CIBC Stock Battered by Hedged Subprime Exposure

TORONTO/VANCOUVER Fri Dec 7, 2007 1:03am EST

TORONTO/VANCOUVER (Reuters) - Canadian Imperial Bank of Commerce (CM.TO) posted an 8 percent jump in fourth-quarter earnings on Thursday but its stock and reputation took further hits from the U.S. housing-derived credit crunch.

CIBC shares sank 5.4 percent in heavy volume after it revealed it expects more U.S. subprime mortgage-related writedowns, and warned of potential "significant losses" from its hedged exposure to the troubled U.S. housing sector.

Chief Executive Gerry McCaughey, who has stressed risk-reduction measures since he took the top job in 2005, said CIBC underestimated the meltdown of the subprime market.

"This, coupled with an over-dependence on the extremely high ratings of these securities, resulted in the build-up of exposures that are too large for CIBC's risk appetite," McCaughey said on a conference call.

CIBC, Canada's fifth-biggest bank, said that as of Oct. 31 it had a notional C$9.3 billion ($9.2 billion) of subprime mortgage exposure through derivatives contracts hedged with unnamed investment-grade counterparties. The fair value of the hedged contracts was C$4 billion, the bank said.

The impact of economic and market condition changes on counterparties could mean "significant future losses," it said.

The bank "again showed its propensity to misstep," BMO Capital Markets analyst Ian de Verteuil said in a note. He said CIBC could take another C$2 billion in subprime charges in the first half of 2008.

A number of unknowns in the release stoked fear, said Bruce Campbell, president of Campbell & Lee Investment Management.

"The question that the market is now trying to come to grips with is what are those hedges, who are the counterparties and how good are they?" Campbell said.

Shares in CIBC sank C$4.69, or 5.4 percent, to C$82.40 on the Toronto Stock Exchange. The stock is down 16 percent year-to-date, the second-worst performer among Canadian banks.

CIBC has the largest exposure among Canadian banks to the U.S. subprime sector, which made home loans to customers with poor credit records, many of whom are now defaulting.

Market conditions have worsened since Oct. 31, CIBC said, and it projected another C$225 million writedown for November.

But analysts said the C$9.3 billion in hedged subprime derivatives contracts -- or $9.8 billion in U.S. dollar terms on Oct. 31 -- grabbed their attention.

"This is a bit more on the risk side than people were expecting out of CIBC," Edward Jones analyst Craig Fehr said. "A primary focus for CIBC in recent quarters and going forward has been the de-risking of the bank, and this seems pretty inconsistent with that message."

Rating agency Moody's changed the outlook on CIBC's debt to negative from stable, citing concern about risk management. Despite expected improvements, "it now appears the bank has not fully addressed appropriate risk-taking at a senior, strategic level," Moody's said.

Blackmont Capital analyst Brad Smith said CIBC's disclosure of its gross subprime exposure confirmed market speculation, and he said several credit insurers have been pressured due to concerns about their ability to honor counterparty contracts.

CIBC said nearly half its hedged portfolio with exposure to subprime real estate was spread among five triple-A rated guarantors, none of which rating agencies have downgraded. But a big chunk of it, with notional value of US$3.5 billion, was hedged with one single-A rated counterparty.

Meanwhile, CIBC said it earned a net C$884 million, or C$2.53 a share, for the three months to Oct. 31, up from year-earlier C$819 million, or C$2.32 a share, with gains driven by its retail business.

CIBC had previously said its unhedged exposure to the subprime market was about US$1.7 billion.

It updated that figure on Thursday, saying its net unhedged exposure to collateralized debt obligations and residential mortgage-backed securities on Oct. 31 was about C$741 million, or $784 million in U.S. dollar terms.

($1=$1.01 Canadian)

(Reporting by Lynne Olver and Nicole Mordant; Editing by Rob Wilson)

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