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

It's now my pleasure to introduce to the stage CIBC's President and CEO, Victor Dodig. All right. Thanks for being here, Victor.

It's always good to be here, just marks another year of life, right ? That's good.

That's how we measure it, financial summits. Victor, there's lots to talk about, but I thought first off the bat, would get your thoughts on something. On the quarterly call last week, you addressed press reports about your mortgage underwriting practices. And I just want to see if there's anything else you can share on this topic.

Well, I'll share with you what I shared in the call last week that we have -- we can't comment on regulatory relationships. I can tell you that our regulatory relationships are constructive. They're productive. Our regulators do a fine job in every jurisdiction that we operate, including our main jurisdiction here in Canada, in keeping the financial systems safe and stable. I can tell you, we've got a great relationship with our Board, and we're investing in our business, including our mortgage business, which is performing well from both a relative growth standpoint as well as a credit quality standpoint. And we feel good about how we're positioned. And that's all I'd really say. I really don't like to comment too much on the media.

Fair enough.

They do a fine job as well, but let them do what they need to do.

They'll do what they do. And we'll talk about the key issues. Credit, obviously, a very important issue on your Q3 call and in your Q3 results. I think it overshadowed other parts of the story that I want to get to. But I think it is important to talk about credit upfront. And really, the key question that I think investors have, if we distill it is just is CIBC a credit outlier among the peer group. And so -- maybe we'll start there and get your response to those, I think, fears that are out there to some extent.

Well, I think credit it's an appropriate topic in the banking sector just given what's happened to rates and what is likely to transpire with the economy over time. And so anyone's guess is to where it goes from here. It might be a soft landing, it might be a little more bumpy, I'm kind of somewhere in between the two. When it comes to our credit quality, it's fine. So yes, the call was overshadowed by your models. There's 2 components to the credit story that I just want to focus on at CIBC. Let me get the first one out of the way, and that's the U.S. CRE piece, which we've been quite clear in the second quarter call and the third quarter call that we have less than 1% of our loans exposed to the U.S. Office space equated to about USD 3.8 billion. We are, by the end of this year, halfway through the maturity schedule. We've seen some losses from that. We've been quite clear that those will be elevated for the next couple of quarters. But that's it. The U.S. story, and we could talk about the U.S. a little later, the U.S. business continues to perform well in an economy that's also evolving given the rising rate environment. When it comes to our credit quality in our mainline Canadian business, I would say it's fine as well. Look past the models and look at our allowance coverage ratios, we're well within the peer group. Look at our performing provisions on a year-to-date basis, we add up all 9 months, and we're well within most of the peer group. So that, to me, is a better reflection of where we are in terms of credit quality. When you look at the underlying consumer credit and you look at gross impaired loans at CIBC, we're well within the peer group. If you look at the impaired component of consumer loans at CIBC, we're well within the peer group. We don't have underwriting standards that deviate from our peer group. We compete in a highly intense -- intensely competitive market, and we feel comfortable with the credit quality that we have in place.

Just digging into that, a lot of people are focusing on the volatility and you're performing PCL number in Canada. And people trying to understand what's driving that? And how big an issue is it from your perspective?

Every financial institution has its own models. Some are more sensitive than others quarter-to-quarter. In the most recent quarter, we saw 2 rate increases. We used total debt service ratio in our models. And as our CRO, Frank Guse, outlined in the quarterly call that resulted in some level of elevation. We also apply expert credit judgment as all our peers do. We have different models. And again, if you look at it over a 9-month basis, the performing provision that our bank is not an outlier. So again, I think it's important to look at it along the continuum. Obviously, we want to deliver consistent earnings growth. And this is maybe we could talk about how the bankers are doing from a pretax, preprovision earnings standpoint, which I think is a reflection of the core earnings of our bank and the core earnings power going forward.

I want to get to that. You touched on the U.S. CRE exposure upfront. Maybe just digging that a little bit more and just getting it out of the way in terms of U.S. $2.1 billion office book in the United States. How high can losses get in that book? How should investors think about that from that quantum?

