-- We believe that the Canadian banking sector is encountering incremental pressure from headwinds facing the Canadian economy, which is heightening economic risk in the banking system.
-- We also believe that industry risk for the Canadian banking sector is increasing. We expect that intensifying competition for loans and deposits will lead to pressure on profitability growth, especially in banks’ retail businesses.
-- We are affirming our ‘A+/A-1’ long- and short-term issuer credit ratings on CIBC, as well as the ‘A+’ issue rating on CIBC’s senior unsecured debt. We are lowering our issue rating on CIBC’s nondeferrable subordinated debt to ‘BBB+’ from ‘A-', and our rating on its preferred shares and hybrids to ‘BBB’ from ‘BBB+'.
-- The stable outlook reflects our expectation that the bank’s credit fundamentals will remain consistent with its current ratings over the next 24 months.
On Dec. 13, 2012, Standard & Poor’s Ratings Services affirmed its ‘A+/A-1’ long- and short-term issuer credit ratings on Canadian Imperial Bank of Commerce and its ‘A+’ issue rating on CIBC’s senior unsecured debt. In addition, we lowered our issue rating on CIBC’s nondeferrable subordinated debt to ‘BBB+’ from ‘A-', and our rating on its preferred shares and hybrid securities to ‘BBB’ from ‘BBB+'. The outlook is stable.
The rating action follows our review of banking sector industry and economic risks in Canada, taking into account the headwinds facing the Canadian economy, high debt levels of Canadian consumers, expectations of decelerating loan demand and continued pressure on margins, particularly in the Canadian retail sector, and areas of continuing weakness in the global economy and financial system.
We believe banks operating in Canada are vulnerable to an expanding set of potential stresses arising from competitive pressure on growth and margins, while asset quality is potentially vulnerable--in light of high consumer indebtedness--to developments that may trigger general economic deterioration in Canada. Consequently, we lowered our anchor stand-alone credit profile (SACP), which is the starting point for our ratings on financial institutions operating primarily in Canada, including CIBC, to ‘a-’ from ‘a’.
This is reflected in our revision of the Banking Industry Country Risk Assessment (BICRA) for Canada to group ‘2’ from ‘1’ and our revision of the industry risk score, a component of the BICRA, to ‘2’ from ‘1’ (see “Various Rating Actions Taken On Canadian Financial Institutions Due To Rising Industry and Economic Risks,” published Dec. 13, 2012, on RatingsDirect on the Global Credit Portal).
We believe that the banks and credit unions are under incremental pressure from the headwinds facing the Canadian economy. The acceleration of household debt to record levels has increased Canadian households’ vulnerability to sudden shocks in incomes, employment, or a spike in interest rates.
Exposure to the consumer sector accounts for nearly three-fifths of total bank loans, and losses on banks’ uninsured loan portfolios--although recent performance levels have generally been strong--may be driven higher in the event of a substantial shock to household creditworthiness, though we expect effective regulatory supervision to remain a positive influence on Canadian bank credit quality.
Although we expect ongoing intensification of competitive dynamics in the Canadian banking sector, we note that overall Canada still remains positioned favorably vis-a-vis most of its global peers. However, a slowing economy risks exacerbating the already-intense competition between banks for loan and deposit share and puts further pressure on the margin and profitability of the Canadian financial institutions’ retail and commercial lending businesses, the cornerstone of Canadian banking and largest contributor to revenues.
We also believe that Canadian financial institutions’ risk tolerances may increase to compensate for lower profitability by reaching for yield through investments, more aggressive lending in higher yielding loans such as personal loans and credit cards, or potentially a pick-up in mergers and acquisitions activity.
Furthermore, we expect that continuing industry conditions will test banks’ operational capabilities. Relative performance in areas such as service standards, cost control, operational effectiveness, underwriting discipline, and ability to integrate acquisitions will likely contribute to changes in market position and financial performance, and will have an impact on the relative credit standing among industry participants. Our ratings on CIBC reflect a combination of factors including the anchor SACP, company-specific factors, and our expectation for extraordinary government support.
For CIBC we start at the anchor of ‘a-'. We then adjust for CIBC’s “adequate” (as our criteria define it) business position as CIBC is the smallest of the big five Canadian banks in terms of total assets, but it holds significant market positions in several business lines, including credit cards, mortgages, and wealth management. CIBC has a stated aim of rebuilding market share through a strategy emphasizing customer focus while taking on generally lower risk credit exposures, although accentuating CIBC’s exposure to the Canadian consumer.
The challenge for the bank is to restore franchise momentum primarily based on customer service while competitors also maintain strong service offerings. Our view of CIBC’s “adequate” capital and earnings is based on a Standard & Poor’s risk-adjusted capital (RAC) ratio that we project will increase to between 8% and 8.5% by 2014, as well as on CIBC’s consistent earnings. The “adequate” risk position takes into account the good quality of CIBC’s domestic portfolio, with a majority of the bank’s impaired loans arising from its more limited Caribbean and U.S. loan portfolios.
We view CIBC’s funding as “average” and liquidity as “adequate”. This is based on the bank’s substantial base of core deposits and a low-risk securities portfolio, while recognizing a material wholesale funding component. It is our view that CIBC is a “systemically important” bank and that it would likely benefit from extraordinary government support in times of stress.
Consequently, the SACP on CIBC benefits from a two-notch uplift for government support relative to its stand-alone credit profile of ‘a-'. (This is an additional notch of support compared to that applied previously when CIBC’s SACP was ‘a’, reflecting the applicable criteria for notching.) Outlook The stable outlook reflects our belief that CIBC’s revised business strategy embraces a lower risk profile than in the past, focusing on the domestic market while avoiding higher risk activities unrelated to its core banking competencies.
Maintaining current ratings will depend on CIBC’s success in maintaining or building its profitability despite the potential for more difficult industry conditions, as the bank focuses on its core commercial banking strengths and executes its revised strategy that emphasizes core-relationship banking.
Ratings retention would also be predicated upon the bank maintaining a RAC ratio consistently above 7%. An upgrade would depend on the establishment of sustained franchise growth momentum relative to peers, with successful execution of its strategy reflected in its business position and capital and earnings. A one-notch improvement in the SACP would result in an unchanged issuer credit rating, due to differences in notching for support applied at different SACP levels.