Canadian Imperial Bank of Commerce (CM) Earnings Call Transcript & Summary

Good day, everyone. Paul Holden here, bank and insurance analyst for CIBC World Markets. Joining me on screen is Shawn Beber, SVP and Chief Risk Officer for CIBC. Shawn, thanks for taking time to join us today. I think this is going to be a very timely discussion on risks facing the bank, given another round of social distancing measures in many jurisdictions, the extension of government support programs, U.S. bank results that have been coming out through the course of the week. We'll go through approximately a 45-minute Q&A session. Those of you listening online, you are free to submit your own questions. There's a little icon in the top right-hand of the screen. It's a little person raising their hand, just click on that, submit your question, and I will include it in the discussion as appropriate. But before we jump into Q&A, I have to remind people the standard forward-looking disclosure. Comments may contain forward-looking statements, which involve assumptions and inherent risks and uncertainties, and actual results may differ materially. Okay. So with that, let's start with the topic that is top of mind for everyone, credit risk. So CIBC has had a material build in credit allowances over the last 2 quarters, taking the ACL ratio from 51 basis points to 86. Outside of the changes in macroeconomic assumptions, I think it might be worth reviewing what action CIBC has taken and why.

Right. So Paul, thanks for having me, and good afternoon, everyone. So the ACL analysis is something that we do a complete review of every quarter. I mean the biggest drivers are the economic forecast as well as portfolio performance. So in Q1, we had a pretty significant provision that added to our allowances. And that was really a function of the first wave of the pandemic and its impacts. So lots of changes to the economic outlook. And also, you'll recall at the time, there was a pretty precipitous drop in the oil and gas prices. So those were big drivers. In the second quarter, we added somewhat to our allowances on performing. And that was, I would say, a function of some incremental changes in the FLI, and we also had the benefit of another quarter of experience in the pandemic. And as you'll hear throughout, there's obviously a lot of uncertainty. And as Paul mentioned in his opening remarks, that uncertainty continues as the path and trajectory of the pandemic, discussion about vaccine and timing for that, government support, all the rest. So in addition to those factors, as I mentioned, we look at the -- at our overall portfolio performance and exercise what we call expert credit judgment. So we look at the portfolio and we take into account all of the various elements that we see impacting the portfolio, so the government support being one. If you think about the Canadian emergency response benefit, it was served. Its impact in terms of what a normal course unemployment rate that we've been seeing sort of the posted rate as it were, relative to what the actual experience is given the unprecedented level of support, that's something that we've taken into account. We've taken into account individual portfolios. So we've done bottoms-up reviews on elements of particularly impacted sectors in the pandemic. So think of oil and gas, as I mentioned, hospitality, leisure, entertainment, all those portfolios, we did more of a bottoms-up analysis to take a view on what we think the implications are going to be for those portfolios. And the last, and certainly not least, are the deferral programs that we and other financial institutions launched. And what the impact of that is in terms of what we would anticipate seeing by way of delinquencies and, ultimately to some degree, credit losses. Some of it, we expect is actually bridging people to better outcomes. And there's also an element of it that we think just changes somewhat the timing of when we would experience delinquencies, and then ultimately, losses. And we talked about that a bit in the last quarter in terms of building in incremental performing provisions to address what we think that timing is that isn't necessarily being captured by the models. So that's a summary of what we're doing, and we'll go through that exact exercise again this quarter, Paul.

Okay. So given there has been some subjectivity built into the allowances, I think the key question that investors are asking is, what conditions would need to be present for CIBC to remove some of those management overlays and more downside scenario weightings? And when do you expect CIBC might be in a position to release provisions?

