Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Canadian Imperial Bank of Commerce (NYSE:CM)

F4Q07 Earnings Call

December 6, 2007, 3:30 PM ET

Executives

John Ferren - VP, IR

Gerald T. McCaughey - President and CEO

Tom Woods - Senior Executive Vice-President and CFO

Sonia A. Baxendale - Senior EVP CIBC Retail Markets

Brian Shaw - Chairman and CEO, CIBC World Markets

Analysts

Brad Smith - Blackmont Capital

John Aiken - Dundee Securities

Michael Goldberg - Desjardins Securities

Andre Hardy - RBC Capital Market

Mario Mendonca - Genuity Capital Markets

Ian De Verteuil - BMO Capital Market

Darko Mihelic - CIBC World Markets

Sumit Malhotra - Merrill Lynch

Shannon Cowherd - Citigroup

James Bantis - Credit Suisse

Presentation

Operator

Good afternoon ladies and gentlemen. Welcome to the CIBC Fourth Quarter and Year-End Results Conference Call. Please be advised that this call is being recorded. To reduce the audio interference within the board room and over the conference call line, please turn your Blackberry off for the duration of the meeting. I would now like to turn the meeting over to Mr. John Ferren, Vice President, Investor Relations. Please go ahead, Mr. Ferren.

John Ferren - Vice President, Investor Relations

Good afternoon and thank you everyone for joining us today. The purpose of our conference call this afternoon is to discuss our Q4 and annual results released earlier today. The call is being audio webcast as usual and will be archived later this evening on cibc.com. In addition to the usual quarterly material, CIBC 2007 consolidated financial statements and MD&A are also available now on our website. This afternoon CIBC's senior management team will deliver some prepared remarks and will be available for a question-and-answer period following.

Before we begin, let me remind you that any individual speaking on behalf of CIBC on today's call may make forward-looking statements that are subject to a variety of risks and uncertainties. Certain material factors or assumptions maybe applied, which could cause CIBC's actual results in future periods to differ materially from the conclusions, forecast or projections in these forward-looking statements. For more information, please refer to the note about forward-looking statements in today's press release.

With that, let me now turn the meeting over to CIBC's President and Chief Executive Officer, Gerry McCaughey.

Gerald T. McCaughey - President and Chief Executive Officer

Good afternoon and thank you for joining us. Today, I will review CIBC's fourth quarter and fiscal 2007 results. I will also comment on our structured credit exposure to the US subprime mortgage market. Following my remarks, our Chief Financial Officer, Tom Woods will provide the financial and risk review. My comments as well, may contain forward-looking statements and actual results could differ materially.

Let me start with our results. This morning, CIBC reported strong net income for the fourth quarter of $884 million, up from $819 million a year ago. Cash earnings per share were $2.55, up from $2.34 a year ago. Return on equity for the quarter was 30.3%. For the year, net income was a record $3.3 billion. Cash earnings per share were also a record $9.30. Return on equity was 28.7% and our Tier 1 capital ratio was strong at 9.7%.

For the second consecutive year, CIBC delivered the highest total shareholder return among the major Canadian banks with 20.2%. Our overall results in 2007 reflect progress against our priorities. Many of our core businesses delivered strong performance that allowed us to observe the CDO write-downs in 2007 and still deliver strong results. Many people across CIBC pulled together to deliver this performance and I want to thank them for their efforts this past year on behalf of our shareholders. However, the year results were marked by challenges in our structured credit business.

Before I turn over to Tom, I am going to comment on the disclosure we have provided regarding our exposure to the US subprime residential mortgage market as well as the actions we are taking in this area. Let me start with our unhedged exposure. As we have disclosed today, our gross unhedged exposure at October 31st was approximately US$1.6 billion. Against this amount we have recorded mark-to-market write-downs of US$860 million offset by write-downs on assets sold of US$41 million leading us to a remaining unhedged exposure of US$784 million as of October 31, 2007. This remaining unhedged exposure is directionally mitigated by the remaining value of the AVX [ph] hedges of US$174 million.

Conditions in the US residential mortgage market have continued to deteriorate in the New Year, in the month of November. And we estimate that we would incur further mark-to-market write-downs on this portfolio in the first quarter. Tom will comment on this during his presentation. In addition to our unhedged exposure, we have also disclosed today $9.8 billion of hedged credit derivative exposure to the US subprime residential mortgage market. Over 90% of the rated underlying assets are AAA rated securities and the average subprime component is about 60%.

We have protection offsetting the $9.8 billion through credit default swaps. 47% of our hedged exposure is spread across five AAA rated financial guarantor. Although the financial performance of these guarantors has received some scrutiny, all five have maintained their AAA rating. None has been downgraded. One has been recapitalized by a parent bank and many of the others are partially or fully owned by other financial institutions. These financial guarantors represent a very important part of the US and global financial systems, and we believe they will continue to play an important role in the future.

As a further hedged against this portion of our exposure, we have purchased approximately US$420 million of additional credit default swap protection against these AAA rated financial guarantors. The next level of our hedged exposure representing 18% is with two large AA rated well diversified institutions. One is the large European multinational bank while the other is a large American multinational insurance... financial services company. Any credit exposure to these two large financial services companies is protected by cash collateral arrangements. We have also purchased approximately US$465 million of directional hedges that we believe will correlate with stresses in this sector.

The rest of our hedged exposure is to one A rated financial guarantor that has recently been put on credit watch. This institution is working closely with advisors and its shareholders and its maintaining an active dialog with its counterparties including ourselves. One possible outcome is a recapitalization of this company. Ultimately, if there are losses, the probability is that these losses would play out over a period of time. Although we would continue to access the counterparties' ability to pay and possibly incur counterparty credit reserve charges in events of losses actually occurring. If that were to happen, CIBC has the capital strength to observe any such losses.

Now that I've outlined our exposure, let me take a minute to put them in context. The business' structuring credit is one that CIBC has been in from many years. These particular exposures formed a small part of a debt capital markets' business and we're not a large contributor to CIBC's profitability. In our risk assessments, we underestimated the extent to which the subprime market might deteriorate and the degree to which that would be... and the degree to which that would impact securities that were structured to be very low risk. This coupled with an overdependence on the extremely high ratings of these securities, resulted in the build up of exposures that are too large for CIBC's risk appetite.

Let me now review the steps we've taken to-date to address our exposure in these areas. First, we halted new business activity and structured credit. Second, we have put on hedges against out unhedged position and for a hedged position, as I mentioned, we've continued to take steps to mitigate extreme tail risk. Third, we have changed leadership over debt capital markets area and our structured credit business is being managed directly by Brian Shaw, the head of our capital markets business.

In addition to these specific actions, we are also strategically examining all of our business activities to ensure that they are aligned with our imperative of delivering consistent and sustainable performance. For example in November, we announced the sale of our US investment banking, cash equities and research business in the United States. The risk return characteristics of these businesses were not consistent with our expectations or strategic framework that we have set for CIBC, a framework we intend to vigorously adhere to.

We also intend to place additional emphasis on building capital strengths, which we believe to be prudent given the uncertainty of the current market conditions. Our Tier 1 ratio is currently at the high end of the industry. With a favorable impact we expect from Basel II, our ongoing earnings and management of our risk rated assets, we expect our capital ratios to continue to be comfortably above our published target. Our focus on building capital strengths means that it is unlikely that we will be active on our share buyback in the first quarter.

In summary, let me say that over the past two years we have focused on positioning the bank for consistency and sustainability. The fact that we have delivered record results this year despite the CDO write-down reflects the opportunity and potential of our core businesses. At the same time, it is clear that we have more work to do to ensure that all of our businesses reflect our strategic risk posture; particularly in certain parts of world markets.

Our world markets product development activities over the years have at times followed US and international money central banks and investment banks. In the case of our current structured credit exposure that was also true. As part of the solution is to not participate in such business activities and therefore we have discontinued them. We will continue to take this approach in other parts of world markets as necessary by seeking out further areas in world markets that do not fit our strategy and risk profile. We want our entire risk activities to be consistent with the progress that we have made so far and the benefits that that has created for the bank.

As always, we believe that balance is important. So our emphasis in 2008 will be equally placed on remediation and management of the areas that are concerned to-date as well as ensuring that our strong healthy businesses continue on their growth path and that other joined them once we are mediated. Thank you. And I will now turn the meeting over to Tom Woods. Tom?

