Canadian Imperial Bank of Commerce to Reveal US Subprime Mortgage Exposure
Debt market holdings larger than expected; at least $1-billion could be at risk for writedown
NEW YORK, TORONTO — Canadian Imperial Bank of Commerce could have as much as $10-billion worth of hedged exposure to the troubled U.S. subprime mortgage sector, although only a fraction of that amount is believed to be at risk of a writedown, according to people who have studied the bank’s dealings.
While this level of exposure would be higher than most analysts have forecast, sources who closely monitor the bank said it appears that CIBC has spread these hedges among many different parties, several of which are in good financial health.
The view is that the risk would be limited to between 10 per cent and 30 per cent of the portfolio - roughly $1-billion to $3-billion - if some of CIBC’s hedging partners were to collapse and the bank had to take a charge.
That damage may already be reflected in CIBC’s market capitalization, which has dropped about $3-billion in value over the past three weeks.
CIBC is expected to reveal the precise amount of its exposure, along with some information about its hedging counterparts, when it reports its year-end results next week, sources said yesterday.
Investors have been anxiously awaiting some clarity on the matter amid the growing deterioration of bond insurers, which provide guarantees on complex debt instruments held by banks like CIBC. The weakened state of these insurers has prompted speculation about massive losses at investment banks, and provided ammunition to short sellers that have helped drive down the price of CIBC’s stock.
CIBC officials declined to comment on the matter, stating that the bank was in a so-called media quiet period, due to its earnings release scheduled for next week.
Three weeks ago, the bank announced it would take $463-million in fourth-quarter charges related to its exposure to the U.S. mortgage market. That was on top of a $290-million charge in the previous quarter. Both of these writedowns stemmed from $1.7-billion worth of collateralized debt obligations that were unhedged.
CDOs are complicated securities that pool together various forms of debt, including subprime mortgages.
The remainder of the bank’s mortgage-related CDO and bond portfolio is hedged, meaning - in theory, at least - that CIBC has offloaded risk to third parties.
The problem is that several of the bond insurers who typically provide these hedges have been whacked by the mortgage fallout. If some of these suffer credit downgrades - or even bankruptcy - as many analysts speculate, the hedges will be impaired and banks will have to bring these CDOs and other mortgage-backed securities back on their books.
That could spawn $77-billion (U.S.) in charges for the world’s largest banks, according to a report issued this month by analysts at JPMorgan Chase & Co. Given the magnitude of these potential losses, some bankers believe U.S. regulators will intervene to help prop up the capital strength of these insurers.
None of the major North American or European banks have quantified their hedged exposure, or disclosed their relationships with various insurers and other counter-parties. That makes it almost impossible to predict the size or likelihood of charges with any degree of certainty.
This lack of information has been a boon for hedge funds, many of which have filled the void by issuing dire predictions about potential losses and simultaneously shorting bank shares. Short sellers borrow stock and agree to repay it at a later date in a bet that it will drop in value and they can profit from the difference.
CIBC, in part because it is thought to be heavily exposed to the subprime mortgage market, and in part because of its reputation for giving investors unpleasant surprises, has been particularly vulnerable. The company’s shares were hammered last spring, when hedge funds openly speculated about its ties to the melting mortgage market. However, they rebounded sharply during the summer, once the bank reported its unhedged exposure.
This fall, however, as bond insurers began to falter, the rumour mill kicked into high gear once again. Hedge funds began calling Canadian bank analysts and faxing money managers to persuade them of the potential writedowns CIBC could face. They also seized upon the fact that CIBC’s chief risk officer, Ken Kilgour, recently left on a one-month medical leave - a sign, they said, of internal pressures.
A CIBC spokesman confirmed that Mr. Kilgour was on leave, but only said he was expected back in early December.
On Nov. 15, an e-mail said to have emanated from a U.S. investment banking firm began circulating in the markets, warning that CIBC could be facing a charge of as much as $4-billion (Canadian).
“Sounds like the ultra bearish view is that at the [minimum] they have $2-billion in future writedowns coming. I have heard in excess of $4-billion,” the unsigned note stated, before estimating that such charges could cut the bank’s share price by 20 to 40 per cent. “Buzz is that its biggest counter-party is on the verge of filing for Chapter 11.”
Around the same time, a hedge fund amassed a short position of almost two million shares in a few days of trading through RBC Dominion Securities Inc. CIBC’s stock, which slid from $102 at the end of October to $92.30 on Nov. 14, dropped 4 per cent on Nov. 15, and was down more than 9 per cent over the next three days.
CIBC set to reveal subprime exposure
SINCLAIR STEWART AND BOYD ERMAN | The Globe and Mail