Friday, February 29, 2008

CIBC Q1 2008 Earnings

RBC Capital Markets, 29 February 2008

CIBC's Q1/08 GAAP EPS were $(4.36), not as bad as our estimated loss of $5.67, primarily because write-offs related to CDOs/RMBS/CLOs/monolines were $600 million less than the $4.0 billion we had expected.

The bank, as expected, was not in a position to assuage concerns over the ultimate value of CDOs, CLOs and monoline hedges.

• We would have hoped to get better disclosure on the underlying assets that are hedged with monolines that are not U.S. RMBS CDOs.

• We expect $1.5 billion in further write-downs in Q2/08 given continued spread deterioration on structured finance assets. A large infusion of capital into the monoline industry would make our forecast overly pessimistic (and could lead to recoveries of past valuation allowances if some of the weaker players are rescued; a scenario we view as unlikely).

We maintain our Sector Perform rating and 12-month price target of $73. Our target valuation implies a P/E multiple among the lowest of the large Canadian banks, reflecting more exposure to sub-prime CDOs and financial guarantors, below average retail banking trends, our concerns over wholesale revenues and lower confidence about unknown exposures. In general, we believe the turn in bank stock prices will likely come when the economic outlook improves, with potential specific upside at CIBC if:

• Financial guarantors are able to secure enough capital to convince rating agencies and capital markets participants that their capital strength is unaffected by the prospects of losses on insured CDOs, and/or

• CIBC can improve its relative performance in domestic retail banking, an area where results have lagged peers.
Scotia Capital, 29 February 2008

• CM reported a 7% decline in cash operating earnings to $2.02 per share slightly below expectations due to weak merchant banking earnings. Reported earnings were a loss of $4.39 per share, due to net charges of $6.36 per share on ACA/other monoline/CDOs and other adjustments. Charges were $1.61 per share higher than pre-announced.

What It Means

• The remaining potential loss currently on the banks hedged RMBS/CDO portfolio is $2,272 million assuming the counterparties (monolines) fail to meet their obligation. The net unhedged CDO portfolio is down to $287 million.

• Under Basel II the tier 1 ratio is 11.4%.

• We maintain a 2-Sector Perform rating with CM considered the highest beta bank stock and an outlier for a Canadian bank given its relatively large exposure to U.S. sub-prime and U.S. monolines. CM is trading at the lowest P/E multiple of the bank group at 8.5x our 2008 earnings estimate, representing a 22% discount to the group. We expect CM's P/E discount to narrow to the 10%-15% range over the next several years as it stabilizes its risk profile.
The Globe and Mail, Matt Hartley, 29 February 2008

One of Canada's biggest banks has allegedly been illegally recording telephone conversations with its customers for more than four months.

Yesterday, CIBC chairman Bill Etherington admitted his bank has so far failed to educate its employees on new privacy standards introduced by the Privacy Commission of Canada last October. Under the new legislation, businesses and telemarketers that place cold calls to customers are now required to ask for permission before recording the conversations.

Mr. Etherington made the admission during the bank's annual general meeting, after being confronted by Rick Garrett, a 55-year-old retiree from Charlottetown, PEI, who flew into Toronto specifically to address the assembled CIBC executives and shareholders regarding the bank's telemarketing practices.

"I think it's sort of an invasion into my home when someone calls me to record my voice and my ups and my downs and my good days and my bad," Mr. Garrett said during the meeting. "I'm a little upset about this bank's slow reaction to what I consider to be an invasion of your customers homes, businesses and cellphones."

Although federal privacy commissioner Jennifer Stoddart made the ruling four months ago, CIBC executives are still working with her office "to determine how this will be properly implemented," Mr. Etherington said in response to Mr. Garrett's question.

Other banks and telecom companies contacted by The Globe say they have already instituted policies requiring telemarketers to inform customers that outbound calls may be recorded.
Financial Post, Duncan Mavin, 29 February 2008

Canadian Imperial Bank of Commerce is putting its stock -- and the fortunes of its shareholders -- at the mercy of hedge funds and other sophisticated players because of the piecemeal way the bank is disclosing its exposure to investments in U.S. subprime mortgages and other complex securities, says a Bay Street analyst.

CIBC's executives fended off calls for more information about their portfolio of collateralized debt obligations (CDOs), residential mortgage backed securities and the like on Thursday after the bank revealed that its write-downs have soared to $4.2-billion since the crisis began last year. (Charges in the first quarter turned a profit of $770-million last year into a loss of $1.5-billion for the first three months of fiscal 2008.)