Tom Woods - Senior Executive Vice-President and Chief Financial Officer

Thank you, Gerry, and good afternoon everybody. My comments as well contain forward-looking statements and actual results could differ materially. I will start with slide 5. It summarizes the financial results for the quarter. As Gerry said, we had cash EPS of $2.55. This was helped by the Visa gain and partially offset by the write-down on our CDO/RMBS exposure. While these two items dominated the quarter, we had good results in several business areas, and continued strong loan loss in expense performance.

Slide 11, retail markets revenue $2.65 billion was well up for recent quarters because of the $456 million Visa gain. Excluding this, revenue was up 7% from Q4 last year.

Slide 13, the first business within retail markets, personal and small business banking. Q4 revenue was up almost 5% from a year ago as deposit balances grew over 7%. Deposit spreads widened in the quarter as the BA rate increased. The BA rate has since fallen back for a transaction deposit spreads are back to normal although GIC pricing has become more competitive. Q1 revenue here will likely be about the same as it was in Q4.

Slide 15, retail brokerage revenue was up 1% from a year ago, but down from the first three quarters of the year due to the change in markets settlement; reflected both in lower trading volumes and lower new issue activity. Q1 will likely be down as well as many investors remain on the sidelines. Slide 16, cards revenue excluding the Visa gain was $374 million in line with recent quarters.

Managed balances were up 11.2% from a year ago, the largest year-on-year growth in six years. We see industry balances up at least 10% again in 2008. Q1 should be another good quarter with the benefit of seasonal balances growth.

Slide 17, mortgage and personal lending revenue was well down this quarter for a number of reasons, very little of which related to volume. As we maintain market share and mortgage and lost only a small amount of share in personal lending. Mortgages accounted for most of the revenue decline, due to the narrower prime BA spread, tighter pricing, lower prepayments fees, lower CMB securitization and various securitization hedging adjustments. Going forward to avoid combining the volatility from hedging activities with core mortgage revenue, we are looking at alternatives were part or all of this revenue would appear under either retail markets or corporate and others, the way some of the other banks do it.

Managed balances and mortgages were up over 13% on the year and almost 4% on the quarter. We foresee industry balances growing 7% to 8% in 2008. Personal lending revenue was also down but not as much as mortgages, due well to the prime BA narrowing and also due to the secured, unsecured mix. Personal loan balances were up almost 3% on the year in total with secured balances up 15% but unsecured down 13%. We expect mortgages and personal lending revenue to be well up in Q1. The prime BA spread is back to normal and mortgage pricing has improved.

Slide 20, retail markets net income excluding the VISA gain was 531 million, up 12% from Q4 a year ago adjusted for the tax recovery we received in the quarter, in that quarter and up 8% excluding FirstCaribbean, which we own 44% last year versus 91% today.

Turning now to CIBC World Markets, revenue was well down from recent quarters due to the $463 million net write-down on CDOs and RMBS related to the US residential mortgage market. First business in world markets, slide 23, capital markets revenue excluding the CDO/RMBS write-downs was $214 million, down from levels we saw earlier in the year. This was due primarily to increases in counterparty credit and other reserves in our hedged structured credit intermediation books.

In addition, our credit post trading business was down due mainly to negative marks on credit derivative trading positions. And our interest rate derivative business was down due to low client activity.

On the positive side, our new issue business was up and foreign exchange continued to be strong helped by the Canadian dollar volatility and a retail customer buying in the US currency. Equities had a good quarter, particularly in equity derivatives, which have high dividend income offset in part by a slowest quarter in retail note structuring. However, so far in Q1 both our debt and equity businesses are off to a slightly slower start.

Slide 24, investment banking and credit products revenue was back to a more normal run rate. Last year... last quarter's revenue included $77 million in gains on credit derivative hedging compared with only $17 million this quarter. Canadian mergers and acquisitions revenue was strong with large transaction for Stelco [ph] or resources in activity. And our US business had a more normal quarter after a very strong Q3.

Q1 revenue will likely be down as the Canadian new issue pipeline is not as strong as it has been and we expect only two months revenue from the US before the sale of our investment banking business there to Oppenheimer closes. Although we have a reasonably large backlog at M&A transactions, the prospects for new M&A business particularly large transactions appears to be lower due to the declining market appetite for leveraged corporate lending.

Slide 25, merchant banking had revenue of $141 million down from the very strong Q3. We had gains in distributions of $164 million offset in part by write-downs and funding cost of 25 million. Approximately 40% of the $164 million were distributions from fund investments, which had higher levels of divestures again this quarter. Merchant banking revenue in 2008 will be driven primarily by how easily sponsors can divest businesses into the leverage finance market. But at the moment it appears our revenue will be down significantly from 2007.

Slide 26, world markets had a net loss of $64 million in Q4. Due mainly to the $302 million after tax write downs on the CDOs and RMBS. The other charges in our structured credit business and the write-offs in connection with the upcoming sale of some of our U.S. businesses.

Go back to slide 9; turning now to our consolidated expenses which were $1.87 billion in Q4. These included $47 million of U.S. divesture write-offs, higher seasonal advertising costs and longer than normal incentive compensation accruals. Q3 expenses benefited from higher mitigation expense reversals. We continued to be running at a better rate adjusted for FirstCaribbean than our objective which is the Q4 2006 baseline of $1.892 billion. Beginning at Q1 we will adjust this baseline further to exclude the cost of our U.S. divest in businesses through... for comparability.

Slide 47; shows the normal disclosure on our tax rate adjusted for the unusual items. This quarter the Visa sale gain was taxed at the capital gains rate, which is half the regular income tax rate. As well we had a higher amount of dividend income which is non-taxable.

Go to slide 51; this provides a breakdown of our CDO/RMBS position that have exposure to U.S. subprime and that are not hedged with counter parties. You can see that as of October 31st we had our U.S. $1.6 billion exposure market roughly $0.50 on the dollar. Although, we did not complete our November march, the outlook for this exposure is to be marked down to about $0.34 on the dollar. For remaining exposure netting to under U.S. $400 million.

All that U.S. $300 million of this $1.6 billion notional has been mark based on independent deal approach which as you know are at very good stress levels. The U.S. $300 million that was marked to model is the most straight forward super senior position we have and in its mark. it is not that different on the quotes we have received.

Although there are no other international banks with October year end to compare these marks to I can tell why that our August and September marks when compared to the published figure for such banks appear to be conservative and certainly the imputed ultimate defaults and loss rates behind these marks are considerably higher than those being generally forecast.

Slide 52; provides the breakdown of our CDO/RMBS positions that have exposure to U.S subprime and that are hedged with counter parties. You can see that all of that U.S $3.5 billion notional is hedged with AAA and AA counterparties. As Gerry said, the single A rated counted party has recently been placed on credit watch. It has began discussions with its rating agency and with its counter parties including CIBC. It's too early to tell what the outcome of these discussions will be. One possible outcome could be a recapitalization possibly involving the counterparties. This would likely result in CIBC taking a counter party credit reserve in excess of the small reserve that was in place as of October 31st.

If a down grade occurred CIBC would have to take a larger counter party credit reserve. Even in an extreme outcome however, we would anticipate that our capital ratios would still be comfortably above our published targets.

Turning now to our credit and market risk management measures, with respect to credit risk on slide 54 specific low mark provisions were $134 million in the fourth quarter, this represents 31 basis points on net loans and acceptances. The $30 million decrease in specific provisions versus Q3, as a result of an $8 million decrease in world markets and a $22 million decrease in retail markets.

World markets recorded a net recovery of $16 million in the fourth quarter as recoveries in the large corporate portfolio increased from Q3 levels. Retail markets loan losses were $150 million in the quarter. Provisions in the personal loan portfolio here declined $23 million versus the prior quarter. The improvement was driven by lower write-offs in our unsecured portfolio.

Net of cash loan declined to $310 million at the end of Q4, growth impaired new formations were up somewhat from Q3, but continue the downward trend over the last several quarters. Or as the industry trend for new formations continues to go up.

Turning to market risk slide 55, displays Q4 distribution of revenue in our trading portfolios. In Q4 54% of trading days were positive down somewhat from prior quarters. The trading revenue here does not include the reductions in mark-to-market value of our strategic credit assets and as this analysis is carried at only at each month end.

Slide 56; our Tier 1 ratio was up five basis points compared with the prior quarter. Internal capital generation was partly offset by higher risk rated assets and exchange rate impacts on our international capital balances. At 9.7% our Tier 1 ratio was well above our 8.5% target.

