CIBC Deal Suggests Lack of Confindence

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Cerberus Capital Management’s $1.05-billion investment in CIBC’s residential real estate portfolio comes in exchange for a capped return of approximately 20%. It appears that CIBC will retain any upside if the assets rise in value above that level.

Collateral supporting the notes Cerberus will receive include most of CIBC’s U.S. subprime residential mortgage-backed securities and collateralized debt obligation investments, which have a notional value estimated at C$6-billion and a current fair value of C$1.136-billion, according to Blackmont Capital analyst Brad Smith.

Mr. Smith told clients:

The announced transaction with Cerberus effectively provides a second layer of fully funded insurance against further losses on the remaining subprime-related asset exposure.

Potential related future losses are reduced by C$1.70 per share, while the 20% return should cut CIBC’s future earnings by C$0.30 per share annually until the notes are repaid, the analyst added.

RBC Capital Markets analyst Andre-Philippe Hardy agreed that the negative EPS impact would be around C$0.30 in the first year, but said this should fall as the notes get amortized.

While both analysts viewed the deal as positive, they noted that areas of risk remain for CIBC. These include C$2.9-billion in fair value of hedges with financial guarantors, C$22.2-billion in structured finance exposures mostly linked to corporate debt and collateralized loan obligations, and another C$2.2-billion in other unhedged holdings of structured credit. CIBC’s non-residential credit exposure, given its relative size to the bank’s C$11.6-billion Tier One capital base, also remains a concern.

CIBC’s conclusion that the additional insurance the Cerberus transaction provides was desirable suggests that management has lost confidence in the ability of its monoline insurance coverage to pay claims, Mr. Smith said.

Adding that despite the bank’s discount valuation, its risk profile is too high to recommend it, Mr. Smith said:

This in turn is consistent with market perceptions as reflected in the elevated level of CDS swaps spreads accorded most monoline debt obligations.

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