Thursday, August 27, 2009

CIBC Q3 2009 Earnings

  
Scotia Capital, 27 August 2009

Q3/09 Earnings Weak, Higher Loan Losses, Revenue Challenged

• Canadian Imperial Bank of Commerce (CM) third quarter earnings were disappointing due to significant deterioration in credit quality and spike in loan losses that overshadowed the improvement in the net interest margin and strong capital ratio. In addition, the bank disclosed that it is facing a potential and substantial tax reassessment from 2005 related to the Enron settlement, once again reminding the market of the bank's legacy and propensity for risk and negative financial surprises. The high credit losses in the quarter and Enron reminder appears to have lowered the market confidence about the emergence of a "De-risked CIBC". We believe CM remains the most revenue challenged of the bank group. On the positive side, reported earnings appear to be stabilizing with the bank covering its common dividend for the first time in fiscal 2009 with a payout ratio of 84% (64% on operating).

• CM reported a decline in cash operating earnings of 18% to $1.36 per share below our estimate and consensus of $1.41 per share due to a spike in loan loss provisions and lower security gains. Higher-than-expected loan losses reduced earnings by $0.14 per share. However, quality of earnings improved due to significantly less reliance on security gains at $0.05 per share versus $0.32 per share last quarter.

• Specific LLPs spiked to $422 million or 1.01% of loans from $329 million or 0.83% of loans in the previous quarter and $203 million or 0.46% of loans a year earlier. Total LLPs were $547 million or1.31% of loans including a general provision of $42 million and $83 million of loan losses within the leveraged loan and other run-offs portfolio that the bank identified as an item of note.

• CIBC Retail Markets earnings continued to disappoint, declining 22% YOY due mainly to credit losses and decline in revenue, with CIBC World Markets earnings more than doubling from a year earlier and now representing 30% of operating earnings.

Items of Note

• Reported cash earnings were $1.04 per share, including items of note/charges totaling $0.32 per share (see Exhibit 1). Total charges included $155 million ($106 million after-tax or $0.27 per share) on mark-to-market losses on credit derivatives in CIBC's corporate loan hedging program, $95 million ($65 million after-tax or $0.17 per share) gain on structured credit run-off activities, $83 million ($56 million after-tax or $0.15 per share) loan losses within the leveraged loan and other run-off portfolios, $42 million ($29 million or $0.07 per share) general provision, and additional net recoveries of $3 million after-tax or nil per share.

Retail Markets Earnings Decline 22%

• Earnings at CIBC Retail Markets were disappointing at $431 million, a decline of 22% YOY due to a doubling of loan loss provisions and decline in revenue.

• Retail loan loss provisions increased 16% quarter over quarter (QOQ) and 89% YOY to $423 million. The major weakness in the portfolio was credit cards, with a loss ratio of 7.4%, a new Canadian record.

• Retail Markets revenue declined 1.3%, with non-interest expense declining 3.8%. Wealth Management revenue declined 19%, with FirstCaribbean revenue increasing 2%. Wealth Management and FirstCaribbean represented 14% and 7% of Retail Markets revenue, respectively.

• Deposit and payment fees improved 1% YOY to $199 million. Card fees were $80 million compared with $85 million in the previous quarter and $81 million a year earlier.

• Mutual fund revenue, which is contained in Wealth Management revenue, declined 20% from a year earlier to $166 million. Mutual fund assets (IFIC) declined 14% YOY to $43.0 billion. Investment management and custodian fees declined 20% from a year earlier to $103 million.

Canadian Retail NIM Improved

• Retail net interest margin (NIM) (loan balances restated) increased a significant 35 basis points (bp) sequentially and 2 bp from a year earlier to 2.80%.

CIBC World Markets

• CIBC World Markets earnings were $181 million, down from $222 million in the previous quarter but up from $77 million a year earlier.

• Corporate and investment banking revenue doubled to $221 million from $110 million a year earlier.

