Wednesday, January 16, 2008

CIBC Raises $2.75 Billion

The Globe and Mail, Tara Perkins, 16 January 2008

Two Canadian institutional investors are contributing the bulk of the $1.5-billion infusion that Canadian Imperial Bank of Commerce is receiving by way of a private placement.

Insurer Manulife Financial Corp. is taking up $500-million worth of CIBC shares, while the Caisse de dépôt et placement du Québec will pick up $450-million.

This is part of the $2.75-billion worth of shares the bank is issuing to repair the financial damage inflicted by the meltdown in the U.S. subprime mortgage market.

CIBC is following in the footsteps of a growing number of global financial institutions that are selling off stakes in themselves to cope with the fallout from their subprime mortgage exposure. But the bank is in a unique position because it has found much of the equity in its domestic market rather than having to rely heavily on foreign investors.

That should be interpreted as a positive sign, because it means the people who know the bank best are willing to put up the money, said Gavin Graham, chief investment officer at Guardian Group of Funds.

Hong Kong billionaire Li Ka-Shing is taking $350-million of the private placement and OMERS Administration Corp. is picking up the remaining $200-million, sources say.

CIBC will also offer at least $1.25-billion worth of discounted shares to public investors to reach the $2.75-billion total. The bank is grappling with a total of more than $3-billion in writedowns related to the U.S. subprime mortgage market.

Yesterday, chief executives of two of Canada's biggest banks said that the equity infusions are a good thing.

"It's very healthy for the financial system - if there are issues - to be recapitalized, rather than for those issues to get worse," Royal Bank of Canada chief executive Gord Nixon told a banking conference.

"Certainly close to home, I think that's a very good thing for the system because, among other things, what it shows is there is a lot of capital support out there for the major financial services companies."

Bank of Nova Scotia chief executive Rick Waugh agreed. "Look what's happening - huge, billions of dollars of sophisticated money finding a home. Good news."

The cash injections will help those banks be more competitive than they otherwise would have been, but their troubles are forcing them to exit certain businesses - and that's creating opportunities for RBC, Mr. Nixon said.

In a note to clients, Credit Suisse analyst Jim Bantis said the "capital injection should significantly reduce the uncertainty surrounding CIBC's financial position, [but] we remain concerned that the core operating franchise remains under siege by its competitors."

Mr. Nixon said the turmoil that's hampering many banks is creating opportunities. "We are seeing business that we might not have seen before."

But Canada's biggest bank isn't salivating over acquisition opportunities, despite the fact that banks are cheaper.

"We do have an environment where unexpected opportunities may present themselves," Mr. Nixon said. "We're in a position to take advantage of those, but we're not going to chase transactions for the sake of doing deals simply because values have come down."

Outside of Canada, he suggested that wealth management deals would be more attractive to RBC right now than buying banks. Both would be priorities over any capital markets, or investment banking, opportunities.

But RBC remains committed to its capital markets business, which accounts for roughly one-quarter of its earnings, Mr. Nixon said.

Investment banking profit growth will likely slow. RBC will be seeking most of its growth this year from consumer banking and wealth management, he suggested.

But Mr. Nixon said he doesn't expect "doom and gloom" in the capital markets business over the next few years.
Reuters, 15 January 2008

Shares of Canadian Imperial Bank of Commerce fell 2.9 percent on Tuesday after the bank said it would issue at least C$2.75 billion ($2.70 billion) in new shares and take additional writedowns for U.S. subprime mortgage-related securities.

While analysts and the bank itself warned that more writedowns could be on the way, some investors said CIBC's recent stock slump already reflected bad news.

"We felt that, on a near-term basis, it was oversold," said Neil Andrew, portfolio manager at Leeward Hedge Funds. His firm bought CIBC shares after the news on Monday.

"We took comfort in the price discount that was offered, as well as the recent fundamental data points that have been revealed," Andrew said.

CIBC's stock issue consists of a C$1.5 billion private placement to four investors at C$65.26 a share, and an offering of C$1.25 billion to a syndicate of underwriters, at C$67.05 apiece. Those are discounts of 9 percent and 7 percent, respectively, to Monday's last price.

