Friday, February 08, 2008

CIBC's Stock Price Influenced by Health of Monolines

Financial Post, Duncan Mavin, 8 February 2008

Canadian Imperial Bank of Commerce has about $2.6-billion exposed to the latest monoline insurer to find itself in trouble, reckons Blackmont Capital analyst Brad Smith.

SCA Ltd — which saw its credit ratings slashed by Moody’s Investors Service on Thursday — is one of a number of monolines that have provided financial guarantees to CIBC’s book of credit derivatives.

If he is correct about the size of CIBC’s exposure to SCA, “the downgrade will greatly increase the likelihood CIBC will need to record a further material loss provision in the first quarter of 2008.

The bank is due to report its first quarter results on February 28. The bank has already taken about $3.3-billion in writedowns related to its book of credit derivatives, including about $2-billion that was hedged with a single monoline insurer.

If the bank takes further massive writedowns, capital ratios will be under pressure despite last month’s $2.9-billion injection of emergency capital at CIBC.
Mr. Smith has a “sell” rating on CIBC, and a twelve-month target price of $66
RBC Capital Markets, 7 February 2008

We believe that CIBC's stock price will be heavily influenced by the health of the financial guarantee industry. A successful resolution of financial guarantors' capital issues would be positive for CIBC, but the timing and chances of success are still uncertain.

• We believe that the market is pricing in approximately $3.5 billion in mark downs over and above the cumulative $3.3 billion that has been announced so far. For CIBC to have writedowns that large, further deterioration in the value of hedged assets and counterparty ratings is required.

• The most optimistic scenario for CIBC would be that hedged assets turn out to be worth more than current values, and/or financial guarantors maintain strong ratings. In that scenario, the bank's Tier 1 capital would increase from a pro-forma 11.4% to 12.5%, book value would increase by 11% and we believe fair value for the stock could be up to $86 per share. This scenario seems overly optimistic to us in the near term.

• The worst case scenario would lead to CIBC raising equity again, in our view, and the stock could see the low $50s. That scenario would imply severe pressure on CDO/CLO valuations and a valuation allowance of 100% on all hedges with financial guarantors. It is important to point out that we believe all banks' share prices would be weak in such a scenario, which would require a very dire recession.

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 come when the economic outlook improves, with potential specific upside at CIBC if:

• AAA-rated 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.