So it's a $3.8 billion book in total. Again, by the end of this fiscal year, we will have been through more than half of it in terms of maturities. We've said that over the next couple of quarters, you should see losses that are similar to what we've seen in the past. But again, it's a fluid market. I think we have to recognize that now you're seeing some funds, raise money and trying to come in to invest in some of these assets. We've increased our allowance coverage ratio from 4.1% in the second quarter to 7.6%. We've telegraphed to our investors that we've got a handle on this. We're working through it with our clients. There'll be some elevated losses, but it's a finite portfolio. It's less than 1% of our portfolio, and we'll work through it and the rest of the U.S. portfolio continues to perform well.

And is there any lessons that you as a CEO draw from the experience in that portfolio specifically?

It is a legacy portfolio that really focused on the institutional real estate segment. When you look at sort of the origination loan to values were in the 60% range. COVID really had a ravaging effect. So one thing you go to first principles and say, our relationship-based bank needs to have a broader and deeper relationships. And that's why we're shifting the U.S. focus away from that aspect of CRE and focusing more on our diversified portfolio in commercial lending, where there's more connectivity to our capital markets business in the U.S., more and more connectivity to our wealth management business, developing a deeper and better relationship with our clients and a better risk profile.

And in terms of -- I think it came up on the COVID, question of -- does this experience in the CRE book in the U.S., does it impact the earnings power of your U.S. business? And how do you view that?

Look, I don't think over the medium term, it impacts. As you course correct and [ Sean ] was quite clear about this, he thinks he can redeploy the resources into the commercial sector as well as deliver better growth in the capital-light segments like wealth management, where you generate more of a noninterest income stream, and we're growing that, and we're implementing some new technology this fall, which will allow us to grow that at a better clip and working closely with the capital markets team to deliver more ancillary fees to our business and to our shareholders. So I think that in the end, loan growth will be in the mid-single digits in the U.S. and it will be more tilted to the diversified industries and away from institutional real estate, and I think that will bode well for our strategy going forward. We've made a good investment in the U.S. It's proven to be a really good one. We're going through a little bump as banks do from time to time, and we're confident in our strategy going forward.

I want to maybe talk a little bit more about the connectivity in the U.S. between the P&C business and wealth and capital markets. But before that, maybe taking a higher level approach, and this came up earlier today as well. I mean it seems pretty clear that the U.S. banking environment is more challenging. We went through a banking crisis, but even beyond that, the regulatory environment, there's an element of a secular change here that is just making it tougher to operate a bank in the U.S. So first off, just to get your thoughts on that, would you agree with that assessment? And then how does that filter to your U.S. growth strategy? Does it -- do you have to adjust your U.S. growth strategy given this reality. But maybe first the premise, like do you accept that?

So I do accept your premise that it's a more difficult operating environment from a macroeconomic standpoint as well as from a regulatory standpoint. I think we all see that, we read the same press. We invest in a business like we invested starting in 2014, but more notably in 2017 to diversify CIBC's earnings to actually have some connectivity in terms of building a North American franchise. We made the right investment. And we didn't invest for a 5-year cycle or a 10-year cycle or a bull market cycle. We've invested recognizing they're all kinds of cycles in banking. Do we feel good about our strategic positioning and focusing on the private economy and not being a high street retail bank, but focusing on entrepreneurs, focusing on their businesses, focusing on their wealth? Do we feel that we can bring our capital markets business close to that? Do we have a proven business model in the Canadian market? Or we've demonstrated that. Today, a good minority of our commercial banking clients have a private banking relationship with this. Over a 3-year period, we've had $18 billion of referrals from our commercial bank in Canada to our wealth management business. We're starting to see the same mechanics take route in the United States as we build those relationships and build out our private banking capabilities. Does our capital markets business work closely with our middle market clients in the Canadian market? It does. It generates really good revenue streams for both retail and commercial banking and wealth management. Are we starting to see the seeds of that strategy grow in the United States? We are. So as a bank, we deploy the capital that you've entrusted us with. We think about what does this look like 10, 15, 20 years out. Your economist talked about the North American economy. If there's any place that it want to be at this time in sort of history, this is an economy -- an economic region that we want to be banking, and specifically banking broadly in the Canadian market, just given our heritage and banking the private economy in the United States, given the shift from public markets to private markets.