Yes. So I'll start from the beginning of your question. In -- over the last couple of quarters, particularly in Q3, we did have a shift in weighting more towards the downside. That's a function of the engagement that we have with our Economics department. So they come up with their forecast. We engage in lengthy discussions, effective challenge, all the rest, to better understand how that -- how we think that economic forecast should apply or needs to be adjusted by way of management overlay. So we spend a lot of time on data on them. Our forecast right now is for an elongated recovery. And so we're looking at seeing a peak in our losses being experienced reflecting the first half of fiscal '21. So if things play out the way we've anticipated, then some of the build and allowances that we've taken by way of overlay to address that timing issue, particularly as it relates to the unsecured consumer lending, we would expect to start potentially seeing some of that overlay move through. I'll caveat that by saying, it all depend on how things play out. If things play out worse than expected, then we wouldn't see those releases. If they perform better than expected, there's certainly the possibility for release. I'd say it's probably early to be seeing that. We want to see sort of the sustained improvement as opposed to any individual blips. So I'd say it's probably a bit early to think about releases. But certainly, some of it would be -- we expect to recognize coming through, because we built it on the basis -- we built some of that provision or added some of that performing allowance in the quarters based on that expectation of time that the deferrals move some of that timing a little further out. And so we needed to add, and then we'd expect to see it come in somewhat.

Okay. So I hear your answer on it being early. A big talking point for people was the release of reserves by JPMorgan earlier this week. I think the one that was interest -- the part of it that was interesting to me is they said, they released reserves across multiple sectors within their commercial and wholesale banking business. I mean is it possible with a K-shaped recovery that we see reversal reserves for certain industries, while others are maintained at current levels? Is that a possibility for CIBC?

Yes. Look, I mean, we look at each portfolio independently. So to the extent we see some type of improvement in one particular area where we have exercised judgment, then we would -- we'd certainly, look at it. As they say, it's a bit early right now, and we want to see some sustainability in that as opposed to necessarily a single quarter. But directionally, yes, this is done on a portfolio basis. And so you could certainly see a divergence in terms of when you recognize those provisions coming through in terms of releases in certain portfolios and not others.

Okay. Another major talking point on the credit theme has been loan deferrals. The majority of which will be rolling off in fiscal Q4, so right about now. There is a concern among certain investors that this will result in a potential cliff in terms of loan impairments. Can you walk us through how you think about impairment risk related to deferral expiries specifically?

Yes. So again, part of the exercise in the prior quarters was to essentially estimate what we think those future allowanced are going to be, and then recognizing them as performing allowances. And so while the deferrals occurred sort of points in time, and they, to your point, they are -- the vast majority are rolling off in the next -- have already rolled off and the balance will roll off in several weeks. But in terms of that, the recognition of the losses, we've taken some of that in, in taking what we would expect to see going forward. As I said, we expect it will be -- those losses will peak in the first half of fiscal '21. And so rather than seeing sort of a cliff of losses, all of a sudden, like it will take time for those delinquencies to ultimately -- those that do tip into interim impairment. But the recognition of the provision earlier on will help, I think, offset some of the P&L impact in that given quarter as to when a particular loan moves into impairment. And it may be helpful just to spend a couple of minutes about sort of that dynamic, that moving from performing provision to impaired. So when we do the performing allowance, that's done based on risk ratings across the portfolio; probabilities of default; the forward-looking indicators, or FLI, the impacts they have in terms of what the loss expectation would be; and then that's aggregated into a portfolio number that sits as the allowance. but each element of that allowance is described to an individual loan. So -- and again, that's based on a probability of default. When a loan goes from performing and tips into impaired, we'll move the element of performing provision that was sort of ascribed to that particular facility into impaired status. But it's not a one-to-one relationship. I mean just at its simplest, you've gone from a probability of default to an impaired status. And so there we do individual analysis, depending on the size of the loan, but each one gets an individual analysis as to what the -- of what we think the impairment is. And there'll be some element of it that you'd expect is captured in a normal course in the performing provision. So while you'll see as one loan goes into impaired status in a given quarter, it will transfer part of the performing provision into that impaired status, and sort of new, to some degree, the P&L loss associated with that particular loan. The rest of the portfolio that has, again, the probability default associated with them, those will get released to the extent that the economic picture improves. And those loans, the vast majority of which will never take into impairment, have their probability default lower and the FLIs improve that outlook. So you can have a timing mismatch between when an individual loan goes into impaired provision -- or releasing allowances because the economic environment has improved or the overlays aren't as required against that broader portfolio. So -- but over the course of, call it, 6 to 8 quarters, you'd expect to see that build in allowances then kind of roll through as it were as the impairments happen, to the extent they occur kind of as expected when we last published. I hope that's helpful context.