If the underwriters exercise their options for additional shares, the new issuance could total C$2.9 billion.

On the Toronto Stock Exchange, CIBC shares dropped C$2.07, or 2.9 percent, to close at C$70.00, in line with the composite index, which lost 2.8 percent on Tuesday.

CIBC shares tumbled 28 percent in 2007, the worst performance among Canadian banks, but they have fallen the least in 2008, with a decline of just 0.8 percent.

At an investor conference on Tuesday, the president and chief executive of Royal Bank of Canada , the country's largest bank, said the recent string of North American bank recapitalizations, including CIBC's, were positive for the financial system overall.

"Close to home, I think that's a very good thing for the system because, amongst other things, what it shows is there is a lot of capital support out there for the major financial services companies," Royal Bank Chief Executive Gordon Nixon said.

Nixon, who spoke at a CEO conference organized by his bank's capital markets unit, said those banks will be more competitive than they would otherwise have been with weak capital ratios. But he said they will become more cautious in the marketplace as well.

CIBC, Canada's fifth-largest bank, said on Monday it would take a further $2.46 billion in pretax writedowns on its unhedged exposure to subprime mortgage securities and the falling value of counterparty protection from U.S.-based bond insurer ACA Financial Guaranty Corp.

Glenn MacNeill, vice-president of investments at Sentry Select Capital Corp in Toronto, said he was "a little anxious" about the magnitude of CIBC's share issue, which is expected to close later this month.

"The C$2.75 billion is bigger than expected," MacNeill said. "They've got to stop having these surprises, they're just not fair to shareholders."

But investors should brace for potentially more writedowns at CIBC, some analysts said. The credit ratings of U.S. bond insurers that are CIBC's counterparties in some subprime-related hedges are on watch for possible downgrades.

CIBC acknowledged that more adjustments were "possible" in its fiscal first quarter, which ends January 31.

Still, the stock offering will give the bank a "considerably higher capital cushion" to deal with its subprime exposure, and it should reassure investors that a cut to CIBC's dividend is not on the way, said Jim Bantis, financial services analyst at Credit Suisse.

Earlier on Tuesday, U.S. bank Citigroup said it would cut its dividend by 41 percent amid a subprime-mortgage induced loss of $9.8 billion. The bank is also raising $14.5 billion in new capital.

Bantis said that, hypothetically, even if CIBC had to write down $4 billion of its remaining $6.5 billion exposure to hedged subprime securities, the Canadian bank's infusion of new capital would keep its Tier 1 capital ratio at a "still comfortable" level of 9.2 percent, above the 7 percent level required by regulators and the bank's own 8.5 percent target.

CIBC has taken other steps in recent weeks to deal with the fallout from its subprime-mortgage missteps.

It exited the structured credit business and sold its U.S. investment banking business, replaced the head of CIBC World Markets as well as its chief risk officer, and appointed David Williamson as its new chief financial officer.

Credit rating agency Moody's said it will be important to see how the management changes affect the bank's "risk management discipline." Moody's kept its negative outlook on CIBC, citing ongoing concerns about risk management.
The Globe and Mail, Derek DeCloet, 15 January 2008

Gerry McCaughey is taking absolutely no chances.

All around him, bankers are fighting, and in some cases begging, for fresh capital. Citigroup, having just accepted $7.5-billion (U.S.) from the Abu Dhabi Investment Authority, is looking for another $10-billion. Merrill Lynch seeks several billion more, Morgan Stanley is cashing a $5-billion cheque, while UBS took a $10-billion investment from an overseas fund and earned a snarky new nickname - Union Bank of Singapore.

It's a good thing for Wall Street that a massive glut of savings exists in Asia and the Middle East. But Hong Kong billionaires, Saudi oil sheiks and government-sponsored investment companies need only so many North American bank shares. A state-run Chinese bank just withdrew from a planned investment in Citi, perhaps because earlier Chinese investments in financial services stocks (Blackstone Group, Barclays) have been money losers so far.

