Moving up in the World
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RESEARCHJanuary REPORT22, 2018 JanuaryCIBC 22, Company 2018 Pitch Insert Picture in Master View Stock Rating HOLD Price Target $131.00 Bear Price Bull Case Target Case $116.84 $131.00 $141.25 Ticker TSX:CM Canadian Imperial Bank of Commerce Market Cap. ($MM) 49,888 Moving up in the World P/TBV 2.5x ROE 17.2% Introduction 52 Week Performance The Canadian Imperial Bank of Commerce (CIBC) is one of the 120 Canadian Big Five Banks, providing various financial services and products to over 11 million people and commanding a market share of 15%. In recent years, CIBC has focused on improving client experiences, growing both customer satisfaction and their overall customer base. The bank has also recently undergone several 110 acquisitions, moving into the U.S. market and competing with other large Canadian banks in this new space. CIBC’s continuous improvement has made them increasingly well-positioned to outperform Canadian peers. 100 Investment Thesis Argument I: Building A Well-Diversified Bank through U.S. Expansion 90 22-Jan-17 22-Jul-17 19-Jan-18 Argument II: Leveraging Market Exposure to Grow Returns CM Index Argument III: Improving Financials and Operating Efficiency Financial Institutions Valuation Neil Shah When compared to the other Canadian banks, CIBC trades at a [email protected] discount on a Price-to-Tangible Book Value and Price-to-Earnings basis. CIBC also boasts the highest dividend yield among its peers. Adam Carnicelli Using a Dividend Discount Model, we arrived at a target price of [email protected] $131, implying a total return of 6.9%. Because of CIBC’s strong business fundamentals and modest implied return , we recommend a Irena Petkovic hold rating. 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Nick Gakena © Queen’s University 2018 [email protected] January 22, 2018 CIBC Company Pitch Table of Contents Company Overview 2 Industry Overview 3 Investment Thesis I 5 Investment Thesis II 6 Investment Thesis III 7 Catalysts & Risks 8 Valuation 9 References 12 1 January 22, 2018 CIBC Company Pitch Company Overview Background and service fees. This segment comprises the majority of CIBC’s revenues and income. CIBC is a leading Canadian-based global financial institution and commonly known as one of the Big Five Commercial Banking pertains to relationship-oriented Canadian banks. The company provides a range of private banking and wealth management services financial products and services to over 11 million catered to middle-market companies, entrepreneurs, individuals, small businesses, commercial, corporate, high-net-worth individuals, and institutional clients. and institutional clients in Canada, the U.S., and Income is fee-based and typically generated as a around the world. Founded in 1867, CIBC has 45,000 percentage of total assets under management. employees and 1,076 branches. The company holds approximately 15% of total market share by revenue, Capital Markets is CIBC’s investment banking advisory making CIBC the fourth most prominent bank in and execution and equity research arm. Clients include Canada. corporate, government, and institutional clients from around the world. Typically, CIBC is compensated Business Lines through advisory fees CIBC operates with four strategic business units: Corporate & Other involves income derived from Personal Banking, Commercial Banking, Capital administrative, audit, risk management, technology, Markets, and Corporate & Other. operations, and other support groups. This segment is relatively insignificant and an instable revenue source. Personal Banking refers to financial advice, small loans, basic investment services, and debit and credit card issuance to both individuals and small businesses. CIBC generates income based on its net interest margins Exhibit I Exhibit II Revenue by Product Segment (MM) Big Five Geographic Segmentation $15,000 100% $10,000 75% $5,000 50% 25% $0 2012 2013 2014 2015 2016 2017 0% Corporate & Other Capital Markets RBC TD Scotiabank BMO CIBC U.S. Commercial Banking Canada U.S. International Canadian Commercial Banking Source(s): Capital IQ Source(s): Capital IQ 2 January 22, 2018 CIBC Company Pitch Industry Overview Canadian banks have enjoyed a long stretch of determined by its net interest margin (NIM). There are enormous profitability since the Financial Crisis. a variety of factors that drive the NIM, including the Earnings growth has been fueled by ballooning overall interest rate environment, the quality