It is a helpful discussion, I think something that's important. And I know something I'd be getting a lot of questions about is how does that interplay between performing allowances and impairments? How will that actually impact earnings next year? So I think that explanation is very helpful. Staying sort of on the theme of deferrals. Canadian residential mortgages represent a disproportionate amount of those deferrals, and CIBC has a significant amount of exposure to Canadian residential mortgages. So one could paint a high-risk picture given a record level of consumer leverage, significant job losses as a result of COVID and then a significant uptake on mortgage payment deferrals, which I think was 15% as of last quarter. Like why should investors be comfortable with that risk for CIBC?

Certainly. We're very comfortable with our exposure. In periods of stress, secured lending generally performed better than unsecured lending. The portfolio -- there's a number of things that give us comfort around the portfolio. First of all, the loan-to-values for our uninsured portfolio of -- I mean, we've got, obviously, insured portfolio. But the uninsured portfolio, loan-to-values are in the 52% range. New originations are in the 63% loan-to-value range and those have been improving somewhat over the last several years. There's a number of reasons for that, house price appreciation, paydowns, some of the regulatory changes and also just some of the tightening in our own policies has sort of brought that new origination as well as the LTV on the state portfolio down. And so you couple that with the benefit of the government support, and depending on your -- the economic analysis, a substantial amount, or even maybe all of the income loss that we've seen as a result of unemployment, has been replaced some -- to some or all extent, by the government support. And so you couple that with the deferral activity that you mentioned, borrowers are in decent shape, and our delinquency levels are very low. This is an asset class that has had very low loss experience over a very long period of time. And so when we look at the portfolio, we're comfortable. And we've seen prudent behavior amongst those taking deferral. So we've seen deposit balances increase in the clients that have mortgages and have taken a deferral. So it certainly demonstrates some level of building for a rainy day or if things get worse. So we've seen a strong increase in deposit balances. And so again, we're quite comfortable with the exposure.

Okay. I mean the housing market does remain strong and surprisingly strong, I think, in 2020. Maybe to press you on the question a little bit more. I mean what's the risk that the housing market softens considerably in 2021? Like how do you -- how are you viewing that risk that the housing market sort of flips over next year with the roll-off of deferrals and maybe government support programs aren't at the quickest same extent?

Yes. So again, I think we're -- we speak a lot with our Economics department. The view right now is that things will probably moderate over the weeks or months, but we're not anticipating any severely drastic view. And as I said, given the loan-to-values, given the behavior of clients, the prudent personal financial management that a number of them have been exhibiting, we don't see a significant deterioration. And we don't see -- it's going to be an increase in loss experience as a result.

Okay. Okay. So you've mentioned now within your answer, sort of the government support programs. Those were recently extended, or at least new programs were rolled out, which effectively or equivalent to serve. In your mind, how important are these programs in terms of mitigating consumer delinquencies?

I think they've been very important. As I said, some or all of the income loss from the high unemployment that has resulted from the pandemic has been replaced by the government programs. And so you take that and couple it with the deferrals, it's had a meaningful impact in terms of supporting Canadians through the pandemic thus far. I'd also say -- I mean it's also reflected in the numbers. So we talked about it in -- particularly in the second quarter. The government support has been a major adjustment that we have made to what the models would otherwise demonstrate in terms of expected credit losses. So as part of the IFRS 9 modeling, government support has been taken into account in terms of lending some of the increase that we would otherwise have seen, sort of the directional use in Q2 in terms of magnitude. But it was significant, and it remains significant. So we've -- it's encouraging to see the continued support. We think clients will continue to benefit from that. And it's been an important element in terms of how the loss experience has been. It's lowered delinquencies. It's lowered insolvencies. And again, to the extent some of that is more of a timing issue and that we expect that's still going to end up in certain borrowers experiencing financial difficulty that ultimately tips it to losses, we've taken a view on that and add it to our performing provisions to reflect that.

Okay. Okay. So continuing on the theme of deferrals, and we already highlighted that the bulk of deferrals would have rolled off by the end of the current quarter. What has been the impairment experience so far with those customers that have rolled off payment deferral?

It's early, but I'd say right now, it's performing in line with expectations. So we expected some increased level of delinquency across, particularly the unsecured side. And we're seeing that, but not in a way that's outside of our expectation thus far.