The missing details make it difficult for analysts and even some highly-sophisticated investors to assess the likelihood of further losses at CIBC, says Genuity Capital Markets analyst Mario Mendonca. But that sort of information is relatively easy to find for hedge funds and other savvy players on Wall Street who have good contacts among the counterparties to CIBC's complex securities, like other big U.S. banks.

"It's a waste of time trying to get information about CIBC from anyone with a 416 (Toronto) telephone number any more," said Mr. Mendonca. "All the best knowledge is with people who have 212 [New York] numbers."

CIBC executives insist, with some justification, that the bank has disclosed more about its exposure to potential losses than its Canadian rivals and even other banks in the U.S. and elsewhere.

But there are still plenty of unanswered questions about the extent and nature of the bank's exposure to monoline insurers, CDOs and other troublesome areas of capital markets activity.

CIBC's subprime losses were first raised in public when a hedge fund manager questioned the bank's management about its investment on an earnings conference call for analysts last year. At the time, most analysts and investors had no idea about the bank's exposure, though the hedge fund manager in question knew the names and other intimate details of the specific investments.

Several bank analysts have also commented on the difficulties in forecasting in the near term for CIBC.

"Given the depressed multiples at which the stock trades, if the balance sheet is secure, the downside arguably appears to be limited," said National Bank analyst Rob Sedran in a note. "That said, with an uncertain environment and the prospect of continuing large charges, we believe a material sustained recovery in the shares will be more difficult to achieve.

One particular area where analysts were left guessing on Thursday was the size of the bank's exposure to 10 financial guarantors where the underlying assets are unrelated to US residential mortgages. CIBC has acknowledged this exposure was in the hole for $885-million at Jan. 31, but chief risk officer Tom Woods refused to give details of the size of the underlying investments when asked by reporters and analysts on Thursday. Some analysts have estimated the size of the book is in the region of $20-billion.

"Unwillingness to disclose details of the distribution or collateral composition of the estimated $22-billion in non-subprime monoline hedges precludes meaningful assessment of the potential magnitude of future loss development," said Blackmont Capital analyst Brad Smith in a note.

The bank also declined to give details about a portion of yesterday's write-downs that it valued at $626-million -- CIBC said this related to a charge on credit protection, but did not answer questions about whether this related to residential mortgages or to some other kind of asset, such as U.S. corporate loans.
Financial Post, Barry Critchley, 29 February 2008

If nothing else, Canadian Imperial Bank of Commerce's 141st annual meeting shows the advantage of staying on script: Emphasize the positives, don't apologize and constantly remind the shareholders that management and the board are responding in an aggressive manner to what is unfolding. And hope that shareholders -- who put up 14 proposals to be voted on at yesterday's meeting, all of which were rejected -- believe it enough to keep owning the stock.

As Tom Woods, former chief financial officer and now chief risk officer, said, "We and other financial institutions clearly underestimated the potential for extreme mortgage defaults [in the U.S.]." In addition, the bank relied "too heavily" on external bond ratings and "underestimated" the high correlation between the subprime mortgage market and the financial health of the monoline insurers.

Woods added the bank -- which yesterday announced $3.3-billion in charges, all part of a $1.456-billion first-quarter loss -- has launched a "complete review of our risk processes," with the goal of managing our risks much better in the future." What wasn't explained is why the bank's former risk processes broke down so dramatically. And where was the oversight, especially from a bank that over the past 20 years has been the epitome of volatility and despite promising a few years back more stability.

Or is the explanation no more complicated than what a member of the risk-management group at a large U.S. bank said: "When the money is flowing, no one cares what we have to say."

Also not fully explained yesterday was how CIBC, whose mantra for the past couple of years has been to de-risk the bank, got enmeshed in a variety of U.S. businesses that some other financial institutions avoided. In short, what was the culture of an organization that believed it could be an active participant in a U.Smarket with some of the smarter and major U.S. players? A partial explanation was that CIBC was in the structured-credit business, a business it deemed to be "low-risk" -- while some of the others weren't.

But through it all, Bill Etherington, chairman for the past five years and a director for the past 15, and Gerry McCaughey, chief executive for the past two and half years, never contemplated standing down. (Indeed, Etherington gave McCaughey the hockey coaches' hex by saying Mc-Caughey and the management have the full support of the "entire" board.)

At a press conference, the two said their goal was to return CIBC to consistent and sustainable performance, though Etherington, who was chair of CIBC at the time of its US$2-billion-plus settlement on Enron-related matters, added he would be retiring as chairman and as a director later this year. Under new rules, CIBC directors can stay for a maximum of 15 years.

Indeed, Etherington was asked why McCaughey -- whose bonus, if any, for 2007, will be revealed next year -- was granted 70,045 options with a strike price of $79.55. He said the grant was in line with normal policy while Mc-Caughey said he accepted them because they were granted by the board.