of the consumer debt levels, strong housing markets, and bank’s loan book, and its operating efficiency. The strategic expansion into the U.S. financial services yield curve is another significant driver of the NIM. market. Low interest rates have allowed consumers to Yield curve flatness adversely affects the profitability of take on record levels of household debt to fuel maturity transformation (the process of borrowing consumption. This has been a boon for banks, but has short-term and lending longer-term at higher rates). raised concerns over Canadians’ ability to repay their Looking at CIBC’s NIM compared against the Canadian debts. A recent survey by Ipsos conducted on behalf of yield curve (spread between 10 and 2 year treasuries), the insolvency trustee MNP Ltd. showed that 48% of we can see they show a positive correlation of 0.36. A Canadians are $200 or less away from being unable to regression of the same set of data shows an R2 value meet their monthly obligations. Rising rates, while of ~0.13, meaning that for every 1% change in the good for earnings, have begun pressuring consumers’ yield curve, CIBC’s NIM changes ~13bps in the same creditworthiness. direction. The United States Federal Reserve published a study in 2017 that analyzed the connection between The Rate Environment the U.S. yield curve and American banks’ NIMs. They found a correlation between NIMs and the yield curve Amidst the backdrop of a forecasted slower economic nearly identical to that of CIBC. The study found that growth, rising rates have contributed to flattening for every 1% change in the yield curve, NIMs would yield curves in Canada and the U.S. This is significant change by 13bps in the same direction, on average. for a number of reasons. A bank’s profitability is Exhibit III Canadian 10-2 Year Yield Curve versus CIBC Net Interest Margin 300 3.0 2.5 230 2.0 160 1.5 90 1.0 20 0.5 (50) 0.0 1995 1998 2001 2004 2007 2010 2013 2016 CDN 10YR - 2YR Yield Curve (bps) (LHS) Net Interest Margin (%) (RHS) Source(s): Bloomberg, Bank of Canada 3 January 22, 2018 CIBC Company Pitch Industry Overview Cont. The yield curve was found to have a greater impact on rules, meaning that the level of RWA calculated using NIMs than rates overall. Many economists believe that internal models must exceed 90% of the level of RWA the yield curve will continue flattening throughout calculated using the standardized Basel model. OFSI is 2018. If this is the case, CIBC will face greater pressure calling to bring this floor down to 75%. This should on its NIM, despite the rising rate environment. benefit banks by allowing them greater capital flexibility and relieving regulatory burdens. This move The Regulatory Environment will also help position Canadian banks better as the world moves toward Basel III adoption in 2022. The Office of the Superintendent of Financial Regulations (OSFI) recently announced that it will U.S. Expansion begin transitioning Canadian banks to new capital adequacy standards outlined in Basel III. The standards With the Canadian market highly saturated, the Big were supposed to begin being phased in in 2022; Five banks have begun looking outside of Canada for however, OFSI believes that it is in Canadian banks’ growth opportunities. RBC and TD have built best interests to begin the transition earlier. Banks will successful franchises in the U.S., while their peers have have until the fourth quarter of this year to become lagged. CIBC recently acquired PrivateBancorp, a compliant with the new regulations. The rules define Chicago-based lender, for $5B. This marks a strong the minimum acceptable level of a bank’s risk- move for CIBC as it attempts to make up for years of weighted assets (RWA) that are calculated using under-investment in the U.S. International operations internal models relative to a standardized model. The will be a key growth driver for Canadian banks moving so-called ‘output floor’ was set at 90% under the old forward. Exhibit IV Exhibit V CIBC NIM Versus Canadian Yield Curve Regression Bank of Canada Overnight and U.S. Fed Funds Rate 350 R² = 0.1279 1.6 300 1.3 250 1 200 CIBC (bps) NIM CIBC 0.7 150 0.4 100 19-Oct-16 19-Feb-17 19-Jun-17 19-Oct-17 (25) 25 75 125 175 225 275 Fed Funds Rate BoC Overnight Rate CDN 10YR-2YR Yield Curve (bps) Source(s): Bloomberg, Bank of Canada Source(s): Bank of Canada 4 January 22, 2018 CIBC Company Pitch Investment Thesis I: Building A Well-Diversified Bank Historically, CIBC has performed relatively poorly than CIBC’s own high expectations.