Underlying Trading Revenue Strong

• Trading revenue (excluding writedowns) was strong this quarter at $219 million versus $178 million in the previous quarter and $121 million a year earlier. Strong trading revenue was driven by fixed income with solid support from foreign exchange and equity.

Capital Markets Revenue

• Capital markets revenue was $254 million versus $218 million in the previous quarter and $202 million a year earlier.

• Underwriting and advisory fees were $132 million in the quarter versus $112 million in the previous quarter and $68 million a year earlier.

Security Gains Moderate

• AFS/FVO gains included in operating earnings moderated to $32 million or $0.05 per share from $186 million or $0.32 per share in the previous quarter, but were higher than the $1 million or nil per share a year earlier.

Unrealized Security Deficit

• The unrealized security deficit improved to $244 million at quarter-end versus a deficit of $720 million in the previous quarter and a surplus of $417 million a year earlier.

Corporate and Other Business Segment

• The corporate and other segment recorded a loss of $48 million versus a loss of $80 million in the previous quarter and a gain of $33 million a year earlier.

• Securitization revenue declined in Q3/09 to $113 million versus $137 million in the previous quarter and $161 million a year earlier. The bank calculated the net income statement impact at a loss of $31 million in Q3/09 versus a gain $25 million in Q2/09.

Loan Loss Provisions Spike

• Specific LLPs spiked to $422 million or 1.01% of loans from $329 million or 0.83% of loans in the previous quarter and $203 million or 0.46% of loans a year earlier. Total LLPs were $547 million or 1.31% of loans including a general provision of $42 million and $83 million of loan losses within the leveraged loan and other run-offs portfolio that the bank identified as an item of note.

• The increase in loan losses was due mainly to credit cards and personal lending, leveraged loans and other run-off portfolios, and U.S. real estate finance business. Credit card loss ratio hit a Canadian record at 7.4%.

• Retail LLPs were $423 million with CIBC World Markets LLPs at $46 million, with the corporate segment recording a $47 million recovery.

• We are increasing our 2009 LLP estimates to $1,400 million or 0.84% of loans from $1,300 million or 0.79% of loans. We are reducing our 2010 LLP estimate to $1,400 million or 0.81% of loans from $1,500 million or 0.88% of loans, respectively.

Impaired Loans Increase

• Gross impaired loans increased 32% to $1,668 million or 1.00% of loans in the quarter versus $1,263 million in the previous quarter and $889 million a year earlier. Gross impaired loans increased materially in the quarter in the business lines of publishing, printing & broadcasting, and real estate and construction.

• Net impaired loans were negative $312 million versus negative $505 million in the previous quarter and negative $595 million a year earlier.

Loan Formations Increase

• Gross impaired loan formations increased to $967 million this quarter from $541 million in the previous quarter and $328 million a year earlier. Net impaired loan formations also increased to $741 million from $407 million in the previous quarter and $206 million a year earlier.

Tier 1 Ratio 12.0%

• Tier 1 ratio increased to 12.0% from 11.5% in the previous quarter, due mainly to the 3% sequential decline in risk-weighted assets.

• The common equity to risk-weighted assets (CE/RWA) ratio was 9.2% compared with 8.9% in the previous quarter and 9.1% a year earlier.

• Total risk-weighted assets declined 3% sequentially and YOY to $115.4 billion, while market-at-risk assets declined 32% sequentially and 41% YOY to $1.7 billion.

• Book value was flat QOQ and declined 2% YOY to $27.87 per share.

Enron Settlement - Tax Reassessment?

• On August 5, 2009, Canada Revenue Agency (CRA) issued draft reassessments proposing to disallow the deduction of the 2005 Enron settlement payments of approximately $3 billion. CIBC is contesting. If entirely successful, CIBC would recognize an additional tax benefit of $214 million or $0.56 per share, plus interest. If entirely unsuccessful, CIBC would incur a tax expense of $826 million or $2.17 per share plus interest. If entirely unsuccessful this would result in a 70 bp reduction in Tier 1 Capital bringing CIBC's ratio down to 11.3%.

