Tuesday, December 18, 2007

CIBC stock overhung by capital infusion concerns

(G&M Streetwise) Two of the world’s biggest banks - Citigroup and UBS - have shored up battered balance sheets with massive capital infusions in recent weeks.

The talk in markets these days is whether CIBC will end up going the same route.

Like the two global banks, CIBC faces a world of pain over its U.S. credit exposure. The problem is compounded by the fact that no one knows just how bad the losses will be on an $11.4-billion (U.S.) portfolio.

Uncertainty over the potential hit, and how the damage will get fixed, now dogs CIBC’s stock. After peaking at $107 this summer, the share price touched 52-week lows of $72 Tuesday. That’s a thin eight times the bank’s projected earnings; Canadian banks typically command a premium of 12 times next year’s forecast profit.

Clearly, the market is expecting CIBC to spill serious amounts of red ink, perhaps enough to force the bank into issuing capital. UBS faced similar issues and got a $11.5-billion bailout from a Singapore fund an another unnamed guardian angel, Citigroup got a $7.7-billion lifeline out of Abu Dhabi.

In the absence of news from the bank, institutions and analysts are busying modelling what they see as best and worst-case scenarios at CIBC, with an emphasis on the worst. Such calculations rope in the possible failure of U.S. bond insurers that are counter-parties to CIBC's hedged positions. It’s not hard to build scenarios that see CIBC write off something in the $4-billion to $5-billion range, and needing an infusion of $1.6-billion to $2-billion to bandage the boo-boo.

In simple terms, there are two issues facing the CIBC board and chief executive officer Gerry McCaughey: When do they deal with the credit losses and, once they decide to move, what is the best way to tap investors? Obviously, UBS and Citigroup chose to move now, on the theory that credit markets are likely to get worse in the new year. And they tapped into deep-pocketed investors.

It’s also not hard to imagine a strategic investor or a sovereign fund or even a wealthy individual stepping up to backstop CIBC. Look at the success Hong Kong billionaire Li Ka-Shing enjoyed when he stepped up as a major investor in the bank - he made $1-billion on that pass. There were rumours Tuesday that a rival Canadian financial institution was prepared to buy a 10-per-cent stake in the bank for $70 a share.

After all, the bank’s considerable earnings power is intact. It’s just the CIBC balance sheet that, once again, needs work.

Obviously, selling equity is far from CIBC’s only option if it does decide to retrench. There are ways to raise cash by securitizing loan portfolios. Assets such as a stake in custodial firm CIBC Mellon could be unloaded, as could newly acquired FirstCaribbean International Bank.

But none of these capital-raising options count as good news for shareholders. Investors are going to assume the worst - massive losses and painful dilution - until we know the full extent of CIBC’s problems, and the cure for its ills.

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