And the news from America - about real estate and mortgages - is getting worse, not better.

So if you're CIBC, you might as well try to get your money while you can.

"You don't mess around at a time like this," says one bank analyst who spoke on condition of anonymity.

Mr. McCaughey's not messing around. His new plan is to build the equivalent of a financial nuclear bunker by raising as much as $2.94-billion (Canadian) in new equity at what can only be described as a distressed price. Ifthings in the U.S. mortgage market get truly catastrophic - as opposed to merely awful, as they are now - CIBC ought to survive, thanks to the flood of dollars coming from Asia's richest man, three of Canada's largest institutions, and the investing public, which will be putting up nearly half the dough.

It's far more than the bank needs. Even after taking another $2.46-billion writeoff on its portfolio of mortgage securities, CIBC stands to come out of this capital-raising exercise with an equity base that's much larger than regulators require. And if the bank were to take another $5-billion mortgage hit (in addition to the $3-billion-plus it has already lost), it would still be financially sound. No rumour-mongering hedge fund manager will be able to whisper "CIBC" and "insolvency" in the same breath.

Still: Why so much money, and why now? The dilution, 12 per cent, is serious. Why burn your shareholders by selling this much equity at $65 when you could have issued shares at $75, $80, maybe even $85? Aside from the obvious - you don't want to wait until you're under duress to recapitalize - there are two other reasons, one personal, one financial.

The first is that Mr. McCaughey's reign, which had been going swimmingly until a few months ago, has been badly thrown off course by the mortgage mess. He had two options: (a) spend the rest of 2008 talking about nothing but one stinking rotten investment and fighting the rumour mill every day, or (b) taking the hit and moving on. Dragging things out serves no one but the short sellers. By issuing this much stock - "it's ridiculous," says one investor in financial company - Mr. McCaughey can return to the more comfortable role of nerdy banker who uses six-syllable words for "loan."

The second reason, the financial one, is more serious. The subprime crisis is set to change how banks operate. How's that? By destroying investor faith in the many kinds of structured investment vehicles and the credit agencies who rate them.

The banking business, circa 1980, was all about taking deposits, making loans and earning profit from the interest spread between the two. But today's bank, as often as not, makes the loan and then sells it to someone else in an intricate asset-backed security. Or maybe it doesn't make the loan at all, but instead flogs some 20-year corporate bond to every yield customer it has over the age of 60.

Ian de Verteuil, the top-ranked bank analyst at BMO Nesbitt Burns, calls it "disintermediation," which is a fancy way of saying that the bank still gets its cut but it doesn't hang on to as much risk. If it doesn't hang on to the risk, it doesn't need as much capital. And that equation - more profit with less capital - is the banker's Holy Grail. It brings higher dividends, higher stock prices and happy investors.

It all works, as long as the investing public continues to buy what the banks are selling. But now they aren't. The structured-bond business isn't dead, but it is limping. U.S. banks issued $322-billion (U.S.) in asset-backed bonds in the second quarter of 2007. Then the credit crunch hit and - boom - the number dropped by nearly 60 per cent in the third quarter.

That can mean only one thing: the banks are going to have to assume more often their former role - as risk-taking lenders, rather than mere middlemen. That means they'll need more capital. It's no place for a bank with a crummy balance sheet, and Gerry McCaughey knows it.
Financial Post, Barry Critchley, 15 January 2008

First there was the announcement of the $2.75-billion common-equity offering-- one of the largest in Canadian history -- then there was a not-so-subtle hint that more writeoffs may be on the way.

Those two dots are connected by the issuer, in this case Canadian Imperial Bank of Commerce, offering equity at a substantial discount to the current trading price. Just like the retail chains: Make it cheap, the crowds pile in; make it even cheaper and everyone piles in. Investors seem to be lapping it up given reports that the issue has met with a warm reception. "It is well oversubscribed," said one underwriter.

Little wonder. The stock, which hit a 52-week high of $103.30 last October, is all but being given away.

