Earlier this week, I received a research report that CIBC has become a “buy idea” which seems like lazy analysis to me. There is a lot of speculation that CIBC bite off more than it could chew- again. A quick recap- there are a lot of numbers being tossed around on CIBC’s sub-prime mortgage exposure. Some say $2.6 billion; others say $1.0 billion. To put this in context, CIBC’s shareholder equity is approximately $13 billion and BMO, the only other Cdn. bank to report on its sub-prime mortgage exposure, listed its exposure at $76 million as of Oct. 31, 2006-significantly less than the numbers floating around for CIBC. As everyone knows, subprime mortgages are as stable as quick-sand right now and CIBC has had to refute twice this week that it has a large exposure- but refused to say how much its exposure was, pouring fuel to the fire (note to CIBC: hire a new public relations firm). CIBC shares lost 4% in June, leading some to believe that it is a reasonably priced stock and a buy idea.
But this is what I found curious- why does a company with a history of being error prone (Enron, Global Crossing, multiple SEC investigations all in this decade alone) become a buy idea because its price falls partially on speculation that it may be approaching its next crisis? It makes no sense to me. If the speculation is true (and no one has proved anything), why would someone buy shares in a company which, given past history, goes from crisis from crisis- is the next one (if there is a next one) going to make them Barings Bank of this decade? Granted, CIBC is a blue-chip dividend paying stock but so was Barings Bank and First Boston (done in by over-exposure to junk bonds of the late 80’s). The point being any large financial institutions can collapse too. There’s a very fine line between success and failure in business; why invest in a company that straddles that line?
I am not picking on CIBC per se. I use it as an example to raise a larger point which is this- companies (regardless of industry) do poorly sometimes because of factors beyond their control (SARS or 9/11 type of events) while other companies are structurally prone to mismanagement; its in their DNA. Just because the price of the latter companies goes down, does that make it a good buy idea? High or low price, are you still not buying an unstable company? Does a house with structural damage become a good house when the price gets low enough?
Let me hear your thoughts on this- does a mismanaged company become a buy when the share price is low enough? Or is a dud a dud at any price?
July 12th, 2007 at 9:10 am
In of itself, I don’t think the company becomes a buy just because it’s price comes down. If the price depreciates AND an event like new management occurs, then it may be worth a look. Otherwise it’s still a dog.
CIBC has underperformed banks like BNS and RBC over the past 15 years by a fair amount, so I don’t know why people would choose to park their money there at all. Just because it’s a blue chip stock doesn’t mean that there aren’t better ones that are in the same sector.
Personally, I use CIBC for banking (via PC Financial) and RRSPs due to its cheap structure. That in of itself should demonstrate that it’s a bad investment
July 12th, 2007 at 9:20 am
Interesting question – Bernstein says to “buy when things are at their worst” but when is that exactly?
A short term note about CIBC – although their shares have come down quite a bit in the last few weeks – the stock went on a tear in the month of May and a good portion of the drop is just giving that gain back. The current price is the same price it was at back in Dec, 06.
I’m not a technical investor but when I look at the chart it doesn’t appear that the current drop is any more meaningful than the big rise in May.
Mike
July 12th, 2007 at 9:54 am
I think the saying “buy when things are at their worst” probably needs some explanation such as buy good stock when things are at their worst.
Just as one additional note about CIBC’s exposure- if the number was $1 billion (again, no one has proved anything) and CIBC lost it all, I read a research paper which said that would be equal to $3.50 off its share price. Its not a dooms-day scenario but it would be yet another blunder. CIBC has the least amount of Tier I Capital among the Cdn. banks so it doesn’t have a lot of money to burn.
Investoid- good point. There are industry peers with declining share prices with much better recent histories. The accurate analysis would be to track those stocks as buy ideas.
July 12th, 2007 at 10:10 am
I don’t believe the number is in the billions. If it is, it’s measuring something different from what the media think they’re measuring (e.g. total notional of CDO is a multiple of your tranche… or they may be the liquidity provider for large ABCP programs…). That said, large exposure doesn’t mean large risk. CIBC has a sizable credit hedging program (that’s why in spokespeople are careful to specify “unhedged” and “direct” exposure) and if most of the exposure is AAA, as they’ve been claiming, it’s unlikely that they will lose 100% of their investment.
July 13th, 2007 at 1:50 pm
Invest Skeptically- I do not trust the AAA ratings in CDO’s simply because CDO’s can be used to cover up poor quality instruments. I’ll allow this quote from the Insurance Journal of April 1, 2005 to explain my reasoning better than I ever could:
[...]
Concerning the rating factors it uses, S&P explained: “The ratings on the individual issuing companies in the pool are not directly related to the ratings on the various tranches. Rather, the structure and protection against default that are part of each tranche will be more important to the investor, but a key component of assessing risk in the CDO tranches will depend on the underlying credit ratings on the issuers in the pool.
“Consequently, the ratings on the pool members are often confidential and not disclosed to investors. This makes it easier for companies with lower ratings, including speculative-grade ratings, to participate in pools without having to deal with the competitive issues related to lower ratings in their insurance businesses.
“If a company is not rated by Standard & Poor’s, the pool organizers typically seek an estimated credit rating using one of a range of ratings products, including Standard & Poor’s Private Credit Assessment, Credit Estimates, or public information ratings. Methods used in estimates of credit ratings are highly model driven and retrospective by nature. Management meetings and the use of confidential information are generally not inputs to the rating process.
[...]
July 13th, 2007 at 11:43 pm
Admin – I don’t think it’s useful to characterize the AAA rating as a “cover up” of poorer quality underlying. The ratings are what they are and investors are supposed to do their homework regardless of rating. The agencies give you a model driven probabilistic assessment of first dollar loss to a given tranche. Even if you believe all the original inputs (rating of underlying names, probabilities of default, recovery rates, and correlations) were all wrong just on a gut level it seems unlikely that large pools of 1000s of mortgages will have losses significantly higher than 20% (or whatever the average subordination for AAA is). Given that the ABX-HE-AAA 07-1 is trading around 98 the market seems to support this view. That said, structured credit is always structurally leveraged. So when you stick MBS tranches inside of a CDO you get a double-leveraged exposure to default risk in your CDO tranche. Now that’s the REAL cover up (for lazy investors who didn’t understand this going in): when something bad happens you find out your real exposure is much larger than the money you put in!
July 14th, 2007 at 2:37 pm
I love the imagery, “it is in their DNA,” and I’m going to use that in the future…
I am bearish on the banking industry as a whole and it is because I believe the world to be in a credit bubble of sorts and interest rates are increasing.
I think banks are going to feel this even if they aren’t particularly exposed to the subprime market.
January 13th, 2008 at 9:03 am
[...] also out of libel zone if you use a mixture of fact and opinion. Here’s what I wrote about CIBC in the past. I back my assertions with previous indiscretions as found by a court of law or [...]