Okay. And if we think about the business banking, the commercial banking sector, specifically, how are you assessing and monitoring the remaining clients that are still on deferrals? Are these mostly in the highly vulnerable sectors of the economy?

So yes. So just to recap. By the end of Q3, we're almost 90% of the deferrals that rolled off in commercial, if that's what you're talking about. The U.S. commercial were later in getting rolled out. And so we have more of those, but they're also -- the majority have rolled off and the rest will roll off over the next, as I said, several weeks. We've had very low delinquency experience for those that are coming off deferral. We do work case -- on a case-by-case basis for those that continue to need some level of support. But we've had very little in the way of second requests for extension, like a handful. And at the same time, for those that we think are going to need further support, we're looking at longer-term solutions, either bilaterally or we've had the number that we put the Business Credit Availability Program, the BCAP program. We put those in place to help through this period. But so far -- again, so far as expected and performing generally well. The commercial clients have, by and large, been flexible. They've taken the action that they've needed to reduce expenses, reserve cash flow. And so we're still working with -- we're obviously working with them. But so far, playing out kind of in line with expectation.

Okay. So like I want to ask a question about credit trends in Canada versus the U.S. So 53% of Q3 performing PCLs were for U.S. commercial and wealth, and that was up from 20% in the prior quarter. So sort of big flip there. Also, CIBC saw deferral balances in the U.S. increase in Q3, while balances, as we've already highlighted, decreased in Canada. So what's different in the U.S. versus Canada that's driving this discrepancy in trends?

So it's a good question. We look at it from a PCL -- or the IFRS 9 exercise that we give each quarter. We look at the U.S. and Canada separately. We've got separate forward-looking indicators and forecast for the region. So in part, the divergence in the first -- sorry, the first quarter of the pandemic, so our Q2 reporting season, there was a lot more consistency where the trends were more in line between Canada and maybe in the U.S. economies. In the second quarter, by and large, we had some level of improvement in the scenarios for Canada, whereas at that time, the U.S. was moving in a bit of a different direction. And so we saw more deterioration in the FLI. The difference between the 2 regions in terms of what we recognize as performing provisions was generally modeled here. And so -- and again, to the extent that we see changes in those FLIs going forward that are divergent between the 2 regions, you could expect to see kind of similar behavior going forward. In terms of the deferral program, I sort of alluded to it a minute ago, but we were -- in the U.S., we launched our programs a little later than we did in Canada in terms of the deferral programs. And they take a little bit of time to roll out and get the paper in count order, et cetera. And so by the time we reported at the end of April, we only had a couple of weeks' worth of activity, I guess, reflected in the deferral numbers. By the time we got to the reporting season in Q3, you've seen sort of the bulk of the program roll out. And now we're in the period where those deferrals are rolling off. And as I said, a majority have already, and the balance will roll off over the next several weeks. So in terms of the number of deferral pattern of -- that it's taken, it's more a timing issue in terms of when the U.S. programs were implemented versus when the Canadian programs were.

Got it. Got it. That's helpful. Okay. Drilling down a little bit more on the commercial exposure. CRE, commercial real estate, is 11% of the overall loan mix. So it's pretty significant. I think it's an area of concern, or at least an area of questions for many investors. I mean CIBC is well diversified by sector across CRE. Which sectors, in particular, has the probability of default increased? And how are you thinking about the risks in those specific sectors?

So it won't be a surprise. The sectors that are most impacted by the pandemic, so hospitality, leisure, hotel. Those are the sectors that have endured more pain than others through the pandemic. And so the real estate lending that would have exposure to those sectors would be the ones that have the elevated risk of default and higher probabilities of default. To what you mentioned, we do have a diversified portfolio. I mean to give a bit of context. In retail, which is one sector that has got a lot of press recently. We're about 40% in commercial real estate mortgages. So those would have low loan-to-values and good debt service coverage ratios. Another 40% would be to large corporate clients. So primarily well capitalized REITs that have strong cash flow profiles. And then about 20% would be on the construction side, and that's with sponsors with strong track records, financial wherewithal, lots of experience and will generally provide varying degrees of guarantee. So we're staying very close to those sectors. Our exposures are pretty manageable. And as you say, we've got a very diversified book, but we feel comfortable, but watching certain areas of where there's real stress and reflecting that as we look at our performing provision allowance -- or performing allowances.

