Narrow-moat Canadian Imperial Bank of Commerce (CM) reported OK fiscal second-quarter results. While capital markets activity made a comeback and commercial and wealth were generally strong, the increased need for investment drove expenses higher, mostly eating up revenue gains. Given the weaker first quarter, and the expectation for continued expense growth, management admitted on the call that it now expects EPS growth to be close to flat for the year, compared with a medium-term goal of 5% or more.
We’ll note that we were already projecting essentially no growth in EPS from 2019 through 2023 and a decline in return on equity of roughly 200 basis points, so this does not alter our projections materially.
However, after some adjustments for higher expense growth and lower longer-term ROE’s, we are lowering our fair value estimate for Canadian shares to $125 from $131 and are lowering our fair value estimate or U.S. shares to US$94 from US$99.
Adjusted diluted EPS was $2.97 for the quarter, essentially flat year over year. Flat adjusted EPS for 2019 implies growth in EPS of roughly 2.5% for the rest of the year. The adjusted return on equity remained roughly constant, coming in at 15.9% compared with 16% last quarter. This means that for the first half of the year, the adjusted return on equity has fallen 210 basis points compared with last year, which is what we were baking in for a longer-term normalized return on equity. Given the potential for further credit deterioration as the cycle matures, we have adjusted our estimates to allow for a bit more deterioration for the return on equity metric.
Canadian personal and small business banking experienced some pressure during the quarter, as heightened expense needs and some increases in provisioning more than ate up the 2% growth in revenue. Given the potential for further normalization of credit, and the fact that management is characterizing the current expense increases as normal, we wouldn’t be surprised if the segment is closer to peak profitability for now.
Canadian commercial banking and wealth management had a good quarter, with assets under management up 7%, positive operating leverage, and good loan and deposit growth. The U.S. commercial banking and wealth segment also had a strong quarter, with adjusted net income up 24%, as strong loan and deposit growth and decent AUM growth more than offset a 9% increase in expenses.
Capital markets had a much better quarter, as provisioning disappeared and better activity levels helped revenue growth 6%.Credit quality generally improved during the quarter and while impairments were up, this was entirely due to a single utilities account again. The bank stated that it has since sold off its exposure to this loan, and removing this, the gross impaired loan ratio would have been 0.43%, roughly flat. Provisioning was also down compared with last quarter and only up slightly year over year.
Similar to the U.S., Canada is seeing some seasoning within credit cards, and CIBC is no exception. Delinquencies, after increasing slightly for the Canadian portfolio in the first quarter, were essentially flat in the second quarter. We’ll also point out that management seems to be okay with lagging revenue growth in the short term, as long as the quality of client relationships is improving in the background. While ultimately the success of any strategy is measured by profitability, if CIBC is indeed more focused on quality relationships rather than chasing growth, this could have a positive effect on underwriting quality and credit costs down the road, a much-needed improvement given how the bank performed in the last downturn.
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