I'll now hand things over to Sonia Baxendale, Head of CIBC Retail Markets.

Sonia A. Baxendale - Senior Executive Vice President CIBC Retail Markets

Thank you Tom. My comment may also include forward-looking information and actual results could differ materially. Overall retail markets performed well in 2007, consistent with our stated strategy. We continue to focus on our three strategic priorities of building strong advisory solution, enhancing the client's experience and offering highly competitive product. We had strong performance in our industry leading credit card business.

Average credit card balances grew 11.2% year-over-year while maintaining a high quality portfolio. 2008 and 2007 average balance growth with both the highest year-over-year increase and the first double digit growth since fiscal 2001. Growth in credit cards was largely driven by two key initiatives launched at the beginning of 2007. The revitalization of Aerogold including mileage multiplier and increased marketing sense. And the launch of the no-fee platinum Visa credit card. Both initiatives have increased new client acquisition. Client's retention and overall spend.

In a highly competitive mortgage market, we achieved full year growth imbalances of 13% with flat market share. This growth was driven through a combination of branch and alternative distribution channel. The introduction of over 120 branch network mortgage specialist, increased capacity of our alternate mortgage distribution channels by our additional mortgage adjudicator and strong marketing investment against key promotions as well as incremental training and support in both channel.

As anticipated, our total lending balances were flat in the quarter and slightly down year-over-year. Our focus in 2007 was to improve acquisition and account management in our lending portfolio and we are making progress. New personal unsecured lending originations are demonstrating better characteristics versus older vintages at similar points in time. We are very pleased with our strong growth in deposits in GIC particularly in this extremely competitive market. This quarter we experienced the highest market share increases of the big six banks.

Our 8.7% combined balanced growth in deposits in GIC was driven by growth in both the CIBC and President's Choice financial brand, revitalization of our bonus savings account offer and increased marketing. This past year in mutual funds, net sales were $1.1 billion, our highest net sales year since 2004. Our performance is driven by a strengthening in our overall fund portfolio. Currently we have 16 four and five star rated funds by Morningstar. We were recently awarded two Canadian investment awards for the Renaissance Canadian Monthly Income fund and the Renaissance Global Healthcare fund.

And last month, we launched two new income oriented funds that will provide incremental growth opportunities in 2008. We had solid year in our full service brokerage business with a record high level of fee-based assets at in excess of $47 billion representing a 12% increase versus 2006. This growth has been supported by continued strength in our separately managed account business. And in the launch of our discretionary investment management program. Good growth and overall revenues with a 4% increase versus 2006. And in distribution we have made progress in 2007 in our strategy to improve clients accessibility in all of our channels.

We are the second largest physical distribution network of branches and ATM, our focus is on improving both the clients and employee experience. We have 40 of the 70 new branch builds in progress, which will open in 2008 and 2009. We increased our 2007 maintenance budget in existing branches by 70% year-over-year. And last Sunday we launched our pilot in three branches in Toronto and two in Vancouver with our Sunday openings. Early feedback from those employees and client is extremely positive.

In summary, 2007 was a solid year for retail market, in 2008 we will build on this foundation and make progress against our key strategic priorities and support us delivering consistent sustainable revenue growth.

Thank you, I will now turn over to Brian Shaw.

Brian Shaw - Chairman and Chief Executive Officer, CIBC World Markets

Thanks Sonia and good afternoon everyone. My remarks may also include forward-looking information and actual result could differ materially. As Tom covered off in his financial review, the fourth quarter earnings performance for World Markets was impacted by the pre-tax, mark-to-market write-down, net of related hedges of $463 million on structured credit positions related to the U.S residential mortgage market.

Largely due to the write-down, net income was down $324 million from the prior quarter. This resulted in a quarterly loss to World Markets of $64 million.

For the full year net income is $601 million down 7% from the $646 million recorded in 06. Revenue for the year was also down 12% over last year primarily due to the mark-to-market structured credit write down. Like other investment banks in the financial services industry, we continue to be impacted by a current market environment characterized by continued volatility and weakness in structured credit products as well as their liquidity. As a result of the challenges in credit market, our focus in 08 will be to significantly refocus our structured credit activity.

Specifically, our emphasis will be on reducing exposures while maximizing recovery, reducing risks and volatility in financial results and on narrowing our credit structuring activities. Given the nature of these securities, and the fact that the market for these products continues to be a liquid, we would expect that management and exiting of these positions will occur over some period of time.

Our second area of focus will be on completing the transition of our U.S. domestic investment banking equities and leveraged financed businesses to Oppenheimer. This sale allows us to reduce resource used in operational complexity. At the same time, it reduces risk and frees up capital without giving up earnings.

Our third area of focus will be in Canada where we have stronger origination and capital market businesses. These are robust and competitive businesses with strong talent and a legacy of high quality client relationship. In addition to our activities with large clients, we have been actively working over several years to extend our reach by developing mid-market relationship and broadening our base. We believe an intensified focus on these core Canadian businesses, including connectivity to targeted capability beyond our home market, provides us with a solid foundation for our business as we move into 08.

Our performance in this quarter demonstrated our continued competitive strength in these core businesses despite difficult market condition. Our Canadian investment and corporate banking business continued its strong 07 performance. Canadian M&A revenue increased by 40% for the quarter. Canadian investment banking revenues overall were up 13% from Q3. Revenue from Canadian equity new issues was flat quarter-over-quarter. Q3 and Q4 were down significantly from the first two quarters reflecting market condition. However, revenues were up strongly for the year due to improved volumes from a variety of sectors.

We also had another solid quarterly performance from both our Canadian and U.S. merchant banking businesses. This was driven strong results in our direct investing activities. Our U.S. real estate finance business also showed profitability in the quarter of challenging market condition.

In summary, CIBC World Markets Q4 results were once again impacted but market and industry conditions characterized by volatility. Like our competitors, we operate in the risk oriented business. Managing market volatility is therefore an integral component of what we do. Given current circumstances in our industry and in the marketplace, our results in the early part of 08 are not likely to match the strength and consistency we saw in the corresponding period last year.

That said, consistent M&A activity throughout the year leaves us with a solid pipeline of business entering 08. We will focus on continued momentum in our core Canadian origination and Capital Markets businesses as a catalyst for the success of our franchise moving forward.

With that I'll turn the meeting back over to John.

John Ferren - Vice President, Investor Relations

Thanks Brian. We will now take questions on the phone.

Question And Answer

Operator

Thank you, we will now take questions from the telephone line. [Operator Instructions]. Our first question is from Brad Smith from Blackmont Capital. Please go ahead.

Brad Smith - Blackmont Capital

Yes, it's sort of a two-prong question. First of all, Gerry I was wondering, in your opening remarks you made some reference about subprime mix, I think 60% was what you said. I just wasn't clear what the other 40% was, is it all day, is it some other mortgage exposure? And then the second question relates to the hedged CDO/RMBS and the position with the single A rated financial... U.S. financial granters. I was just curios that notional amount of $3.5 or $3.46 billion and seems like a rather large amount for a single credit exposure, is that somehow different in the criteria that you would use in managing your loan credit exposures for example?

Gerald T. McCaughey - President and Chief Executive Officer

Well I'll start with the second question first and then Tom will give you a breakdown of the exposures on the subprime percentages. The transaction question on the single A were intermediation transactions and essentially those are back-to-back derivative transactions, it's now clear that the combination of having a concentrated exposure to a single A rated counter party in a significantly stressed market is not a position, that we would chose to be in.

At the onset here, the securities underlying the A rated hedge were rated as AAA super senior. As a result of that the coverage to that normal risk management systems would throw off from the view point of our credit risk equivalent, the coverage of a single A would under the risk management systems least efficient to offset that.

The issue here is that the structuring features that were to provide the protections, that one would have expected have not functioned the way that we thought in a significantly stressed marketplace. Now that has led to a number of changes in our risk management practices. First and foremost, we're not doing this type of business anymore. Secondly, in addition to the normal credit risk equivalent, we have put on, notional limit for any assets that would resemble that.

And thirdly in our normal loan practices, this is not something that could take place because there are concentration limits around industries and concentration limits around single name exposures that would pick up this type of issue. Does that answer your second question?

Brad Smith - Blackmont Capital

Yes. I think it does. Thank you very much. Just to be clear you've now put notional limits in place in your risk management practices?

