THE HEDGEYE EDGE
CIBC (CM) is one of the most exposed Canadian banks to the Canadian housing bubble. The company’s roughly $190 billion in residential home exposure includes some $20 billion in condo exposure and $19 billion in HELOC exposure – two of the riskier categories. CIBC generates an outsized ROE by putting extremely low levels of capital against its loan exposure.
For instance, the company generates an almost 80% ROE on its Retail and Business Banking business by posting just $4 billion in equity capital against a loan book of over $200 billion. The Canadian property market is wildly overvalued and when it corrects, CIBC will find itself overearning and poorly capitalized to withstand the storm.
INTERMEDIATE TERM (TREND)
There are numerous negative developments set to transpire over the intermediate term. On the housing front, the Canadian government has recently implemented measures that will make it far more difficult for low-down payment buyers to obtain a mortgage. It’s estimated that as much as 30% of those buyers who were approved in 2015 will no longer qualify under the new regulations.
Further, the Canadian government is evaluating risk-sharing measures that would see big banks, like CIBC, sharing a portion of the risk for insured loans.
Finally, the recent downturn in energy prices has again put Western Canada (Alberta, Saskatchewan, and the Prairie Provinces) on the hot seat. CM has substantial loan exposure to these areas.
LONG TERM (TAIL)
The Canadian property market is poised for an historic correction. Home values across Canada have tripled since 2000. Household debt has also tripled since 2000. Meanwhile, household mortgage debt to GDP is now at 70%, the same level it reached in the US in 2006.
The Canadian economy is heavily dependent on the property market and its downstream effects: construction, lending, brokerage, insurance, furnishings, etc. We expect an unwind of Canada’s property bubble to occur in the coming 1-2 years.
The primary asset for Canadian banks, including CIBC, are residential real estate loans. While much of the exposure is insured, there is a sizeable amount that is not. Moreover, CIBC has substantial non-mortgage exposure, both commercial and consumer, that will become impaired once the property bubble bursts.
CIBC trades at a high multiple to tangible book value (2.2x) because it currently generates impressive returns on capital. Once the property market corrects, however, the bank will need to provision substantially higher amounts for bad loans, which will put its earnings power, and its returns under pressure, collapsing its high multiple to tangible book value.
ONE-YEAR TRAILING CHART