I wanted to talk about credit risk as it relates to housing and the higher-for-longer scenario. And how significant a risk factor is that? I mean, you have the value of nonamortizing variable rate mortgages and your book moved up to $50 billion in Q3 from $44 billion. How worried should investors be about that? And more broadly, the ability of consumers to bear significantly higher rates. And so how should we think about that from a risk perspective?

Well, if you think of it from our clients' perspectives, rates have gone up and it's created anxiety and stress in the lives of Canadians that own homes and have mortgages. There's no doubt about that. That holds true across the system, and I think we have to be very sensitive to that. When I look at what is happening from an underlying credit standpoint, there's a couple of things that I'd say, one is, we have a $260 billion mortgage book, give or take, a couple of billion. 33% of that is variable. So it's about $80 billion, $50 billion is nonamortizing today. So in the variable rate world, you have seen an effect on clients as rates have gone up. We haven't seen issues as they've renewed. We've seen some clients take early action. We know that the average payment for a variable rate mortgage, which is adjudicated by the way, at a higher rate. So it's not as those adjudicated on artificially low rates in the past given the rules we have in our country. People are paying more. As they pay more, you ask yourself, can they afford it? One is they have equity in their homes. The loan-to-value on overall mortgage book is on the insured components 53%. So they have built wealth there. They also have excess deposits relative to where they were pre-COVID to the tune of about $10,000 on average per mortgage holder. So when you look at that increased payment, you look at that deposit buffer, that provides some buffer. And my belief is that rates next year will start to head lower as the economy starts to course correct. And I believe that clients want to preserve as much of the wealth in their homes as they have possible. So as long as they're working, I think that they can withstand these higher rates as they are today. And the thing I worry about for clients is just the wealth effect of the home equity they've built in their homes, 53% loan to value, what does that look like in a more difficult scenario? In a more difficult scenario, you lose some of that home equity value. And I'm hopeful that rates will head in the right direction, that the central banks have made all the right decisions to cool off the economy and cool inflation to the point where we'll have, I think, a relatively constructive landing. It will be a bit bumpy, but relatively constructive relative to where it was maybe a couple of months ago and what views people had. So I don't worry about our mortgage portfolio from a credit standpoint. I worry about our clients. I worry about the fact that we want to stay close to them. We want to help them with solutions. We want to make sure that their families are well taken care of, and I see some construction of action on the part of our clients. And I see their ability to withstand the higher payments per month, just given some of the cushions that have been built up during the COVID period.

So you highlighted the cushions that the consumer has. And I thought maybe you could comment, taking the conversation back to CRE. And I think you've talked on this a little bit in past calls, but the difference between the environment in Canada versus the U.S., our Chief Economist just talked about it. Why is it that even from a CRE perspective, Canada is looking more resilient from an Office perspective, especially relative to the U.S. And so the key factors there?

Well, one of the key factors is the nature of the ownership of Canadian commercial real estate and the fact that there's recourse to most of it. That is one factor. The second factor is what [ JF ] highlighted, and I listened to [ JF ] earlier about the demographics and particularly the inbound new Canadians who want to build a new life here. The demographics of population growth in Canada, I believe in the G7 and the G20 are like the most robust than any nation in that grouping. That is attractive. Those new Canadians come in with education, with hopes and dreams, with skills, with some money. And I think all of that will bode well for commercial real estate in the Canadian market. Now you're going to see the bumps and grinds, but I think over the cycle, you'll see that get to a better footing. And some property will probably get repurposed. And we'll get to the conversation on homeownership and affordability at some point, but we need to think about how do we rezone some of these properties to allow for more residential occupancy in our urban and suburban centers where this commercial real estate sits.

Maybe that's a good segue in terms of residential real estate, I think it's well understood now that there is a big imbalance between supply and demand. And so we need more supply, but it strikes to me that there's a contradiction between that need and rising capital rules for banks, higher taxes. In that environment, well, I'm curious, your perspective on that. Is there an issue in terms of banks being constrained from a credit availability perspective? Or is that not the issue here. When you look at this policy problem from your perspective as a big bank CEO, where do you see the issue?