Gerald T. McCaughey - President and Chief Executive Officer

For assets that would not be picked up by single name concentration or industry concentration limits.

Brad Smith - Blackmont Capital

Right.

Gerald T. McCaughey - President and Chief Executive Officer

We have done that any areas, where we have a single name and industry concentration limit, it's not necessary because that fairly robust and operates under model that are very common across the industry.

Brad Smith - Blackmont Capital

Great. Thank you

Gerald T. McCaughey - President and Chief Executive Officer

Okay, Tom

Tom Woods - Senior Executive Vice-President and Chief Financial Officer

Yes, Brad, its Tom. Just on your first question the comment in Gerry's presentation related to the hedge block and how the underlying mortgages, underneath the various reference asset, the 25 reference asset is under 60% subprime in the underline. Now as many of you know, that doesn't necessarily mean the other 40% are necessarily going to perform the way non-subprime has performed in the past, a fair bit of that, what's called Alt A which is better than subprime, but it still mortgage business that has inferior documentation, compared to prime mortgages which are in there as well. The point we are making here is, the underlying in this portfolio are not 100% subprime, they are about 60% subprime

Brad Smith - Blackmont Capital

And just one follow-up the leverage in those CDO, mezzanine RMBS roughly of the 25 references, what it might... how you can characterize the leverage there?

Gerald T. McCaughey - President and Chief Executive Officer

It's ten to one?

Tom Woods - Senior Executive Vice-President and Chief Financial Officer

Yes, the attachment points are... just looking at the range, I mean they range from 12 up to 50 with an average attachment point of about 30%. So what that mean is the super senior tranches are senior to the junior tranches by 70 to 30. So, this 30% subordination.

Brad Smith - Blackmont Capital

Okay. Terrific thank you.

Operator

Thank you. Our next question is from John Aiken from Dundee Securities. Please go ahead

John Aiken - Dundee Securities

Good afternoon, in terms of the underlying... I am sorry, obviously this is on the hedged CDO exposure. In relation to be underlying CDOs that were brought on to the deduction on the balance sheet. Was this actually... were these originally purchase for the balance sheet [ph] was it brought in from a conduit?

Brian Shaw - Chairman and Chief Executive Officer, CIBC World Markets

Its Brian Shaw, I will have a shot at that. Maybe I will start off, by just describing two different tranches of activity. And I wasn't sure which one you're referring to. But let me cover both, we had a business that was involved in structuring transaction. In other worlds, we bought securities, we pull them and we looked to move them off to other holders. That is the business we refer to as the long or unhedged position and so effectively think of that is getting our pipeline jammed up as market deteriorated.

A second category of investment was what we might refer to as intermediation, where we planned to have those on the balance sheet. And create a low risk portfolio of positive spread income. So you've got some of each in the inventory.

John Aiken - Dundee Securities

Okay. Thanks Brian. And is there... can you give us a sense of what the vintages on the underlying CDOs?

Tom Woods - Senior Executive Vice-President and Chief Financial Officer

Yes, there are variety of vintages 06, 02 would be the one that would be the highest. And I think those 06, 01 would be second is that right Jeff [ph], roughly? Is there is bit of 07, 01 in there. Tiny bit of 07, 01 and not much 05?

Unidentified Company Representative

05 and 07 about the same...

Unidentified Company Representative

About the same...

Tom Woods - Senior Executive Vice-President and Chief Financial Officer

So, mainly 06, 02 and 06, 01 with a bit of 07 and a bit of 05.

John Aiken - Dundee Securities

Thanks and...

Brian Shaw - Chairman and Chief Executive Officer, CIBC World Markets

Maybe I can just jump back in its Brian Shaw. I missed part of your question, I think, when you had... you had asked it also when you asked, you had asked it also in the context of conduit. Not to confuse issues, none of the positions that we have on the balance sheet, whether in the structured category i.e. what we call unhedged or in the intermediation category has any particular reference to conduits, we did not put any products on our balance sheet that was otherwise destined to go in conduit. I think that was perhaps what you were asking.

John Aiken - Dundee Securities

Yes, thanks Mike. And just finally, Tom you had mentioned in your prepared comments that there was... you had taken some counterparty credits balance as at October 31. Can you let us know what the magnitude of that was?

Tom Woods - Senior Executive Vice-President and Chief Financial Officer

Yes, that is formulaically driven based on an internal rating system. For that single area, it's the formulaically driven number and it was under $20 million.

John Aiken - Dundee Securities

That's great. Thank you very much.

Operator

Thank you. Our next question is from Michael Goldberg with Desjardins Securities. Please go ahead.

Michael Goldberg - Desjardins Securities

Thank you. In view of the uncertainty regarding your exposure to the structured credits and your objective to build capital, would the prudent thing to do in terms of expectation be to not look for any dividend increase until this cloud has dissipated?

Gerald T. McCaughey - President and Chief Executive Officer

Michael, its Gerry here. First of all, I think that from a view point of capital, capital availability that the buyback is or for other capital investment activities has a far greater impact, and so that's the area wherein at least in the first quarter, I wanted to be very clear that we do not expect to resume the buyback. In the area of dividends, we have had very a clear policy in place around our dividend payout and the fact that we intend to payout 40% to 50% of our earnings. It's my view that subject to continuous review with the Board of Directors, as we always do, that policy is one that we are going to stick with. And I think that what we'll need to do is review the ongoing earnings profile as we proceed throughout 2008 to determine where we are in relation to the 40% to 50% payout ratio.

If as the year progresses, we feel we are on reasonably solid ground in terms of needing to adjusted our dividend upwards to achieve our 40% to 50%, then I think that we would look very seriously at that because the 40% to 50% payout ratio is intended to be in relation to what we view as our sustainable earnings and our earnings over the longer term. In addition to that, the differential from a dividend increase in the period of time that we are looking at would not have a major impact on our capital cushion. So I think that it's fair to say that in the near term, the share buyback is something that is improbable. I think that you should look at our dividend exactly the way we have talked about for the last two years and we will review for increases against our targets that we had stated.

Michael Goldberg - Desjardins Securities

Okay. And I have one another going back to slide 52. The mark on the AAA is 61% of notional and its 51% on the A, why such a small deference?

Tom Woods - Senior Executive Vice-President and Chief Financial Officer

Michael, it's Tom. Keep in mind, these marks are on the underlying not a reflection of the quality of the counterparty. So they... what it tells you is the underlying positions of the CDO of CDMA/RMBS [ph] on the 14 reference assets in row one are slightly better quality than the CDMA/RMBS supported by the A.

Michael Goldberg - Desjardins Securities

Okay. And one more, you sad that you would be... Gerry, you sad that you would be reviewing world markets for other areas where return might not compensate for risk. Could you give us some idea of what areas within world markets you are concerned that there isn't the appropriate risk return balance?

Gerald T. McCaughey - President and Chief Executive Officer

Well, our structured credit business that Brian Shaw is currently managing directly is an area of primary focus, the entire structured credit business. And on an ongoing basis, we recently did make some changes internally in terms of our overall debt capital markets business and the management that has been put in place is working closely with Brian Shaw to review the businesses overall within that capital market at this time to make sure that we have the right configuration from the viewpoint of capital deployment and capital return. I think it would be a good idea that Brian would expand on this a bit because he is participating and leading these reviews. Brian?

Brian Shaw - Chairman and Chief Executive Officer, CIBC World Markets

Maybe I'll just add a couple of comments. I think it would be worthwhile stating that given all circumstances including market conditions, we have been fairly, actively undergoing a bit of a reorganization of the senior leadership team at world markets. In the last period of time, we have appointed two new Deputy Chairman for World Markets; one to run our origination businesses and another to be a senior person in the trading room. Those two individuals and myself are also working together to table what I call a bit of a revised plan for our desk capital market group, which of course is the business unit in which structured credit resides. So there is that activity going on.

In addition, I think as reference we did change some of our leadership in the debt capital markets area and also in some of... in one of our businesses outside of Canada. So I think the net results of all of that is a fairly significantly revamped leadership team at world markets, which is now doing a number of sets of... creating a number of sets of output to ensure that all the businesses we have, we are comfortable with.

Gerald T. McCaughey - President and Chief Executive Officer

And Michael, its Gerry here. Another example of this would be the fact that we have recently announced our divestiture of our US investment banking business as well as our US cash equities and research business. And those businesses, we believe, were not giving us adequate return for the capital deployed and the risks that we would have to take to be in those businesses. And that's the type of review that it is ongoing.

