Sub-prime: Damage control

CIBC strives to get out from under the sub-prime mess.

It couldn’t have been more prophetic. The very week Canadian Imperial Bank of Commerce announced the departure of several top executives in a bid to quell worry over its sub-prime loan exposure, chunks of the CIBC logo adorning the bank’s headquarters in downtown Toronto plunged 58 storeys, attracting the attention of emergency crews who shut down part of the financial district for the morning. The sign, not the one on the ground, couldn’t be ignored: Was CIBC falling apart?

The bank has certainly been a bit shaky of late. In mid-December, investors were surprised when CIBC (TSX: CM) announced another “large charge” for yet more dodgy sub-prime loans. CEO Gerry McCaughey was forced to disclose a $9.8-billion exposure to the sector when the company insuring its off-balance-sheet credit derivatives, ACA Financial Guaranty Corp., was downgraded by Standard & Poor’s. But while the latest announcement might be taken as a bit of a surprise considering all the talk from McCaughey about “de-risking” the bank since he joined in 2005, was it really such a shock? This is the organization, after all, that walked into Enron with eyes wide open and, in the words of one Bay Street wag, “would cross the street to trip over a hole.” It would have been a surprise if CIBC wasn’t involved in this credit debacle, which has seen some of the biggest names on Wall Street — Bear Stearns, Citigroup, JP Morgan — seriously tripped up. That it didn’t disappoint confirmed, if nothing else, the bank’s consistency.

To be fair to CIBC, it’s tough being one of the smaller Canadian banks. You’ve got to run hard to keep up with front-runners who always have more resources, time and money. If you don’t want to trail the pack, you’ve got to make up for the structural differences somehow, and that can mean taking big risks. If you founder in the good years, you’ll fall out of the race altogether. Better to rack up that risk, maintain your place in the pack, and then let the aggressive business model blow off at the end of the cycle. You can always put the company back together before the next cycle.

And that’s exactly what McCaughey seems to be doing. In a bid to get CIBC back on course, he sacrificed two top executives to the restructuring gods and hired TSX Group CEO Richard Nesbitt, who becomes the new head of CIBC World Markets, and turnaround guy David Williamson, who takes over as CFO. McCaughey followed up the head office house cleaning with a quick sale of some large equity stakes to friendly investors like Manulife Financial, Hong Kong billionaire Li Ka-Shing, Ontario pension plan OMERS and Caisse de dépôt et placement du Québec, all of whom bought stock at significant discounts. Shareholders already in CIBC saw their stakes significantly diluted, but at least the bank will be okay. Well, we hope it will.

No one knows for sure how much more bad news will shake out. Estimates are that up to US$800 billion in sub-prime-related bonds may have to be reset, a process that could run into 2009. A week after the CIBC cuts, Citigroup announced that it would take another large writedown, slash its dividend, cut its workforce and undertake a fire sale on ownershipstakes, which will be the second of such sales for the U.S. bank this winter. In December, Citigroup said it was trading an ownership stake for cash from a Mideast sovereign wealth fund — which gets us to what might be the real and lasting effect of this sub-prime mess.

Over the past month, we’ve seen a stepping out, a debutante’s ball of sorts, for sovereign wealth funds, large, state-connected funds flush with currency reserves and petrodollars. A Kuwaiti fund bailed out Merrill Lynch, UBS tapped an unidentified Mideast investor and Citigroup had the China Development Bank lined up before that deal fell through and a Singapore fund came to the rescue.

But the sales are sparking concern in the West. What does it mean that the Abu Dhabi Investment Authority, a petrodollar-rich investing arm of a Persian Gulf emirate, has stepped in to buy big chunks of the biggest firms in U.S. free-market capitalism? This is either the first steps toward a more “multilateral” financial world order, or the rise of a new form of state-controlled, single-party, hybrid capitalism that some say defines modern China, Russia and the principalities of the Middle East. French President Nicolas Sarkozy recently decried the “aggressive” tactics of the funds, and the subject is on the minds of many (see Q&A page 13).

CIBC’s fire sale wasn’t so spectacular, but it did raise questions. Was the large equity sell-off ($2.75 billion) a desperate play to keep the bank solvent, or a belated attempt by McCaughey to live up to his reputation for being hyper risk-averse and extra cautious? We’ll put our faith in the big brains at the pension funds, who we trust wouldn’t have made the deal if they didn’t think it was a winning bet. CIBC has lots of cash on the books, it’s not owned by Communists and it looks like it’ll survive through to the next cycle, which, one assumes, will give it time to spruce itself up for the following business cycle and get in line for whatever comes down the pipe. Let’s just hope that logo sign gets fixed before the next blow-up. It’s a bit creepy.