibility for the outcome of investing in any
exempt market security. Only your financial advisor can recommend
whether this investment is suitable for your particular situation. It is
vital that investors study the Offering Memorandum to review the
risk of the exempt market securities.
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