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Morningstar | Tougher Capital Markets Environment and Higher Provisioning Slow Earnings Growth for CIBC. See Updated Analyst Note from 28 Feb 2019

Narrow-moat rated Canadian Imperial Bank of Commerce reported okay fiscal first-quarter results that were hit by higher credit provisions and lower capital markets activity. Lower capital markets activity hit all the Canadian banks this quarter, and with the recovery in markets at the start of 2019, it would not be unreasonable to expect some pick up in issuance and deal activity for the rest of the year. We’ll note that we were already projecting essentially no growth in EPS from 2019 through 2023 and a decline in return on equity of roughly 200 basis points. As such, we are maintaining our fair value estimate for Canadian shares at CAD 131, and increasing our fair value estimate for U.S. shares to $99 from $98, as exchange rates have changed since our last update.

Adjusted diluted EPS was down roughly 5% year over year, coming in at CAD 3.01. The adjusted return on equity dipped below 17% for the second quarter in a row, at 16%. As previously mentioned, the Capital Markets segment had a difficult quarter, with adjusted net income down almost 40% year over year as overall activity levels in key areas declined. Provisioning in this segment also spiked. While results were weak for the capital markets segment, results for all other segments were generally better. The U.S. segment continued its strong growth, with loans, deposits, and net income all up double-digits. Management also reported that the PrivateBancorp unit, which was acquired in mid-2017, turned accretive to earnings in the current quarter. This was 1.5 years ahead of schedule. This is, of course, good news, especially considering the price paid for the acquisition, which we viewed as being on the higher side. However, we will note that the bank undoubtedly received a hefty boost from tax reform.

Growth in Canadian Personal and Small Business was slower, with loans up 3%, and adjusted net income down 4%, largely due to increased provisioning. We were impressed by the expense discipline, as expenses were flat, and believe a normalization of credit costs is quite expected. The story was similar for the Canadian Commercial Banking and Wealth Management segment, where higher provisioning and controlled expenses led to adjusted net income growth of only 1.5%.

Credit quality was a key issue during the quarter, and management stressed that it believes the credit marks in the quarter were all isolated events. We think there is some truth to this, as the largest shift in impairments and provisioning came from the utilities portfolio, which was undoubtedly related to the California wildfires. We had already seen another Canadian bank take a charge here as well. However, there were some other shifts that suggest a gradual credit cycle normalization, including slight increases in gross impaired loans within the Canadian mortgage and personal lending portfolios, with delinquencies also creeping up in these portfolios. Management cited increasing interest rates as a reason. These are key trends to watch. We are comforted a bit by the fact that CIBC is now undergrowing the broader market within the real estate secured personal lending portfolio. CIBC had been one of the most aggressive pursuers of growth, particularly within Canadian real estate, and now we see that year-over-year balances within mortgages have grown slower than all peers, ranked at number 6 for yet another quarter.