I think it's very important to also emphasize that the purchase of this is to reinforce a very focused world markets on businesses that we have tremendous track record in and we've done very well, and I think when you think about our world markets business, it's important to think about the core... reinforcement of the core and other activities that may have gone up in a more peripheral of the areas that we would tend to examine. We have a very strong Canadian investment banking business, in our debt capital market business, our foreign exchange and fixed income businesses are strong and in the United States during a difficult period, our US real estate finance activities have performed extremely well over the course of the summer and into the fall, and have had a record of high profitability.

And we will continue to focus on those businesses and the purpose here is twofold. First and foremost to ensure that our risk management has the right focus, and that that focus is working well with the businesses. In order to that, we believe that we should focus on the other activities where we're strongest and other activities that are more peripheral or may have been gone up around the key businesses. If they are supportive of the businesses such as some of our overseas operations, then I think that that's important because they strengthen core activities. If on the other hand they have gone up as a result of opportunism in certain areas because we happen to be there, I think that requires closer scrutiny. Does that answer your question, Michael?

Michael Goldberg - Desjardins Securities

Yes, Thank you.

Operator

Thank you. Our next question is from Rob Sedran [ph] from National Bank Financial. Please go ahead.

Unidentified Analyst

Hi. Good afternoon. My question surrounds the end game on the CDO and RMBS issue and I guess I'm also going to focus on the hedged exposure. The hedge is I'm assuming have to do with underlying credit quality, but not necessarily the value of the CDOs and we talked a lot about counterparty risks. But if the market recovers and you could sell these securities, let's say $0.80 and $1, would you have to book $2 billion loss or is there some kind of benefit you would recognize on the hedge?

Tom Woods - Senior Executive Vice-President and Chief Financial Officer

Rob, it's Tom. I mean at the moment we are intermediaries between counterparties on either side. So at the moment we have positive mark-to-market on the exposures on the page with the counterparties. They in effect things stock right now would owe us that money and we in turn would owe the other side money. So we would not want to collapse either side because you'd be unhedged in respect of that. So the objective here would be to... in order to mitigate that counterparty risk attempt to work our positions down on both sides at prices that were... we felt were reasonable. So that's the challenge going forward and hopefully, it should match on either side.

Gerald T. McCaughey - President and Chief Executive Officer

Gerry here. I think also when one looks at this portfolio, we needed to consider the fact that the portfolio is something that has also been managed on an active basis. In my remarks I talked about some of the offset that we have engaged in and for example, we have been purchasing credit default swap from broad based, highly rated counterparties to our banks as an offset against extreme tail risk for our AAA exposure, our AAA counterparties that are hedging our exposure.

In the case of AA, we have full cash collateral arrangements and so we have the offset in hand. And in terms of the A that is the area that we have mentioned is more challenging, and we are working with that counterparty on the restructuring activity. But there is an active strategy in place that we believe will be successful in terms of mitigating the exposure in terms of our AAA and AA counterparties in terms of the A as we say it's an ongoing series of activities in terms of working with the counterparty.

Unidentified Analyst

That's helpful. Thank you.

Operator

Thank you. Our next question is from Andre Hardy from RBC Capital Market. Please go ahead.

Andre Hardy - RBC Capital Market

Thanks, two questions. One on slide 57, the fourth box, asset back commercial paper; how much of that $17.3 billion would be invested in structured finance assets and how much leverage in general would there be in those conduits? And my other question relates to your US real estate finance business. How much risk would you keep on that balance sheet in that business whether hedged or unhedged and what would keep the problems that are facing US residential real estate from spilling over into that business?

Gerald T. McCaughey - President and Chief Executive Officer

I'll answer the second question first. And then I will turn the first question over to Tom Woods. In our real estate finance business, first of all, this is in the commercial real estate area, it's not in the residential real estate area. In that business, we are involved in the origination of real estate loans and so our team works directly with the commercial real estate counterparty and does the underwriting. So the risk that one has seen come in through the structured credit business in subprime, which as a result to that fact that there are multiple counterparties involved in the chain of origination, that risk is not present in terms of our activities in the commercial real estate sector in the United States because we do the underwriting ourselves.

That's the first difference in terms of these businesses. Secondly, the asset class while it of course can come under cyclical pressure also has characteristics that are quite different from a loan underwriting view point than the residential sector was in the United States. Thirdly, our real estate team has managed through this cycle quite well, despite the turmoil of the summer. They cleared product in September. And any origination that has occurred since than has been a pace of the new market conditions and Brain Shaw will talk in a second about the activities that were engaged in today.

But the group managed through this period quite well. They did managed their inventory through the summer with hedges in the fashion that allowed them to pick up any spread widening, so that they could clear inventory in September. On an ongoing basis, the group proceeds with caution. Because of the fact that this is an area that when you are originating these loans, you are originating them at a level that doesn't have the... initially this AAA super senior element to it, and so it receives tremendous amount of scrutiny. And I think that that is something that has been very helpful here because the management of ongoing risk when it is perceived as part of the core activity, is something that I think allows for a wider margin established forever. Brian, why don't you talk a little more about that?

Brian Shaw - Chairman and Chief Executive Officer, CIBC World Markets

Just a couple of additional comments, so in that business we do both fixed rate and floating rate lending. One attribute of the business is that we've been fairly active in developing a hedged program for that business both in terms of interest rate, hedging and also spread hedging. So as you probably know, there has been quite a backup in CMBS spreads in the recent period. But our book is in good shape with respect to the hedging we've done. Another point would be that one of the problems in subprime residential is the whole way loan scheme to be initiated, which is obviously with the benefit of hindsight seemed to have not been perfect. Here, we take an approach of individually adjudicating each separate credit. So I think that gives us quite a high quality way to develop business. The credit adjudicating is all alone and it is on each individual asset, so I think that's a bit of a different approach then in the other space. And just lastly, it is fair to say that given the spread widening and the backup that we have seen, volumes have slowed so we are seeing loan originations flow and we are taking a cautious approach given some of the changes going on in that space.

Andre Hardy - RBC Capital Market

That's helpful, but can you clarify how much stays on your balance sheet once you securitize assets?

Brian Shaw - Chairman and Chief Executive Officer, CIBC World Markets

I guess I see the portfolios having three components; the bulk or the core component is fairly a short-term cycle to originating and distributing in that fixed rate mortgage product. So at this movement in time, we have a very modest portfolio of position that would be... I'll do a quick calculation in a moment. But a small number of single hundreds of millions of dollars. We have another component of our portfolio that's a little longer standing. But in aggregate it's certainly less than 1% of our asset base.

Andre Hardy - RBC Capital Market

And that's unhedged and is there an issue with hedged? Like there would have been in the residential loan?

Unidentified Company Representative

Now, that's the... I'm speaking there about the aggregate size of the portfolio and against that we have some interest rate hedges and some spread hedges.

Andre Hardy - RBC Capital Market

Okay. That's helpful, thank you. And on the asset back paper?

Tom Woods - Senior Executive Vice-President and Chief Financial Officer

Yes, Andre [ph] it's Tom. The way to think of this is, of the $17.3 billion in back stop liquidity facilities, $15.7 million of that is to CIBC's sponsored and structured debt facilities, those are conduit and those are the ones we've listed in the press releases. So, the other $1.6 million are to conduit that we have sponsored, but third parties have structured. Or we've given line to conduits that are structured and sponsored by third parties. Of that $1.6 billion, there's no real estate exposure as our understanding. And more... just as importantly two-thirds of that $1.6 billion are general market disruption facilities as opposed to global liquidity facilities.

Andre Hardy - RBC Capital Market

Okay. Thanks.

Operator

Thank you. Our next question is from Mario Mendonca from Genuity Capital. Please go ahead.

Mario Mendonca - Genuity Capital Markets

First just to clarify the response to Andre's [ph] question. The inventory of commercial mortgage-backed securities, Tom you'd say that that's less or Brian rather less than 1% of banks total assets on a gross exposure basis. Is that true?

Unidentified Company Representative

Mario say that again what are you looking --

Mario Mendonca - Genuity Capital Markets

Part of this is real estate finance business. The commercial mortgage-backed securities on the banks books now, anything... Brian you characterize that as been less than 1% of the banks total assets gross.

Brian Shaw - Chairman and Chief Executive Officer, CIBC World Markets

Yes its less than 1%.

