CIBC is gaining ground on strong fundamentals
Fears of mortgage related calamity are overblown
Canadian Imperial Bank of Commerce (CM.TO) has moved up nicely off its lows on the strength of solid quarterly results and a nudge upwards in the dividend to CDN$3.60 a share. The company’s brief trip to less than CDN$50 a share and to a price well below book value created a rare opportunity for wise investors to show a little courage and load up on the company’s shares. Today the shares closed at CDN$56.10, up CDN$2.74 on the day for a nice 5% move on the day.
Short term moves don’t interest me all that much, but Big Five Canadian banks that trade below book value get my attention. One year ago CIBC shares were trading at CDN$65 a share and I thought that was low in relation to the bank’s earnings power. The shares now yield ~7% and I expect the dividend to keep growing as the Canadian economy recovers from the disastrous Liberal government policies and Trudeau gets tossed into the wastebin of history next election, likely in early 2025 and certainly when the current term ends no later than 20 October 2025.
Canada’s weak economy is an outgrowth of Liberal stupidity in Ottawa with massive federal debts, persistent deficits and a Prime Minister who doesn’t concern himself with monetary policy, fiscal policy, energy policy or any other policy other than buying enough votes to keep himself in power. His disgraceful conduct has made Canada a laughing stock on the world stage and crippled the housing industry with home prices well over what ordinary Canadians can afford and interest rates crushing household budgets. That will change after 2025.
Investors fled the Canadian banks fearing mortgage delinquencies would decimate bank profits and they were right, but like most reactions to risk, the fear was overdone. Enormous immigration (with the Canadian population growing about 1 million persons a year) has kept demand for homes strong despite the high costs and nosebleed interest rates and prices, while softening, have not collapsed. Two thirds of Canadians are mortgage free and insulated from the chaos Trudeau has caused. Many of the others will face higher monthly mortgage costs as their mortgages roll over, and without any doubt there will be people who lose their homes and personal bankruptcies, a legacy of electing an inept Prime Minister and an incompetent Minister of Finance. But Canada’s largest banks are well capitalized, well-managed and have more than enough stamina to weather the mortgage storm now underway and to emerge stronger and more profitable.
TD Bank sees home prices falling by 10% by the end of first quarter 2024 and I suspect this is conservative and the outcome will be worse for homeowners but better for home buyers. The average loan to value ratio for Canadian mortgagees is 58% and a 20% drop in home prices would leave this ratio less than 75% percent which is still reasonably healthy. Defaults will happen, power of sale proceedings will contribute to homes changing hands, and buyers will find the market more hospitable than now. Banks will either be repaid in full or take relatively small losses, with house prices still well above the average mortgage held by banks of just over $300,000 and the highest ratio mortgages typically insured.
Mortgage default rates in the third quarter of 2023 were 0.15%. The banks hold $1.5 trillion in mortgages. Assuming the mortgage delinquencies are evenly distributed across the outstanding mortgages, defaults total $22.5 billion and losses on those defaults at a 10% rate (which I think is conservative, but representative) amount to $2 to $3 billion in total. To lose 10%, the mortgagor would have to sell the property for 20% less than the mortgage principal, an unlikely event. The Big Five Canadian banks have set aside $2.5 billion (as of March 2023) for credit losses.
The banks are pretty well reserved and can readily set aside more reserves given the combined net income of the largest Canadian banks is on the order of $60 billion.
In my opinion, the risk to the banks from the mortgage sector is manageable and will pass. I like the banks for their reliable history of steady profit and dividend growth and think CIBC will be among the larger beneficiaries of economic recovery. I hold options on 10,000 shares that expire in 2026 at a strice price of CDN$50 a share. I will be surprised if that holding does not make me a few hundred thousand dollars before the options expire.