We're not constrained from a credit standpoint in terms of supporting our clients as they want to achieve the dream of homeownership. This is a supply problem first and foremost. You can read -- anybody that's out there, that's an authority and what's going on and do the math on how many people want to build a new life in Canada. And the current run rate of buildings -- building units, which is 200,000 to 250,000 depending on the year. We're going to -- the CMHC says we're going to fall short by 3 million to 3.5 million units by 2030. Divide that by a number of 7 or 8, pick your year, we're probably building half of what we need to build to accommodate. Now does it all need to be built? Is there a way of freeing up the existing capacity that exists in urban basements to actually get people to rent more and give them the incentive to rent more. That provides a stream of rental income, it also provides a stream of housing. Governments need to coordinate more in terms of housing policy and not have a municipal government with a strategy and a provincial government with a strategy and a federal government driving robust immigration but not being as mindful as they should be around housing. And do we need more coordination in that regard? What do you need to kind of make that work? There's lots of ideas around land availability. Governments own a lot of land. Shouldn't some of that land be freed up in the hands of the private sector, who can help build out both homes that can be owned, but more importantly, purpose-built rental. Purpose-built rental is something that we need to drive more of. So a land component, partnering with the private sector, maybe we need to be creative and think about how Canadians, who've got money invested in their RSPs can invest in these rental units themselves as a tax break so that we feel we have a stake in the game. And we're building a new country, a bigger country, a country that welcomes people not just through the borders, but also when they settle here, so they have a roof over their heads. I think that needs to start to happen in a meaningful way. Our Chief Economist, Benny Tal, has talked about waiving HST on purpose-built rental. Can you put in a provision like the U.S. has Section 1031 where you can actually invest in a purpose-built rental that if you sell it and you roll it into another purpose-built rental, you defer your capital gain. We need really bold policies, coordinated policies, policies that bring in the private sector, policies that bring in Canadians -- everyday Canadians who want to save a lot of stake in the future of our country and the future of immigrants who can contribute to say, let's make this work. And that requires a great degree of coordination and it needs to happen probably in the next 12 months.

That's -- I mean, I think you've been kind of leading voice on this issue, and I think that really resonates. One thing I wanted to talk about bring it back into the business, one thing that struck me in your results and didn't come up on the call was the growth in cards that you've seen on a sequential basis, very strong growth. And there's another bank that saw similar growth as well on a quarter-to-quarter basis. But when I saw that kind of growth, 7% quarter-over-quarter growth in card balances, it struck me as high in this kind of environment. And so I'm wondering, from your perspective, is this the right point in the cycle for that kind of growth? What's your perspective on that? So really a question on the appropriateness of that kind of growth in the cards portfolio right now for CIBC and how do you view that?

Well, a couple of things there. It's a good question. So on our credit card portfolio, it's been a deliberate strategy to build out a robust card portfolio that is travel and nontravel, that skews to a premium client base and that allows us to franchise clients over time. So let me talk about that a little bit. But let me also ask you to just look at the third quarter results in terms of 90-plus day delinquencies and net write-offs, and you'll see that our card portfolio is behaving well from a credit quality standpoint. You're seeing the growth because we're growing our cards portfolio. We're growing our -- we have an Aeroplan franchise. We should -- another bank does as well, that's fine. We -- and those clients have deep relationships with us. We have an Aventura franchise that we've built out over the years that's formidable. That allows clients to fly anywhere just like some of our competitors do. So we have a dedicated airline program, a fly anywhere credit program, that's a travel segment. Then we have the non-travel. The CIBC dividend card, which has been growing robustly and the Costco credit card. That portfolio is not only attracting an attractive client base to our franchise. It's also giving us the opportunity to franchise clients for banking over time. And that's what's driving our growth. So it skews premium. It's well diversified. We feel comfortable with the credit quality. We feel comfortable with the underlying client behaviors. And we're encouraged -- we're 15, 16 months into the Costco relationship, we're already starting to see the franchising of clients from a banking standpoint. And let me just remind you that of that 2.4 million, 2.5 million cardholders within Costco, 2/3 of them would be affluent -- mass affluent clients, the kind that would fit into our relationship-oriented strategy within our Canadian personal bank that will allow a deeper and better relationship to flourish from there.