The reason? Well, the price for the $1.25-billion public portion of the deal was set at $67.05, a price that represents a 7% discount to the bank's trading price of $72.07 at the time the stock was halted.

On top of that there are the 4% underwriting fees that will make their way to the underwriters involved in the transaction. Accordingly, CIBC will receive $64.14 from selling common shares. (CIBC and UBS are joint bookrunners and each have 30% of the issue.)

There is also a $1.5-billion private-placement portion to the transaction. Those shares are being purchased by four investors: The Caisse de depot et placement du Quebec; Cheung Kong Holdings Ltd.; Manulife Financial (which anted up $500-million), and OMERS. Those investors bought their shares at $65.26 apiece -- a level that represents a 9.5% discount to CIBC's recent trading price.

On top of that, the four institutions are set to receive a 4% commitment fee -- believed to be a first for Canada. There is nothing like receiving a little incentive for those investors who came to the rescue of the bank whose middle name is trouble. For receiving that juicy fee, the four institutions are required to hold their newly acquired shares for four months.

Two of the institutions have a CIBC connection. A few years back, there were reports that Manulife lobbed a merger proposal at CIBC, only for that plan to be rejected by the federal government. Meanwhile, Cheung Kong Holdings is a holding company associated with Li Ka-shing, the Hong Kong-based billionaire. Three years back, almost to the day, on Jan. 12, 2005, Mr. Li announced the sale of 17 million shares at $70 a share. That sale amounted to 4.9% of the bank's outstanding common shares. At the time, Mr. Li said he had "been pleased to be an investor in CIBC for many years, and this investment in the Bank has earned a handsome return." Mr. Li donated some the proceeds from the share sale to the Li Ka-shing Foundation.

Presumably, the four institutions agreed to make their investment after being canvassed by CIBC and after doing their own due diligence. It's understood that CIBC first approached institutional investors on Jan. 4, the first Friday of the new year. "It took 10 days to get it done. That's a long time for a deal like this. So they obviously got squeezed," said one market participant, who added that similar deals done by U.S. banks were wrapped up relatively quickly. (Most of the U.S. deals were done with sovereign funds.)

It's not known whom CIBC approached but it's worth noting that B.C. Investment Management Corp. (with assets of more than $83-billion).; Alberta Investment Management Corp. (more than $70-billion); Ontario Teachers Pension Plan Board (more than $100-billion) and CPP Investment Board (assets of $121-billion) didn't invest. And CIBC sold common shares in contrast to some of the U.S. institutions which offered high-yielding preferred shares.

Maybe the list of non-buyers was never asked, but it could also be that even a sweet discount wasn't enough for them to belly up to the bar for CIBC.

Private Placement: - $1.5-billion from Manulife, Caisse, Li Ka-shing, OMERS at $62.65/share or a 13.5% discount to the current price of $72.07 ($65.26 a share, less 4% commitment fee).

Bought Deal - $1.25-billion to $1.437-billion at $67.05/share or a 7% discount to the current price.

Why his deal now? - To bring CIBC's Tier 1 capital ratio to an acceptable level of 11.3% if no more write-downs related to its subprime-mortgage exposure in the U.S. are taken beyond the already-announced $2.4-billion; 10.2% if another $2-billion is needed; 9% if another $4-billion is needed.

Goal - Keeping Tier 1 capital ratio above 8.5%
The Globe and Mail, Richard Blackwell, Tara Perkins, Lori McLeod, 14 January 2008

Canadian Imperial Bank of Commerce's massive $2.75-billion stock offering puts it in a bullet-proof position to weather more writedowns that may be in the pipeline, bank watchers said Monday.

The $2.75-billion issue comes as the bank is in the process of taking about $3.4-billion (U.S.) in pretax writedowns for its exposure to U.S. subprime loans, including $2.46-billion announced Monday.

CIBC said it would place $1.5-billion (Canadian) of the new shares with a group of four investors, including Hong Kong billionaire Li Ka-shing, at a price of $65.26 apiece, well below the $72.07 the stock was fetching just before the sale was announced Monday afternoon. The rest will go to other investors at $67.05 a share.

