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Morningstar | Steady Results for CIBC in 3Q; Mortgage Portfolio Looks Healthy; Returns Remain Excellent

Narrow-moat-rated Canadian Imperial Bank of Commerce reported another quarter of strong results, and our long-term thesis on the firm remains unchanged. We are increasing our fair value estimate for Canadian shares to CAD 132 from CAD 131 and decreasing our fair value estimate for U.S. shares to $102 from $103, as exchange rates have changed since our last update.

Adjusted diluted EPS was up 11.2% year over year, coming in at CAD 3.08. The adjusted return on equity remained above 17%, at 17.1%. These continue to be top-tier numbers for the bank compared with peers. Further, the credit quality of the mortgage portfolio remained excellent, as the percentage of gross impaired Canadian mortgages decreased by 1 basis point to 0.24%, the percentage of write-offs remained at 0.01%, and delinquencies remained range-bound at 0.24%. Canadian mortgage balances were flat quarter over quarter, fitting well within our overall thesis of slowing mortgage and consumer loan growth for Canada. Credit card balances were also roughly flat quarter over quarter. The performance of the consumer portfolio, particularly mortgages, will be a key item going forward for the bank. With interest rates rising and more financial pressure coming for Canadian consumers, the credit cycle should be closer to turning than not. CIBC had been one of the most aggressive pursuers of growth, particularly within Canadian real estate, although we do note the bank has slowed down here and is back to industry growth levels for most of its consumer portfolios. We think it is fear around this past growth that has led to a discount in the stock despite the current, much improved performance. With the bank currently generating between 30 and 40 basis points of internal capital per quarter, and a current common equity Tier 1 ratio of 11.3%, it would take quite a deterioration to cause serious issues for the bank.

Results were generally strong for all segments, with most reporting growing net income and operating leverage year over year. The primary drag we noticed was a one-time hit to both revenue and provisions from the restructuring of the government bonds of Barbados. CIBC has exposure here through its FirstCaribbean segment. The capital markets segment saw some rebound in nontrading revenue and continues to invest in U.S.-based opportunities, leading to higher expenses. Net interest income was up for CIBC as a whole, as margins expanded in both Canada and the U.S. based operations. Results for CIBC Bank USA (formerly PrivateBank) have been exceptionally strong, with adjusted net income up over 30% since the second quarter. Origination volumes for Canadian uninsured mortgages actually picked up slightly during the quarter, increasing to 9 billion from 7 billion. Our overall thesis on the Canadian market, where we have built in a steady slowdown in consumer loan growth, remains in place. Even if CIBC misses mortgage growth estimates for a single year, this should not affect the long-term value of the firm. In our view, the more important consideration is how well credit quality holds up. As long as CIBC can avoid serious hits to its credit quality and can maintain a return on average equity of 15% over the longer term (the bank is currently consistently above 17%), the bank is arguably undervalued at today’s prices.