Genuity Research imagines another $2B writedown for CIBC

It goes to show you how well capitalized the Canadian banks are, when CIBC (CM:TSX) could (down the road) write off another $3.7 billion, and still have sufficient Tier 1 capital according to a research note put out this morning by Genuity Capital Markets. This assumes, of course, that credit spreads widen in the coming six weeks (the bank’s fiscal year end is October 31st, which would be a key mark-to-market valuation day for CIBC’s auditors):

CM held an investor day in Toronto that included a discussion of the two business lines, as well as risk management and financial targets. Regarding retail markets, the bank articulated a growth strategy heavily leveraged to opening more branches and extending hours. In this respect, the bank’s strategy is very much the same as its peers, and in our view is designed to maintain market share rather than take market share from its peers.

Regarding the exposure to Lehman Brothers (LEH-Z: US$0.21, Not Rated), management indicated that as of Friday the bank has $25 million in exposure, net of collateral and netting agreements with LEH. Although credit spreads have increased significantly since Friday, management suggested that the exposure should not increase significantly from the $25 million disclosed. The challenge now for CM (indeed for all LEH counterparties) is to replace LEH with a different counterparty. The cost to replace the counterparty depends on how CM is positioned in the trade (i.e., short or long credit) and, at this juncture, this cannot be ascertained.

A spike in credit spreads for leverage loans, CMBX and other products, as well as spike in mono-line CDS spreads, could easily drive another $2.0 billion in charges for CM. We estimate, however, that the bank could absorb $3.7 billion in pretax charges in Q4/08 alone and emerge with a Tier 1 ratio of 9.0% or greater.

We do not believe that the jump in credit spreads will result in CM taking subprime and non-subprime charges sufficient to significantly damage the bank’s capital strength. Additionally, at an 18% discount to the group, CM’s valuation is attractive. However, we continue to believe that the Street’s perception of CM as the bank most exposed to the deterioration in U.S. structured credit products will weigh on performance in the near-term. Accordingly, with AIG struggling to regain its footing and structured product credit spreads remaining very volatile, we are not comfortable rating CM anything higher than a HOLD.

MRM