Mario Mendonca - Genuity Capital Markets

Gross, okay. The... I had a question, I want to make sure I understand all this disclosure on page 52. It sounds to me that if the subprime market were not to deteriorate any further from where it was on October 31st, the exposure at this point would be... and if only that single A rated counter party would have failed, the exposure would have then be precisely the $1.7 billion the far right above table.

Brian Shaw - Chairman and Chief Executive Officer, CIBC World Markets

Yes that's correct based on the marks that we have today. Correct, as of October 31st.

Mario Mendonca - Genuity Capital Markets

And maybe you could just tell us how things probably deteriorate because November was a tough one

Brian Shaw - Chairman and Chief Executive Officer, CIBC World Markets

Yes and this is probably a good part for me to make a few comment on the challenges in marking and I know many of you perhaps all of you understand a lot of this. But as of November we haven't done mark as of November, but we have started on our unhedged book as I told you and things have clearly deteriorated there.

How much of that has influenced by the U.S. investment banks count there year end November 30th influencing the marks is hard to know. But, as I said in my presentation the imputive loss rates there are way above any prediction of what will actually transpire by extrapolating the trajectories of the delinquency. Hence that [ph] did try and answer your question that $1.7 million would be higher based on the close that we have. I want to emphasize, so that a number at a point in time, the ultimate losses would play it over a period in time. But to your question Mario, if this Company were to... for example be downgraded, or worst, we would have to base our P&L charge on the marks that we are looking at there. And, to the extent those marks proved to be pessimistic as things play out over times and any gains would be brought back through our P&L in the future.

Gerald T. McCaughey - President and Chief Executive Officer

Mario its Gerry here, the peak exposure would... on the real estate finance business in United States as per your previous question, would have been more in the range of 1%. But they did liquidate their... a large portion of their inventory in September as a result of their distribution activities. And so they would be well below that at this time. So, for example in the past they would originate their mortgages at the client level, build up to as much as $2 billion of mortgages maybe a little bit more, then those would be securitize to third parties not CIBC.

At this time they would be running because of what Brian talked about earlier on, much slower activity levels. They would probably be running at half that in terms of the level of originations that we are holding for a distribution down the road. And that is as a result of new origination that would occur to be distributed post our September deal that we did. So the levels are actually 1% I think would be higher than we would expect to be at this time.

Mario Mendonca - Genuity Capital Markets

And finally when you prefer to China eliminate some opportunistic businesses, the businesses that came above as you suggest opportunistically. The decision to write protection for some parties and then buy protection from others? Does that qualify as one of those businesses as you'd say really count out just for just opportunistic reasons?

Gerald T. McCaughey - President and Chief Executive Officer

I think you are talking about what Brian referred to as the intermediation business?

Mario Mendonca - Genuity Capital Markets

Right.

Gerald T. McCaughey - President and Chief Executive Officer

We are no longer going to be participating in those types of activities. We would, from time-to-time, its not that we would never do a transaction like that again because there is many derivative activities that take place that involves at times hedging your self with one counterparty and then possibly laying it off elsewhere later on. And so the fact is that, we do continue in the business of working with derivatives to hedge our activities in a time hedged client activities. But this business that Brian was talking about where its purpose was to intermediate or stand in the middle of two counterparty and build exposures and hold them on our books. We are not interested in continuing in those activities.

Mario Mendonca - Genuity Capital Markets

Thanks.

Operator

Our next question is from Ian De Verteuil from BMO Capital Market. Please go ahead.

Ian De Verteuil - BMO Capital Market

Thanks. So the intermediation business which gave rises to this $10 billion of positions, when were these positions put in place and what would you hope to see to have been CIBC's value added.

Brian Shaw - Chairman and Chief Executive Officer, CIBC World Markets

Ian this is Brian those positions would have been put in place in fairly recent time frame for the most part within the last 18 months. There may have been... and I don't have data right in front of me. A more modest portfolio prior to that time, but substantially in the period I described. And I guess on the second part of your question, I guess it's a... an age old view in financial market that one of the things you need to do to be successful is get yourself inserted into the information flow and the client interaction gain to a sufficient extent that you then see opportunities that come from that.

Whether it be the equity business or the debt flow business and I would say the credit gain... where the credit business is really not much different. So the value add or perhaps the motivations the best way say is... was to have sufficient volume of the activity that has allowed us to do things, have client relationships thereby get information and create a broader based business.

I think as Jerry eluded to earlier it did not get to the point where it was ever a very meaningful bottom-line contributor and therefore ending up in this circumstance is something that is not something that we has management obviously reflect on is not being something we set out to achieve. But nonetheless this is where we are at. So I think the way to think about it is a way to create efficient levels of interaction in the market place to drive the business forward on the few different fronts.

Ian De Verteuil - BMO Capital Market

The second question is, it looks 35% of your insurance which is just from the lowest retail insurer, why would you have done that, why... okay I think ECA has a total, looks as if you are almost 10% of all their counter party exposure. Why would the bank have chosen to go with that line as opposed to somebody that was much higher rated?

Brian Shaw - Chairman and Chief Executive Officer, CIBC World Markets

Well I guess I would say a version of what Gerry said earlier. We set out to create what we thought as the time was a low risk, positive spread intermediation portfolio. We were looking for opportunity, the particular counter party in question happened to have a business plan that had been active in the very space that were in, and I think as Jerry suggested or as I'll suggest now, a combination of having today a very concentrated single A rated counter party and a very stressed market even though our primary objective was roughing our protecting triple A portfolio is not one we feel very comfortable with today.

In the final analysis the, I think I talked a little bit about how we got there, I guess with benefit of hindsight, we have underestimated or we overestimated the expense value of the diversification we thought we had. And we underestimated the severity of the security performance and the counter party performance in a stressed market. That's basically what it comes down to.

Ian De Verteuil - BMO Capital Market

I guess want to pick up on a point you've made on being in the flow and having information on this. I mean I'd love to hear Jerry's response to this. I mean it certainly seems that if a number of people knew you had $10 billion worth of gross exposure and relatively large exposure to a relatively lowly rated counter party. Gerry, how do you think about that?

Gerald T. McCaughey - President and Chief Executive Officer

Ian, if could just repeat the question I just wandered.

Ian De Verteuil - BMO Capital Market

It certainly seems as if some people knew you had $10 billion worth of growth exposure with fairly high concentration towards lower rated counter parties in this current situation. And I am just sort of wondering how do you perceive that?

Unidentified Company Representative

Do I perceive that people seemed like you're saying that people knew about it, do I, I am not sure the direct question, Ian.

Ian De Verteuil - BMO Capital Market

May be I will go on then.

Gerald T. McCaughey - President and Chief Executive Officer

I mean I can take a stab at it, but I mean you can just if you were little more direct I could be sure I answered it. But while you're thinking about that I will take a shot at what I think the question was. The situation awareness around our counter party risk picked up steam after the A rated counter party was put on watch by the rating agencies, and I think that what took place at the time was that the activity levels picked up a fair bit in the market place in terms of discussions amongst a variety of people in the market place about what the implications of that might be, as well what the potential workout might be on a recapitalization basis, because the activity level in terms of people speculating on this insofar as we could see from... and you're never certain because are looking at your stock price movement and you're picking up things from analyst comments.

But all of that seemed to pick up a fair bit of steam after that counter party was put on watch, and we think that's when the focus in the market place shifted in that area. Also, we had been fairly clear that the exposure that we have that we'd been talking about was our unhedged exposure and then at a certain point of time when that counter party went on watch, people looked at our decorations where we had been clear that we were not yet talking about our hedged exposure and we didn't have a reason to, once it went on watch I think people started to focus on that more so than they had in the past. So if you're asking why the pickup in interest on the part of the market place, I think it was related to the counter party going on watch. Did that answer your question?

Ian De Verteuil - BMO Capital Market

I think so, but it's I think we are all aware the counter party was on watch but the counter party the thing is about 7% or 8% of all counter party exposure in this space but it ended up being 35% of your exposure. I guess my next question is that how I mean do you feel the bank needs to add talent in the risk management area?

Gerald T. McCaughey - President and Chief Executive Officer

Well the first of all from a risk management viewpoint I think we need to not be in certain businesses and this one of them as I've stated earlier on. That's the first thing. The value adds for the risk taken doesn't fit our criteria in terms of long-term returns with lack of volatility. The second thing is that I think that it's important for me to talk about the fact that when one was looking at this during the period of time when you had the wrapping process going on, the perception would have been that you had diversification in terms of the underlying assets that were being hedged by the counter party. Today, sub prime real estate has reacted with a very high collation across all geographies and across all of these securities.