Okay. I mean so you gave some pretty good context there on the retail exposure. Office is an area where I'd argue it's kind of tougher to get a handle on the risks there, at least from my perspective regarding future occupancy rates, rental rates, et cetera. How are you assessing risk in the office exposure?

So again, maybe I'll start with some portfolio specifics. It's about 40 -- actually more than 50% of the -- of our office portfolio is commercial partnership, good loan-to-value ratios, big cash flow profiles, and a pretty granular portfolio in terms of individual loans or mortgages. About 30% would be the large corporates. And then the remaining 20% would be, again, in terms of construction with strong sponsors and long track records. And in terms of -- you're right. I think there are still questions about what is all this going to be. Are employers going to need more office space in order to generate the appropriate distancing for employees? Or are they going to need less because more folks are working from home, et cetera? I mean, I think, that all needs to play out over time. We're obviously paying very close attention to it. But given the portfolio of characteristics that we have, the sponsors that we work with, the large REITs that we went to, we feel quite good about the portfolio overall and realistic about where we see pockets of stress, we're taking appropriate action. But overall, the portfolio, we think, is in -- is holding up well through the pandemic so far. We've not seen broad-based deterioration thus far.

Okay. Okay. Let's drill down into another area of risk that's been highlighted by folks, and that's oil and gas. So for CIBC, that's only 2% of the loan portfolio. But again, as a frequent talking point for investors, how should people like myself and investors think about that risk there? Does it all really come down to benchmark crude oil prices? Or are there any more nuances we should be aware of in terms of thinking about your credit exposure in that sector?

Yes. So we've provided sort of an additional disclosure around the oil and gas portfolio for a while now. There's certainly a strong inverse correlation between oil prices and probability of defaults. It factors into our IFRS 9 allowances in so much as change in oil prices is an important element of the industrial sector that the oil and gas extraction business gets into. And so the -- that relationship we saw took overlays in terms of provisioning, particularly in the second fiscal quarter, given how quickly oil prices declined and the impact it had on our price decks. We did the -- this spring involved terminations. Things have improved somewhat since then. Obviously, we had -- we saw some real disruption in that market in the -- really going through the pandemic, but the oil prices have recovered somewhat. That's having -- had an improvement in terms of the price decks. That, in the normal course, would have some implication on increased collateral values because the change in the oil price has an impact on collateral values in terms of like reserve base lending, which is a part of the portfolio. So we're watching it very carefully. And we think we are appropriately provisioned for what we see in terms of how things are developing in that sector. And as I said, as we watch the oil price improvement, that takes a bit of pressure off from where we were.

Okay. Good. I think that's a pretty thorough discussion on credit risk. And Shawn, your job encompasses far more than just credit risk. So let's talk about some of the other key areas of risk outside of credit, and particularly those that are being highlighted, say, by COVID-induced trends. So maybe starting with the use of digital and online banking tools. How do you monitor and protect against cyber risk in this type of environment where the use of those tools is increasing dramatically?

Yes. So it's a great question. And yes, I mean, beyond credit risk, there are a lot of other risks that our group stays very close to monitoring. And it's been -- the pandemic has had so many different facets. As it relates to digital, we've stepped up with our authentication. We do a lot of client education in terms of strong passwords. We continue to develop and improve on our cybersecurity posture. It's strong. Every bank is investing to continue to strengthen and adapt in those context. And so we continue to advance our analytics for fraud monitoring. We provide opportunities for fraud alerts so that clients are notified. We see account activity that is sort of out of the usual as it were to help them identify and work with us to reduce fraud. So there's a lot of work going on, and it's, to some degree, accelerated insomuch as the adoption of digital, particularly in a remote environment like we've been working in through this pandemic. It has, as you said, has shown a light on the need to continue to do that. But we're comfortable with where we are, and we continue to invest to enhance authentication measures and the monitoring activity that goes on to keep our clients and the bank generally safe.

Okay. Other operational type risks have also sort of popped up this year, or I should say, increased this year with the work-from-home, maybe you have some data privacy potential issues or concerns there. Also increased use of third-party vendors. Maybe you can spend some time talking about how you've thought about those risks and address those risks this year?