As for the positives, CIBC has raised capital -- a $2.9-billion equity financing was completed last month and its Tier 1 capital ratio at 11.4% is the highest of any of the top 25 banks in North America -- while changes have been made in the management ranks and on the board. And it argues that it has the best disclosure of any of the Canadian banks.
The Globe and Mail, Tara Perkins, 29 February 2008

Canadian Imperial Bank of Commerce reported a first-quarter loss of $1.456-billion on Thursday, compared to a profit of $770-million a year earlier, as the bank took a slew of charges related to its subprime mortgage exposure.

The writedowns and paper losses included a $2.28-billion (pre-tax) charge because of the bank's exposure to troubled bond insurer ACA Financial Guaranty Corp.; a $626-million charge on exposure to other financial guarantors; $473-million of paper losses on securities tied to the U.S. mortgage market; and a $108-million loss on the sale of some of the bank's U.S. business to Oppenheimer Holdings Inc. as well as management changes and the restructuring of some other businesses.

Those items, amounting to $3.49-billion, were partially offset by two much smaller gains; $56-million on tax-related items, and $171-million on the changing value of credit derivatives on corporate loans.

“Our losses related to the U.S. residential mortgage market are a significant disappointment and are not aligned with our strategic imperative of consistent and sustainable performance,” stated CEO Gerry McCaughey.

The bank cautioned that “market and economic conditions relating to the financial guarantors may change in the future, which could result in significant future losses.”

But it said that, despite a more challenging operating environment, including squeezed margins on consumer loans, its consumer banking operations performed well during the quarter, with CIBC Retail Markets posting earnings of $657-million, up 15 per cent from a year ago.

But CIBC increased its provisions for bad loans by $29-million, or 20 per cent, as a result of lower recoveries in its corporate lending book.

The bank had said in mid-January it would be taking a $2.46-billion (U.S.) pre-tax writedown on its subprime mortgage exposure for the two months ended Dec. 31.

At the same time, the beleaguered financial institution announced plans to raise at least $2.75-billion (Canadian) by selling its stock at a discount in order to shore up its finances.

About $1.5-billion of that equity infusion came from a private placement that was scooped up by Manulife Financial Corp., Caisse de depot et placement du Quebec, Hong Kong billionaire Li Ka-Shing and OMERS Administration Corp.

In total, CIBC wound up raising $2.9-billion. “Our enhanced capital position provides a cushion against further deterioration of market conditions, particularly related to the U.S. residential mortgage market where we have exposure, while enabling continued investment in our strong core businesses,” Mr. McCaughey stated Thursday.

The bank said that balance sheet strength will remain its most important priority in 2008.

Its capital raising efforts were among the many steps it took as it sought to assure the investment community in the wake of its subprime-related writedowns.

Roughly a week before the equity infusion announcement, Mr. McCaughey shook up the bank's senior management team, bringing in Richard Nesbitt, who was heading TSX Group Inc., to run CIBC's investment banking operation, CIBC World Markets. Mr. Nesbitt officially takes up his post on Friday.

As Mr. McCaughey was rejigging his senior team, the bank finished the sale of its U.S. domestic investment banking business to Oppenheimer Holdings Inc., causing an $80-million loss.

Looking forward, CIBC said that its consumer banking operations should benefit from continued low unemployment rates, falling interest rates, and healthy housing markets, supporting both loans and deposit growth, although a slower pace of real estate price increases might cause mortgage growth rates to moderate.

On the investment banking side, it said that mergers and acquisition and equity activity will likely be slower because of a softer stock market and credit concerns affecting leveraged deals.

“We expect loan demand to increase due to reduced investor appetite for commercial paper,” it added.

CIBC left its dividend unchanged at 87 cents per share.

Meanwhile, at the bank's annual general meeting on Thursday morning, shareholders voted nearly 45 per cent in favour of a proposal that the bank adopt a policy to give shareholders the opportunity to vote at each annual meeting to ratify executive compensation packages — a so-called “say on pay.”

The bank's chairman said the bank will continue dialogue on the issue, suggesting the bank is open to the possibility of adopting such a policy.

Also on Thursday, CIBC rival Toronto-Dominion Bank reported a first-quarter profit of $970-million, up 5 per cent from $921-million a year earlier, marking the beginning of bank earnings season. TD also raised its quarterly dividend by 2 cents, or 3.5 per cent, to 59 cents.

TD's investment bank saw earnings drop 17 per cent from a year ago while its Canadian consumer banking operations boosted earnings by 10 per cent.

Meanwhile, National Bank reported a 6 per cent increase in profit to $255-million.