At the time, the perception would have been that these were super senior triple A securities and I know today that sounds very hollow looking at the marks on this. But these were securities that the structuring was intended to give diversification across large geographies and mitigation around the potential for a highly, high co-relation across the full suite of securities. So there was a perception, there was diversification among the securities which would have diminished the concern around this single A rated counter party having such a large exposure.

Under risk management systems, classic risk management systems, the credit risk equivalents that these securities would throw off would be reasonably small, and would map to the capacity of a single A rated counter party - which, at the time people thought of as being investment grade and well into the area of investment grade by all the standards that existed from a coverage viewpoint at that time.

That leads me to your second part of your question. When one can look at all of those mechanical indicators and say that all of those boxes would be checked off, and yet you find yourself in a situation that subsequently is unacceptable, I think there are two things that you do: you look at the business that you were in and you will ask whether or not the returns or worth it, and we've said the answer is no; and you also look at the risk management practices that got you there and to your question, I think that we do need to be stronger in that area and we are looking at that.

Ian De Verteuil - BMO Capital Market

Because it does seem to me that as you say you've checked off all the boxes, things according to your systems that will work, but it's almost as if because of the extensive turnover in the risk management area, you know there weren't enough people that can smell where these things can come out and it does, you know, it is something I wonder why, you know you have done a great job in controlling cost and getting the organization tighter. But I wonder whether one of the implications... one of the side effects of that has been a thinner risk management that the bank really needs. Anyway, that's just for smooth, Gerry.

Gerald T. McCaughey - President and Chief Executive Officer

I have to emphasize that when I speak about risk management, I am not speaking specifically about only the formal risk management staff function. I am talking about risk management across all areas of CIBC that would have been associated with these activities. The first thing that I think is extremely important to remember is that all activities start with the ticket being written. And therefore, I think that the risk management and thought process that takes place at the origination level in this case is important. I think in addition to that, there are elements of the classic risk management systems that in this particular case throw off results that can lead to large variances that you have noted and I think therefore that in a world that's rapidly evolving, I think that the classic risk management algorithms that are used, need to have further checks put into them.

And then of course I think that one can always decide whether or not more resources would make a difference, and that's something that we would also look at. But I believe that first and foremost, we have to decide about the businesses that we are in and whether or not, the risk profile fits CIBC and whether or not the returns... the type of returns that our shareholders are interested in. Once we have decided that as I said first and foremost, I believe that the responsibility for risk starts when you originate and write the ticket, and we have to make sure that we that right. We also need to make sure that all of our algorithms for the risk management system are correctly calibrated for the risk in the environment. And I think it's a changing environment. So we either have to be excellent or not in those businesses.

And thirdly, one should always look at whether or not starting levels are adequate. I do want to emphasize however, that I think that there are some elements of this business, that is... it's a business question first and above whether or not you want to be in them, as I said in my earlier remarks, CIBC has tended to go where the large international banks and money center banks have been, in terms of some of our activities.

We are now having an experience that is more similar to those types of competitors, in terms of our loss experience. And I think that historically, we have tended to participate in those marketplaces and I think we have to be more circumspect then we have in the past. So I think this is more a business question than a risk management question. But we are reviewing our risk management practices.

Operator

Thank you. Our next question is from Darko Mihelic from CIBC World Markets. Please go ahead.

Darko Mihelic - CIBC World Markets

Hi, good afternoon. I have a couple of clarification points and then a few questions as well. The first point of clarification is Gerry you mentioned that you have cash collateral with the AA. It might... it didn't sound like you included the single A exposure, so the first question is that. Do you have any cash collateral that's already been posted by ACA. Second question point of clarification again, you mentioned that it maybe a slow sort of drip of losses over time. And I guess my question from that standpoint would be, if you had lent money to ACA, wouldn't you have classified the loan as impaired already and taken a large provision. And why wouldn't that be the case with the counterparty risk? Third question along those lines is you mentioned that it maybe recapitalized, it almost sounded though as you are leaning towards CIBC playing in the recapitalization. Would that be true? In other words would you be willing to be a participant in the bailout to save the counterparty? And then I guess the fourth question is it sounds like you want to reduce your risk exposure even to the AAA and the AA. How much are you are willing to loose in that endeavor? And then my last question is with respect to Basel II coming into play. What will be the estimated impact on your capital ratios? Thank you.

Gerald T. McCaughey - President and Chief Executive Officer

So the first question I am going to turn over to Tom in a minute. It's around your... it's with the loan and impairment and Tom will talk to you about that fact that if this is... if they are down rated, there will be an evaluation adjustment, which I think would come, would match your view of its acting like an impaired loan. So Tom will answer that one in a minute. But I will take the recapitalization question and whether or not, we would participate in that first... whether or not we would participate in that. We are not actually at that stage. The counterparty that we are working with, has not up until now, made a request of capital. And in fact has indicated that they feel that their capital position is something that is adequate, although I think that these matters are being updated, as the rating agencies are rolling out their new models in turns of testing the various financial guarantors in the marketplace.

So we have not had a request in that area. If we did, it is something that we would consider. We have to consider it versus the other alternative and we would have to consider it also in terms of its investment merit. The third question that you had, I think, was around the AAA and AA. And I have to say that first of all in terms of the AA, we have no particular reason to take any form of loss there. There is no value add from at least, perceptually from a risk diminution view point because full cash collateral is exactly that. You are fully secured against the collateral that you have in hand.

And in terms of AAAs at this time, what we have been doing is buying credit default swaps against the broad portfolio of counterparties that we have as a form of insurance against extreme tail risk. We, in fact, think that the purchase of the credit default swap, the $420 million that I mentioned, we in fact think that will be something that there maybe more opportunity and as time goes by. Credit spreads in those areas have actually been tightening in, in the last week or 10 days. And in that scenario, that we could see adding to our credit default swaps that we've purchased against those AAA counterparties, which as they say, is just a matter of insuring against extreme tail risk in that area. Our view is that we would participate in a limited fashion if these are too expensive because we really do think its remote tail risk. But if the prices came in because of spreads tightening, we might purchase more and again it's just against the potential for extreme tail risk. So I will turn it over to Tom for the impairment question and then I just want to check we have answered all of your questions. Tom?

Tom Woods - Senior Executive Vice-President and Chief Financial Officer

Yes, Darko on the impairment question. We would treat this A rated financial guarantor the same as any other counterparty in any of our derivative contracts. As at October 31st, this is a company whose rating agency actually went public and said that no company in that state was in danger of being put on credit watch. Now that changed about 9 or 10 days later. Certainly with a downgrade and I think I covered this in my presentation, we would take a counterparty credit reserve. If your question is, let's say they don't get downgraded for a period of time through Q1, but they would still... they were still on credit watch and there was still some doubt, would we take a counterparty credit reserve? I don't want to prejudge where we'd be at the end of January. But I would say that the odds about taking something of this uncertainty continued would be pretty high, nowhere near the magnitude of that mark-to-market loss, but we would treat it just the same way we treat any other counterparty, and if there was any doubt on collectability, we'd have to take impairments.

Darko Mihelic - CIBC World Markets

Okay. Thank you. And I guess my other question was Basel II. It had any estimation of the impact on capital. And while I am still on the horn, just another question, do you have any subprime auto exposures we should be worried about?

Gerald T. McCaughey - President and Chief Executive Officer

Okay. The Basel II question, we've got a very good idea what our 9.7 Q4 Basel I, Tier 1 ratio maps too. We and the other banks are all on the same position, however, I'm not disclosing that until we have final regulatory approval by... towards the end of the month. But it's... I would say it's meaningful and it reflects the fact that we have got a large book of mortgages, Canadian mortgages, low risk mortgages in Canada. We have got a corporate loan book that is quite low risk, so be worth today. The capital is the same for any risk graded corporate loan, when you overlay the low risk corporate loan portfolio we have today on that. Those two benefits more than offset the new operational risk capital charges.

Darko Mihelic - CIBC World Markets

Great. Thank you. And subprime auto, any exposure there?

Unidentified Company Representative

Thank you, if you question on US subprime auto, given the increasing concern for that sector is also the border [ph].

Darko Mihelic - CIBC World Markets

Yes.