As we have -- there's been a lot of change since the pandemic came on in terms of sending thousands of employees into a remote work environment. We've got a strong culture -- in the first instance, a strong risk culture across the bank. And we spent a lot of time talking about safeguarding the bank, safeguarding information. That has served us well through the pandemic. There's obviously a lot of technology solutions that go wrap around the use of technology in a remote environment to, again, monitor activity, watch for the types of issues that you're talking about, data leakage, et cetera. Where we do find it, which is very minimal, we act quickly on it. We've got an investigative team that gets engaged right away. And again, continue to invest in and have been investing through the pandemic to continue to expand that coverage as this remote work environment continues. And the longer it continues, obviously, we continue to evolve our risk posture around those elements. As well as reinforcing with our employees all of the safe practices and building in and compensating controls to address the remote work environment, with lots of testing and increased monitoring.

Okay. I was going to ask you about climate risk and sort of ESG more broadly, and how you're thinking about it. But there's an interesting question from the audience, actually, on how we're -- how CIBC is including ESG factors into credit risk and, therefore, cost of borrowing going forward?

That's a great question. So we incorporate ESG analysis into our normal course due diligence exercise. We recognize all elements that the ESG presents varying degrees of credit risk. We're also building new tools around ESG, and particularly around climate risk, as folks recognize there's 2 elements of climate risk. There's physical risks, sort of the risk of changing climate and severe weather events impacting physical premises as well as supply chains. And then as well a transition risk. So the risk of increase -- or changes in regulatory environment, et cetera, that will impact industries. And so we've been developing a climate transition tool that we're going to look to incorporate into our credit adjudication platforms, to help score different borrowers against a variety of criteria in terms of exposure to carve in. What their -- what the transition plans are. How mature those plans are. How far along the journey they are. And what their -- the inherent exposure is for that industry, and building that into a tool that can be used as part of the overall credit adjudication program. But it's certainly an evolving field. There's a lot of -- we're spending a lot of time developing scenario analysis. It's a complex area. I spoke about it a couple of weeks ago at our sustainability -- CIBC Sustainability Conference. That's going to take a lot of collaboration and work across organizations to build the scenarios that we think will be really valuable in terms of, obviously, not predicting the future, but creating different pathways that we could see things developing and then responding from appropriate risk and obviously, a front office perspective to those potential outcomes. It's a great question, and it's certainly topical.

Well, it's a very thoughtful answer, too. So I'm glad to hear that answer. Another risk that's kind of, I'd say, come to the forefront this year, and that's related to some media articles regarding the FinCEN Files is anti-money laundering. And I know the bank has done a lot of work over the years on AML. How are you evolving -- how are you viewing that evolving risk? Is it getting tougher to monitor money laundering activities? Or are we really getting ahead of the curve on it? How are you viewing it?

Yes. So again, it's a very, very important area, obviously, for financial decisions generally. I would say the stakes continue to rise. I mean the speed with which -- obviously, money travels across the world. The complexity of those pathways, and activity generally increasing, all lead to additional focus needing to be placed to AML generally. So we work with our regulators, with industry participants across a number of different programs to continue to enhance our AML platform. We -- and we're not alone, the industry generally continues to invest. An area that has been invested in and will continue to need to be invested in about long-term plans in place for -- to continue that investment in terms of the tools, the sophistication of the tools, the learning, the case management, the reporting. And from a regulatory perspective, it's an area that the regulatory expectations continue to rise. With the sophistication of money laundering and terrorist financing, generally banks have an important role to play as part of rooting it out. And so the regulatory expectations of us continue to increase. We continue to develop the tools to keep up and stay ahead of what is going on. And we've got a very strong partnership with the front office, because it's not only the clients that we're working with, but it's actors outside of the organization that we need to be on guard for and make sure that we're not being used as a -- to facilitate. And so all of the investment in the systems, tools, processes and the team are all geared towards continuing to meet that expectation.

Okay. We have more questions from those on the line. I probably also have more questions, but Shawn, I promised you a 45-minute discussion. And I think that we're at 45 minutes. So I appreciate your time, appreciate the thoughtful answers, and appreciate everyone for joining us today. We'll try to get back to you on your questions in due course. Thanks again.

Thanks very much.