Thursday, July 12, 2007

Blackmont Capital Comments on Banks' Subprime Exposure

Financial Post, Duncan Mavin, 12 July 2007

It can be difficult to discern exactly how Canada’s banks are exposed to the turbulent U.S. sub-prime mortgage market as Blackmont Capital analyst Brad Smith can likely testify after spending the last couple of weeks “Staring into the Structured Finance Labyrinth” to prepare his report of the same title.

Some of the banks may have got involved through the booming global trade in complex credit derivatives called collateralized debt obligations, or CDOs — the market has grown at a compound annual rate of 99% since 2002 and stood at more than US$34-trillion in 2006, says Mr. Smith. CDOs are ultimately tied to mortgage-backed securities, which are securities backed by pools of often sub-prime mortgages.

But finding out who holds these CDOs and how much they hold is not an easy task.

“Disclosure of derivative trading activity has improved greatly in recent years, but remains inadequate for drawing definitive conclusions regarding any given bank’s ultimate exposure to credit derivative trading,” says Mr. Smith.

Fortunately, the Blackmont analyst has done some of the hard work, compiling figures for the Canadian banks where information is available.

Among the conclusions he has been able to draw is that Bank of Nova Scotia has the smallest exposure to credit derivatives, weighted for risk, compared to market capitalization.

Canadian Imperial Bank of Commerce has the highest exposure, almost 6 times the size of Scotiabank’s when compared to market capitalization, according to Mr. Smith’s calculations. “CIBC’s involvement in credit derivative swap trading has ballooned since 2005,” he notes.

It is also worth noting that CIBC issued a press release on Tuesday that played down its exposure to the U.S. sub-prime real estate mortgage market. The bank said its “unhedged” exposure is “well below” a rumoured amount of US$2.6-billion.

CIBC has not confirmed what its actual exposure is.