Unidentified Company Representative

I am not aware of any. I don't believe we have any.

Darko Mihelic - CIBC World Markets

Okay, great. Thank you.

Operator

Thank you. Our next question is from Sumit Malhotra from Merrill Lynch. Please go ahead.

Sumit Malhotra - Merrill Lynch

Hi, Tom, I just wanted to follow up on the process when it comes to a downgrade for some of your counterparties. You mentioned, I think it was formulaic for the A rated exposure. I believe you said it was $20 million that you had setup as a reserve. You don't sound quite as concerned about the AAA ones, but what's the process there in terms timing? Does a downgrade automatically trigger CIBC having to establish one of these adjustments in terms of the counterparty credit reserve? Can you give us a little bit more color on how that works because you described it as formulaic, but some more detail on that regard would be helpful?

Gerald T. McCaughey - President and Chief Executive Officer

Well, yes, Sumit. When we have, as part of our risk management governance processes, I mean I call it formulaic it's... there is a very specific policy that quantifies the percentage counterparty credit reserve that's required that maps to our internal risk grading processes, which generally are the same or very similar to the public rating agencies. So we have a risk rating on this company today. I have to say though that given the magnitude of this mark-to-market exposure and how it's grown and while this is always an overlay, I would say here, we would not rely solely on the formulaically driven percentage mark-to-market. So it's really a two-step process. You look at what your formulae tell you and then you overlay your judgment in terms of how things might play out. Any to be very frank, in the extreme case that this company were to file, we would take the entire mark-to-market because that would be the only metric we would have to assess the exposure.

Sumit Malhotra - Merrill Lynch

And just to be clear, so right now the only amount that has had any kind of P&L impact is, did you say $20 million?

Gerald T. McCaughey - President and Chief Executive Officer

I think it's about $17 million is the formula driven number as of October 31, which as I said, given what's happened since then, is obviously not efficient but that's the decision we make at the end of January.

Sumit Malhotra - Merrill Lynch

Okay and nothing yet for the AAA and AA exposures?

Gerald T. McCaughey - President and Chief Executive Officer

Yes, there are tiny amounts. Again, those are formulaically driven, but I would say the same situation would occur there. Again, given the magnitude of the mark-to-market positions, we would assess those numbers and decide whether increases would be required but those would be much small in magnitude.

Sumit Malhotra - Merrill Lynch

Okay. And lastly Tom on the ABCP on slide 57, you talk about a $61 million valuation adjustment for the third party. I didn't see that if you flag that hit the... it sounds like it hit the P&L this quarter, this is, I think the new disclosure you given us today. Just wanted to confirm that was one of the items that came through this quarter and a little bit of color on the $3.1 billion of CIBC's sponsored paper that you are holding. What's the nature of the market in terms of the CIBC's sponsored paper. How comfortable are you with that?

Tom Woods - Senior Executive Vice-President and Chief Financial Officer

Yes, Sumit, the $61 million or $59 million here, $18 million of that was through P&L. The other $41 million was through OCI or the consolidated income on the balance sheet because of that 358, we are 326 is available for sale accounting treatment. So any mark is through the P&L... is through OCI until divested. And then the remaining 32 is for trading, so that's the $18 million. And that represents about 17% mark, based on the face of 358. But all the 18 went through the P&L. The $3.1 billion number was the amount that we held on our books of the CIBCs sponsored ABCP as of October 31, and even as of October 31, that market was still a bit unsettled, and security and for any paper and any day that didn't role and the market knew that as the support mechanism to that. Today that number is in and around 1 billion... $1.4 billion and it's a much settled market, I am talking about the bank sponsored ABCP.

Sumit Malhotra - Merrill Lynch

Okay. Thanks very much.

Operator

Thank you. Our next question is from Shannon Cowherd from Citigroup.

Shannon Cowherd - Citigroup

Hi, Sonia mentioned an increase on maintenance budget at the branches and even add to that these pediatricians [ph] you're paying for. How does that bode with the cost control initiative that you're [ph] establishing, the benchmark below the Q4 '06 number? And will you quantify what the new benchmark will be?

Sonia A. Baxendale - Senior Executive Vice President CIBC Retail Markets

Well, that... this is Sonia here. The expenses that I was commenting on throughout my comments both the upgrades to our branch network, as well as increased advertising, marketing, etcetera, all of those costs are built into the total number that Tom has shown to you and has been our part our expense base throughout this year. So they've been fully recognized. So they are within that the expense guidelines and the productivity target that were identified.

Shannon Cowherd - Citigroup

So the target was what, $1.8 billion, that's why you were kind of benchmarking yourself to? That's still the same benchmark?

Tom Woods - Senior Executive Vice-President and Chief Financial Officer

Say it again Shannon, sorry.

Shannon Cowherd - Citigroup

The Q4 '06 number that we were to look at was $1.8 billion. Is that correct?

Tom Woods - Senior Executive Vice-President and Chief Financial Officer

$1.8 billion to $2 billion.

Shannon Cowherd - Citigroup

And then so what's the new number? Did you put that in the packet and I missed it?

Tom Woods - Senior Executive Vice-President and Chief Financial Officer

No. What we have committed is for fiscal 2008 to stick to that target in our expenses. Now the two adjustments we're making just to be sure it's apples-to-apples back in Q4 '06, we were equity accounting our 44% interest in FirstCaribbean, so there was no expenses coming through on that line. Now of course we are consolidating, so we're bearing those expenses. So we going to take out those expenses when we compare back to the 18.92 [ph].

Secondly, as we are about to divest some of our US businesses, those costs will go away. We're not going to give ourselves the benefit of that. We are going to take those out as well and continue to report apples-to-apples with that 18.92, and today the number for Q1 was under $1.8 billion.

As we know... as we said before that there is a lot of puts and takes to your currency is actually helping us now, but that will be less of an issue once we divest the business, the brokerage commissions. I mean you want a good equity market and hence pay higher brokerage commissions; but nonetheless we found it helped to discipline if you set a target and work towards that.

John Ferren - Vice President, Investor Relations

It's John Ferren here. Operator, we are going to take one more question. I hope everyone appreciates. We've run along a little longer today, so we'll take one more question but please do follow-up with us more later on.

Operator

Thank you. Our last question is from Jim Bantis from Credit Suisse. Please go ahead.

James Bantis - Credit Suisse

Hi, thanks. When I think of CIBC's prospects for 2008 going forward, obviously a lot of discussion regarding the potential write-down, but also looking at the earnings power the retail bank is a key component of it. And when I look at the revenue momentum on the retail side if I back out the Visa gain and make adjustments for FirstCaribbean on a year-over-year basis for the full year, you've got less than 3% growth and when I look at the quarter, it's less than 2% revenue growth. And I just wanted to see if you can talk about what the core revenue run rate is and what the potential offering leverage is for 2008?

Sonia A. Baxendale - Senior Executive Vice President CIBC Retail Markets

Sonia here. Let me start and Tom may want to add. Overall, in terms of our revenue growth in retail market as we've talked about before, it has been negatively impacted by our unsecured lending business and the decline in that business as a result of us addressing legacy risk issues and so over the past two years, that has been a shrinking business as we talked about previously. Our focus now is on growing that portfolio from a smaller, higher quality foundation based on loans, so we would expect to see some reasonable improvement in that area throughout 2008.

James Bantis - Credit Suisse

And then maybe the last question is Tom when I look at the EPS growth target 5% to 10% per annum, not to be cute here but what would your base EPS number be for 2007?

Tom Woods - Senior Executive Vice-President and Chief Financial Officer

We have reported what we are calling adjustments and I believe the number for '07 was around $8.90, $8.88, so that's the base, but I want to stress Jim, and I suspect you know that that 5% to 10% is the medium term objective. We grew over 20% in 2007, so that's not single year guidance but that reflects what we think we can do or perhaps even exceed over the medium term.

Gerald T. McCaughey - President and Chief Executive Officer

Okay. I think we have done everyone. We've got another event we've got to go to. I know there is still a couple of you on the line. Feel free to give John Ferren or myself a call afterwards, and they will try to answer any questions. Thanks very much everybody.

Operator

Thank you. The conference is now ended. Please disconnect your lines at this time. Thank you for your participation and have a nice day.

Copyright policy: All transcripts on this site are copyright Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

Source: Canadian Imperial Bank of Commerce F4Q07 (Qtr End 10/31/07) Earnings Call Transcript
This Transcript
All Transcripts