I want to talk about expenses. That was definitely an area where I think CIBC stood out positively in Q3, only 1 or 2 banks had to see negative operating leverage this quarter. And so when it comes to expense management, certainly feels like CIBC is -- and a few investors comment this to me like they're ahead of the curve -- that your bank is ahead of the curve when it comes to expense management. But the question that comes up sometimes afterwards is, oh, they're probably under-investing. There's a question, are they under-investing? So how do you respond to that?

Look at the continuum of what we've tried to achieve over the last number of years. Last year, we had -- we were at the upper end of revenue growth, preprovision earnings growth and certainly investment or expense growth. And at the end of the year, we signaled to our investors that now we've seen the peak of our investments and you'll get to a different run rate going forward with the goal of achieving positive operating leverage, which we achieved this quarter. Our goal is to continue to achieve that going forward. Why? Because we've made the investments. We've made the scale investments in cloud. We've made the scale investments in digital financial planning. We've made the scale investments in our client relationship management platform. We've made the scale investments in anti-money laundering. We made the scale investments in cyber. And those -- some of those, particularly, some are defense, some are offense, will allow us now to harvest those investments and build positive operating leverage going forward. We are not starving our businesses for investment. We have made significant investments, large investments in our bank, modernizing it and continuing to modernize important parts going forward. So when you see a lower expense run rate, it's because some of the technology is working for us, just like the narrative that we laid out at the very beginning, and it's allowing us to achieve efficiencies and to get scale. And with that, we're going to continue to push for efficiency in terms of how we operate our bank going forward because I think the revenue environment will be more challenged than it has been in the last 2 years. And doing that in a way we can still deliver positive operating leverage.

And we've been hearing a lot about that in terms of a more challenged revenue environment and how banks actually manage through that both on the expense side, but also from just revenue initiatives.

Right. So as we focus on our biggest business, our Canadian Banking business, a real focus for us is our Imperial Service, which continues to stand unique in the marketplace in terms of a relationship manager that manages both sides of the balance sheet. It is a client base that is capital light in terms of its holdings with us. That's affluent. Our CIBC GoalPlanner has uncovered significant assets at other financial institutions that allow us to have genuine conversations on how to consolidate and deepen those relationships. Our Costco credit card portfolio will feed into that Imperial Service affluent narrative as we continue to grow that. We've also identified clients within our [ Mainline Personal Bank ] that's best served by Imperial Service. So we have an affluent strategy that's clear, that's highly articulated, that's capital light. And at the same time, we recognize what I call the bifurcation of Canadian retail banking. There are clients who want digital and direct, there are clients who want a relationship. When it comes to the digital and direct clients, we acquired over 650,000 clients in our Canadian consumer franchise over the trailing 12 months. That is a feeder for the future. Some are affluent, many are emerging affluent and Canadians who have hopes and dreams. And we want to make sure that we're growing that pipeline of clients going forward through our Simplii Financial platform as well as through our [ Mainline Personal Bank ]. In that regard, we've launched [ Smart Insights ] which is a light version of planning for our core client base. J.D. Power just ranked this as the best mobile banking platform in the country. Now we live within a very competitive group. The Canadian banks are really good at mobile. We want to stay at the leading edge of that and be relevant to our clients. We think that, that strategy within Canadian banking overall will drive a good result -- capital-light result, continuing to grow our U.S. -- our Canadian Wealth Management business, also a capital-light business. And then making sure that our capital markets continues to perform consistently and that our U.S. region can make that pivot that we discussed earlier and delivered the results that our investors expect. So we feel good about how we've engineered our franchise going forward. And now it's just a matter of executing against that and U.S. investors holding us accountable to those results.

Victor, you talked about investing in the business and some of the key tech investments that you're making. One topic that I'm asking all of your peers, is really related to AI 2023. It's all over the news and the question from an AI perspective. I mean, I'd be happy if you could talk a little bit about what CIBC is doing in the realm of AI, but I really look at it more from the perspective of key takeaways for investors. Is this something that can move the needle on expenses, revenues, both, neither. How do you see that from your perspective?

