CIBC Outdoes Peers as Less Risk Adds Stability

Chief Executive Officer Gerald McCaughey’s mission to reduce risk at Canadian Imperial Bank of Commerce is rewarding shareholders with a less-volatile stock that’s beating its peers.

CIBC generated the best risk-adjusted returns among Canada’s six-largest lenders in the past 12 months, according to a Bloomberg Riskless Return ranking. That compares with the five-year period beginning with the financial crisis when the Toronto-based lender was the worst performer and most-volatile stock as debt writedowns caused investors to shun the shares.

CIBC has returned 1.18 percent in the past year after accounting for price swings, ahead of Bank of Montreal’s 1.16 percent risk-adjusted return and six times that of National Bank of Canada and Toronto-Dominion Bank, according to data compiled by Bloomberg through yesterday. CIBC also outperformed Bank of Nova Scotia and Royal Bank of Canada, whose risk-adjusted returns were both 0.72 percent.

“Gerry McCaughey’s done a great job de-risking the bank,” Ian Nakamoto, director of research at MacDougall MacDougall & MacTier Inc. in Toronto, which manages about C$4 billion ($3.9 billion) including bank stocks, said in an April 22 interview. “He’s playing into the mantra of what bank investors want: relatively low-risk situations.”

CIBC under McCaughey spent the past five years focusing on Canadian banking and wealth management. McCaughey has repeated a refrain since at least December 2011 that CIBC’s first principle is to be a lower-risk bank that delivers consistent and sustainable earnings.

‘First Principle’

“What we try to control is our operating framework, be it normal operations, incremental investment, capital levels,” McCaughey, 57, said yesterday in an interview in Ottawa after the bank’s annual investor meeting. “We seek to adhere to our first principle, to be a lower-risk bank. That is our policy now and it will be our policy in the future.”

CIBC earned 68 percent of its annual profit last year from retail and business banking, according to financial statements. Wealth management made up 10 percent of earnings, with wholesale banking contributing 18 percent of profit.

“An unintended consequence of the de-risking effort is an over-reliance on earnings generated by its Canadian personal and commercial-banking business, generally, and to the Canadian household specifically,” Peter Routledge, a National Bank Financial analyst who rates the stock the equivalent of hold, said in an April 24 interview from Toronto. “CIBC risks becoming a low-risk, low-growth bank.”

Bank Missteps

Nakamoto said he prefers the slower growth, lower risk approach than the alternative strategy. “I always view banks as an area where you don’t want anything too exciting to happen,” he said. “Most of the exciting stocks have been killed.”

McCaughey’s low-risk directive follows years of missteps on risky U.S. subprime mortgages, structured debt and Enron Corp. CIBC had more than C$10.7 billion of pretax writedowns between 2007 and 2009, more than any other bank in the country during the financial crisis. Before then, the bank agreed to pay Enron shareholders $2.4 billion to settle claims from a class-action lawsuit tied to the failed energy trader. The Enron settlement was announced Aug. 2, 2005, the day after McCaughey took over as CEO from John Hunkin, who retired.

McCaughey stepped up efforts to lower risks after taking writedowns during the financial crisis, selling most of CIBC’s New York-based investment bank, exiting businesses such as European leveraged finance and scaling back on debt securities.

‘No Surprises’

“From the first day he took the job, a key mandate for Gerry has been to reduce the risk profile of CIBC,” Sumit Malhotra, an analyst at Macquarie Capital Markets in Toronto, said in an April 24 interview. “It took a little while, but from a financial perspective I think CIBC has become the new bank of no surprises.”

The risk-adjusted return, which isn’t annualized, is calculated by dividing total return by volatility, or the degree of daily price variation, giving a measure of income per unit of risk. A higher volatility means the price of an asset can swing dramatically in a short period, increasing the potential for unexpected losses.

“CIBC is basically a very simplified bank,” David Atkins, a portfolio manager at Cardinal Capital in Winnipeg, Manitoba, who manages C$1.7 billion including Canadian bank stocks, said in an April 22 interview. “They’ve probably set out and accomplished what they wanted to do.”

Steady Growth

CIBC has returned 12.7 percent in the past 12 months with price swings, the best among Canada’s largest six lenders, according to the data. In comparison, Bank of Montreal had a 12.6 percent return, Royal Bank returned 10.8 percent, Scotiabank 9.3 percent and National Bank 2.5 percent. Toronto-Dominion returned 2.2 percent in the period.

The stock closed yesterday little changed at C$78.91 for a market value of C$31.6 billion. CIBC advanced 7.4 percent in the 12 months through yesterday, the best performing stock along with Bank of Montreal in the eight-company Standard & Poor’s/TSX Commercial Banks Index.

“If you look at CIBC now, their dividend growth potential is very good, their earnings growth is steady,” Atkins said. “I’m not expecting them to really shoot the lights out, but if you can get 8, 10 percent earnings growth and you’re still getting 10 percent dividend growth, that’s going to be a very good investment over the long term.”

Most Volatile

Canadian lenders have been ranked the world’s soundest for the past five years by the Geneva-based World Economic Forum. The banks index during the five-year period outperformed Canada’s benchmark S&P/TSX Composite Index, which has been almost unchanged in that span when accounting for volatility.

Canada’s commercial banks index returned 1.9 percent on a risk-adjusted basis for the five years, compared with the 0.5 percent decline of the KBW Bank Index of 24 U.S. lenders.

The Chicago Board Options Exchange Volatility Index, which reflects an estimate of future volatility of the S&P 500 Index, dropped to 13.62 yesterday from a November 2008 peak of 80.86.

McCaughey’s push for lower risk may come at a cost to investors, according to National Bank’s Routledge.

“Over periods longer than a year, lower risk can translate into slower growth and ultimately weaker shareholder returns,” Routledge said. “Fortune favors the bold.”

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