DBRS Confirms Canadian Imperial Bank of Commerce at AA; Trend Remains Negative

DBRS Limited (DBRS) has today confirmed the ratings of Canadian Imperial Bank of Commerce (CIBC or the Bank) and its related entities, including CIBC’s Issuer Rating at AA, Deposits & Senior Debt rating at AA and Short-Term Instruments rating at R-1 (high). CIBC’s long-term Deposits & Senior Debt rating of AA is composed of an intrinsic assessment (IA) of AA (low) and a support assessment of SA2, reflecting the expectation of timely, systemic support from the Government of Canada (rated AAA with a Stable trend by DBRS). The SA2 designation results in a one-notch benefit to the Deposits & Senior Debt rating. The trend on the senior long-term debt, short-term instruments and older-style subordinated debt remains Negative, while other capital instruments whose ratings are notched down from the Bank’s IA continue to have Stable trends.

The maintenance of the Negative trend reflects DBRS’s view that ongoing changes in Canadian legislation and regulation indicate that the potential for timely support for systemically important institutions is declining, leading to a likely change in DBRS’s support assessment to SA3 from SA2. The legislation enacting the bank recapitalization, or bail-in, regime is moving forward, but DBRS does not yet have sufficient clarity on the details of the implementation to remove the benefit of systemic support from the affected ratings.

Supporting the Bank’s IA of AA (low), DBRS recognizes CIBC’s strong and resilient profitability, its broad footprint across Canada and its strong market position in domestic wealth management and capital markets. The Bank’s ratings are further supported by its conservative risk profile, diverse funding mix, strong liquidity and well-capitalized balance sheet. The ratings also consider the Bank’s increasing exposure to the highly indebted Canadian consumer as well as to residential mortgages in the Greater Toronto Area (GTA), which has seen rapid sustained price appreciation over the past several years. While these mortgages appear to be conservatively underwritten, DBRS remains concerned that CIBC is increasing its exposure to this sector while other peers are pulling back at this point in the cycle.

The ability of CIBC to consistently generate strong and resilient earnings underpins the Bank’s ratings. Even excluding some non-core gains, the Bank reported the highest return on average common equity (as calculated by DBRS) in its peer group for both 1Q17 and YE2016. Moreover, CIBC’s returns on both equity and assets have been consistently high relative to its peers over the past five years. For 1Q17, the Bank’s return on average common equity and return on average assets were 25.2% and 1.06%, respectively. All business segments also reported increased earnings year over year (YoY). For 1Q17, overall net income totalled $1.4 billion, compared to $0.98 billion for 1Q16, a 43% increase. Adjusting for non-core items, including a $245 million after-tax gain on sale and lease back of certain retail properties as well as a $4 million (after-tax) amortization of intangible assets, 1Q17 net income still grew by a solid 13% YoY.

The Bank’s sound risk profile is dominated by credit risk, which accounted for 83% of regulatory risk-weighted assets as of January 31, 2017. Positively, CIBC’s overall asset quality remains strong, with impaired loans and provisions remaining at very low levels, despite elevated losses in the oil and gas portfolio.

CIBC’s residential mortgage book has doubled to $186 billion at the end of 1Q17 from $93.5 billion at YE2010, outpacing the growth rate of most peers. DBRS views this with concern, given the unsustainable growth in house prices in selected markets, especially the GTA where any severe price correction would adversely impact the Bank’s profitability. Nonetheless, as of 1Q17, credit quality metrics in these mortgages appears to be strong with 76% having a Beacon score of over 700. Moreover, 51% of the Canadian residential mortgage portfolio is insured, with the uninsured portion having an average loan-to-value (LTV) ratio of 64%.

While the Bank’s outstanding exposure to the energy sector is manageable, loan losses could amplify if energy prices again turn lower or if peripheral effects from the oil and gas downturn start to affect retail consumers in Alberta and Saskatchewan. Positively, however, oil and gas loans only comprise 1.8% of total loans and mining represents less than 1%.

CIBC maintains a strong funding and liquidity profile underpinned by its robust client-sourced deposit base, which is further supplemented by a wide range of wholesale funding options. Although the Bank relies relatively more on wholesale funding than its peers, DBRS views the level of utilization to be satisfactory. Meanwhile, the Bank’s liquidity coverage ratio of 119% for 1Q17, was safely above the 100% regulatory minimum.

Capitalization at CIBC remains solid, although going forward internal capital generation may face additional challenges, as a result of low interest rates and the potential for rising provisioning requirements. Although, CIBC currently has the highest Common Equity Tier 1 (CET1) ratio in its peer group at 11.9%, this ratio is expected to drop by 150 basis points to 170 basis points to slightly above 10%, once the pending acquisition of U.S. banking company PrivateBancorp closes. Moreover, management is committed to rebuilding CET1 toward the 10.5% range.

RATING DRIVERS
An elevated risk appetite or a material increase in the growth of capital markets business could negatively affect the rating. Moreover, a severe downturn in the real estate market which would lead to a sustained deterioration in asset quality, could pressure the ratings. Lastly, if systemic support is removed, CIBC’s long-term ratings would likely be downgraded.

While positive rating pressure is unlikely given the Negative trend, on an intrinsic basis, successfully executing the client-centric strategy and growing market share in both Canada and the United States, while maintaining strong underwriting standards would be viewed favourably.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating
Organizations are hereby incorporated by reference and can be found on the issuer page at
www.dbrs.com.

The applicable methodologies are the Global Methodology for Rating Banks and Banking Organisations (July 2016), Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2017) and DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2017), which can be found on our website under Methodologies.

The primary sources of information used for this rating include company documents and SNL Financial LC. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

Lead Analyst: Peter Stavropoulos
Rating Committee Chair: Michael Driscoll