I see AI having a notable impact over the medium to long term. I think it can be a little overhyped in the short term. But when we look at it, we see a couple of broad areas of application to the bank, which we think will have net financial benefit to our shareholders over time. So, one is, have you built a cloud capability to deal with the power of what you need to do in analytics when it comes to AI? Have you organized your data in a way that you can use that data to your advantage when it comes to AI? And then how do you apply it going forward? We're already using it in our credit card business in terms of how we understand client purchasing behavior and how we can drive a better outcome for them and for our shareholders. We also now are looking at -- so there's a revenue component to it. We believe that it can be used with our financial advisers and our digital financial planning platform and how we use our CRM system to drive a better outcome by helping our advisers understand clients better. We think that AI will take some of the grant work out of writing investment proposals, doing KYCs, some of those important factors that we need to do from a regulatory standpoint, but may lighten the load in terms of what an adviser has to do in terms of serving the clients appropriately. We already are applying a use case. We have 7,000 people in our banking center network that serve our core clients, not in our affluent segment, but our core clients. They call a national support line. And our support line has 50,000 pages of data. So they can go through the 50,000 pages or they can call. Most of them tend to call. AI is being used now, and we're seeing the large language model kick in, in terms of its efficiency. It's gone like 35% to 81%, pushing it to the high 90s in terms of our team being able to use all that data to be able to answer questions in terms of products and services for their clients. And when you have turnover at the entry level, it's really important that, that AI is working for you. And the AI is being engineered in a way that it recognizes who's asking the question, what's your tenure what's your level, which is something that today ChatGPT doesn't do. It doesn't know who's asking the question, doesn't know what kind of experience they have. So we're trying to understand the experience of the user, make the user experience better and get answers to our clients more quickly. That takes the friction out of working at a large complex organization out, and it makes them more pleasant, both for our team and for our clients. So we're using it to drive revenue, drive better cost efficiencies, and we're going to be using it for the protection of the bank when it comes to cybersecurity.

I think you said not a near-term benefit, but you definitely see benefits.

I think so. I think it's important to kind of do this in a measured way. It's also important to just start focusing on large language models that apply the generic aspects of how we operate our business before we start using too much client data. That's something we need to be very sensitive to.

Finally, I wanted to talk about capital in the few minutes that we had left. And just ask a question in terms of the capital benefit that you expect to get from the transition to the advanced approach in your U.S. portfolios and sort of how you view -- how significant should investors view that?

Sure. Well, let me just talk about capital from -- what is our operating posture on capital. Currently, the buffers are at 3.5%, which means minimum is 11.5%. And our view is you need to operate at 12% to 12.5%. We're at 12.2% today. We've been very focused on building our business while also building capital. So over the course of this year, we've built capital through organic capital generation through our DRIP, which we have in place on a quarterly basis and through strategic risk transfers that we employ from time to time. So our next parameter is to see what happens at the end of the year in terms of the capital buffers as articulated by our regulators. If it stays at 3.5% operating in the 12% to 12.5% range is the place we'd like to be. And we want to start deploying some more capital in some of the businesses to drive growth. If it goes to 13%, we have a plan to build up to that 12.5% to 13% range and probably operate in that 12.5% range under that type of a regime. When it comes to AIRB, we have made an application to move our U.S. models to an advanced approach. That plus the Basel III reforms of the first quarter of 2024 FRTB, et cetera, should deliver a net capital benefit. That puts us on that path of 12.5% and if need be higher depending on where the buffers are. So we feel good about where we are. We feel good about how we can build capital. And then as the economy evolves and things become clear, we'll have a better sense on how to deploy that going forward to generate returns for our shareholders.

And that's already built into your guidance on capital the U.S...

It is. It is, yes.

And then just finally, on the U.S., will changing capital rules in the U.S. impact CIBC in any way? And could it just be as simple as creating opportunities as maybe some competitors in the U.S. struggle more.

Yes. Well, we'll see where the rules actually fall out in the end. I mean, in the end, we look at it more from a top of the house perspective, and there may be certain parameters that as a large foreign banking organization we need to apply into the United States that will probably relate more to funding and liquidity than it will to capital. I think from a capital standpoint, we're fine. And I don't think that will -- we kind of look at the OSFI kind of buffers as our leading kind of guidance.

I think with that, we're basically out of time. So thank you so much, Victor. Always great speaking to you.

Thanks Meny. Always great questions from Meny. Always great to see you. Thank you for your investment in our bank. Thank you.