The size of the issue took many observers and investors by surprise, and some suggested there could be more writedown pain to come. With its equity infusion, the bank could comfortably afford to take an additional $4-billion in pretax writedowns and still have enough capital to satisfy regulators.

Because the issue was quite a bit bigger than the market expected, “it does suggest that clearly there are further writedowns that are going to take place,” said Juliette John, a vice-president at Bissett Investment Management.

“Is there another shoe to drop?” asked Shane Jones, managing director of Canadian equities at Scotia Cassels, who said the bank has raised far more funds than it needs.

The bank said it does not expect any further writedowns, but it is possible they might be required before its quarter ends Jan. 31. It will not be updating investors before its results come out on Feb. 28.

Despite those concerns, most observers said they think the move will help support CIBC's stock price, because it gives so much backing to the balance sheet. “It really does provide a cushion, should there be any unexpected or unforeseen issues that arise,” said Brenda Lum, an analyst at DBRS Ltd.

DBRS still has the bank under review with negative implications due to concerns with overall risk management.

CIBC appears to be operating under the philosophy that it is better to be safe than sorry, analysts said. Having to go back to the market for a further infusion in the future could be costly, while it would be relatively easy for the bank to buy back shares if it found it no longer needed the cushion.

Murray Leith, director of research at investment adviser Odlum Brown Ltd. in Vancouver, said that while the size of CIBC's issue was a surprise, in the long run it will be good for the stock.

“I admit being shocked, off the bat, by the size of the equity offering,” he said. CIBC already had the capacity to deal with major writedowns, but now “with this amount of money being raised their balance sheet is rock solid,” he added.

There's no question that CIBC's cost of funding loans has increased in recent months because of concerns over the writedowns, Mr. Leith said. But this move will cut those costs sharply, and increase profits.

He described the new capital as “as a pretty smart insurance policy,” even if it is dilutive to existing shareholders, some of whom will not be happy.

“This will probably leave a bad taste in a bunch of people's mouths and I expect it will trade down tomorrow,” Mr. Leith said.

“But the way I look at it is that they are taking all the downside out of the stock, and of all the Canadian banks I think this is the one that will do it [perform best] over the next 12 months.”

Ms. John agreed that CIBC will likely emerge in very good shape. “You can't overlook the fact … that this bank does have the power to earn a lot of money,” she said.

Still, the price discount of the new shares is actually even deeper than it appears on the surface. That's because there is also a 4 per cent “commitment fee” paid to the main investor group – equivalent to another discount of $2.61 a share.
National Bank Financial, 14 January 2008

Subprime Exposure Remains the Defining Issue In view of the lower-risk strategy that had been articulated since management was changed and the Enron charge was taken in 2005, we believe that this issue is more troubling than prior missteps by the bank, regardless of whether some of the more dire potential financial implications are realized.

Discounted P/E Valuation Well Outside Historical Levels We believe the discounted multiple implies that earnings estimates are too high either because i) subprime-related charges will be large enough to require a dilutive equity issue in order to recapitalize, or ii) wholesale earnings will be greatly compromised by a move to avoid risk.

It Appears Much Bad News is Reflected in the Valuation We believe the current valuation is reflecting either an equity issue of roughly $2.4 billion or a core earnings contraction at CIBC World Markets of more than 50%. Although we do not see a high probability of either event occurring, nor are we able to dismiss the possibility, given the still uncertain outlook.

DCF Implications Consistent With P/E Analysis We believe the DCF analysis also shows that there is much negative news currently reflected in the valuation. However, it also demonstrates that once the subprime issue is largely resolved, there is still significant value in the franchise.

Conclusion – With Poor Visibility, We Remain Cautious Once it is apparent that the subprime issue is contained, we believe the valuation can begin to recover. Until that time, we expect volatility to remain. With an above-average risk profile and the potential for more negative news, we believe a more cautious stance is warranted and reiterate our SectorPerform rating.