Recommendation

• We are trimming our 2009 earnings estimate to $5.90 per share from $6.00 per share due to higher-than-expected loan loss provisions in Q3/09. Our 2010 earnings estimate remains unchanged at $6.30 per share.

• Our 12-month share price target remains unchanged at $75, representing 12.7x our 2009 earnings estimate and 11.9x our 2010 earnings estimate.

• We maintain our 2-Sector Perform rating based on stabilizing earnings base and leverage to lower loan losses as the credit cycle turns, offset by weak revenue growth outlook and weaker operating platforms.
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Financial Post, John Greenwood, 26 August 2009

Four years after Canadian Imperial Bank of Commerce paid a record $3-billion settlement to disentangle itself from Enron litigation, the spectre of the failed U.S. energy trader has come back to haunt Canada's fifth-largest bank.

CIBC disclosed Wednesday that it is preparing to go to court with the Canada Revenue Agency to defend its position that the settlement is tax-deductible.

If the bank wins it will recognize a tax benefit of $214-million, but if the government prevails CIBC could end up having to pay $826-million.

"This is not a small amount to CIBC, representing roughly 8% of its book value," said Jim Bantis, an analyst at Credit Suisse.

The matter was disclosed in CIBC's third-quarter results.

Speaking on a conference call with analysts, Gerry McCaughey, chief executive, said CIBC has for some time been "anticipating reassessment would be probable" but went public after it became almost certain on Aug. 5 that the CRA would challenge the deduction.

CIBC reported net income for the third quarter of $434-million, or $1.02 a share, up from $71-million (11¢) last year.

At the same time, the bank made total loan loss provisions of $547-million in the quarter, more than double the comparable figure for last year and significantly higher than analysts expected.

The results came out a day after Bank of Montreal kicked off earnings season with earnings that were well ahead of analyst estimates.

Shares in CIBC declined 5.3%, ending the day at $65.01 after diving nearly 10% at the opening of trading on the Toronto Stock Exchange.

John Aiken, an analyst at Dundee Capital Markets, said he was "disappointed" by CIBC's rising loan loss provisions. "Based on BMO having almost everything going right, you start to believe that this is what to expect and that the [troubled economy] is not going to bite the banks but CIBC demonstrated a very different experience," he said.

Total revenue for the quarter was $2.86-billion, up from $1.9-billion a year ago. Canada's fifth largest bank had a Tier 1 ratio of 12% and declared a dividend of 87¢ for the current quarter.

Of Canada's major banks CIBC suffered the worst from the financial crisis, with about $10-billion of writedowns related to structured credit products over the past 18 months.

The quarter contained some good news on that front as there were no major writedowns.

In the three months ended July 31, CIBC did have $155-million of mark to market losses on credit derivatives due to narrowing spreads in the bank's loan hedging portfolio. This was partly offset by a $95-million gain on what the bank called structured credit runoff activities.

With worst of the red ink from credit derivitives mostly behind it, Mr. McCaughey said CIBC sees securitization as an opportunity. At its peak, the bank had about $17-billion of assets in its securitization trusts, which has since been run down to about $4-billion.

Bank officials said conditions in the market suggest demand for securitized products is re-emerging along with profit margins.

The results come a day after the Bank of Canada warned that the recovery in the Canadian economy could be derailed by a soaring loonie. The bank's deputy governor Timothy Lane said on Tuesday that the BOC may have to intervene to halt the rise.

Analysts said that of all the major banks CIBC is particularly sensitive to changes in economic conditions because of its high exposure to consumer credit cards. As a rule, consumers are much more likely to default on their credit cards than other forms of debt such as mortgages and car loans.

CIBC's retail markets business reported net income of $416-million, down 26% from last year because of deteriorating economic conditions and rising loan losses.

In wholesale banking, CIBC had a net profit of $86-million, compared with a loss of $541-million for the same period last year. The improved result was primarily due to gains in structured credit operations.

On the conference call, Mr. McCaughey said the bank is on the lookout for growth opportunities but declined to comment specifically on rumours earlier this month that the bank is looking to acquire a minority stake in an Irish bank.
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