BRENDA DALGLISH November 2 1992



BRENDA DALGLISH November 2 1992




Al Flood, the new chairman of the country's second-largest bank, the Canadian Imperial Bank of Commerce (CIBC), began his banking

career as a messenger, at the age of 16. It was 1951 in the small town of Monkton, Ont., near the Mennonite farming communities west of Kitchener. “I came from a fairly modest background,” Flood said. “My father encouraged me to go out and earn some money, earn my own way.” From that humble beginning, Flood, 57, scaled the corporate ladder and emerged earlier this year as the victor in a succession contest among a handful of the bank’s senior officers. He now says that one of his goals as chairman is to help the bank loosen its stiff hierarchical structure—a pecking order so rigid that a previous chairman once decreed that subordinates should not initiate conversations with him. “People can talk to meanytime,” said Flood, “and many of the employees call me by my first name.” But Flood’s appointment was followed by the abrupt departure of several of the bank’s key employees, a sign, perhaps, that the new environment is not quite as congenial as Flood suggests.

Flood has assumed one of the most powerful financial jobs in Canada at a time when the world economy appears to be entering a new cycle of slow growth and low inflation. Only half-joking, he said: “Maybe you could say that I am taking over at the wrong time.” Flood anticipates that the challenge of the deflationary climate will be a trying one for a society— and a banking industry—that has grown accustomed to the forgiving effects of steady inflation for 30 years. For its part, the CIBC has already experienced its first sobering lesson in deflation: the collapse of one of its prize customers, real estate giant Olympia & York

Developments Ltd. (O&Y) of Toronto.

As head of ClBC’s corporate bank, Flood worked closely with O&Y’s Paul Reichmann, and was on the frontline of the commercial real estate debacle, just as he had been during the 1970s when he was a senior executive in the bank’s U.S. and Latin American operations. Then, the bank was making massive loans to the frequently unsavory governments of such countries as Brazil, Mexico and Argentina. “I

take full responsibility,”

Flood said, adding that his past experience will help him avoid such mistakes in the future.

So far this year, the bank, which recorded assets of $132 billion on July 31, expects to set aside an estimated $1.75 billion in the current fiscal year for bad loans, including its O&Y exposure. In the 1990s, the bank will clearly have to prevent making mistakes of that magnitude. “We will have to be very careful how we manage our overheads and our risks, because we can’t afford to have too much wastage or too many losses,” Flood noted.

“We will not be able to offset future losses with an expansion of substantial new business.”

Although Flood’s most recent experience has been in international and corporate lending, he predicts that in the 1990s, most of his bank’s growth will take place among individual retail clients and

smallto mid-sized businesses. Said Flood: “The large corporations can go to the public capital markets a lot more, and not use the commercial banking system on a heavily concentrated basis.” This shift will be a benefit to

the smaller business segment, which has in the past been frustrated by the banking industry’s preference for extending loans secured by assets rather than cash flow, a practice that favors large, established companies. “We have a responsibility to support that whole segment because that’s where your new jobs are going to come from,” he added. “And the real challenge this decade is going to be job creation.” The CBC’s shift in focus from its bigger to its

smaller domestic customers could also lead to a welcome change for its shareholders. According to industry accounting practices, bank-loan losses come directly out of profits, and during the last decade, reported loan losses have frequently been higher than profits. As well, most of those loan provisions are a result of the banks’ international and corporate lending activities. The CIBC has turned in a particularly poor performance. It had huge losses on its loans to less developed countries and it was lead banker to two of the three biggest Canadian business failures of all time, O&Y and Dome Petroleum. Flood’s key role in exposing the bank to such financial disasters did not, however, deter the bank’s board of directors from promoting him. Alf Powis, chairman of the board’s succession committee, dismissed the impressive list of lending losses: “Every other bank in the world was

doing the same thing.” In the case of O&Y, Powis, who is also chairman of natural resources giant Noranda Inc., noted that the bank’s exposure had been substantially reduced in recent years. “Everybody made mis-

CIBC's profits and loan-loss reserves

million * includes special loan-loss provision for Less Developed Countries (LDC) debt ** for the first nine months of the bank's fiscal year Source: CIBC

takes,” said Powis. “The Commerce certainly wasn’t immune from them. Hopefully, we have all learned a lesson.”

But Michael Mackenzie, chief of the federal office of the superintendent of financial institutions in Ottawa, expressed more concern about the financial adventures of the banks and trust companies. “One of the fundamental problems of institutions that get into trouble,” he said, “is a lack of accountability built into the management structure and culture, and that includes boards of directors and professional advisers.” Mackenzie declined to comment about the CIBC specifically, but in general, he

said, “when people make mistakes with other people’s money, they should be held accountable in some way.”

For his part, Flood says that he does not think that another O&Y-scale debacle could happen. “I would hope not,” he said. “I don’t think we would have the same concentration in one company, or in one industry.”

That has become a familiar refrain from many senior bankers. Three years ago, Flood’s predecessor, Donald Fullerton, was equally ready to confess his mistakes. “Like many financial institutions worldwide, your management made a number of mistakes in the 1970s

which reflected the euphoria that can develop during a long round of relative economic prosperity,” Fullerton told the bank’s annual meeting in January, 1990. “The 1980s were spent relearning the lessons of the 1930s.”

As the Canadian economy limps through a severe recession, Powis puts credit quality at the top of his list of priorities for the CIBC’s management. Under Fullerton, the bank’s risk management system was revamped and turned over to a team of executives headed by Gerald Beasley, executive vice-president of risk management. Flood explained that the bank has introduced a “strong risk-rating system.” Said Flood: “There are people continuously looking at portfolio management, tracking where the concentration of risk is occurring.” He added: “We are doing a lot more loan syndication and selling more assets, if you like, moving things around.”

The spectacular loan losses of Canadian banks have been cushioned by consistent profitability in other segments of their business— in particular retail banking services. As a result, shareholders have not had to bear the full financial burden of the last decade. In fact, bank stocks have outperformed most other stockmarket categories during this recession. In 1991, Canada’s six major banks achieved an average annual return on equity of 13 per cent. And even in the first three quarters of fiscal 1992 to July 31, they achieved a 7.6-per-cent return, better than many of their corporate clients.

Although shares of the CIBC have been lacklustre performers lately, at least one topranked banking analyst says that he is starting to warm to them. Said Hugh Brown of Bums Fry Ltd.: “They have had credit problems blow up for two [business] cycles now. I think they have learned some lessons from that.” Brown added that the CIBC’s senior executives “are quite embarrassed about the whole thing. They thought they had the systems in place and some of the big problems are really violations of their own [credit-risk management] manual.”

But Brown added that the proof of the CIBC’s success—or failure—will only become apparent in the next economic downturn—if the current depression ends soon—probably some time towards the end of this decade. “I think during the last recession they wrote the manual, but no one read it,” Brown said. “This time, they have revised it slightly, but now they have a guy who gets up every day and reads it.” Brown said that he will start recommending that investors buy CIBC shares when he is convinced that its loan-loss provisions are back to more normal levels.

The extent of the loan losses depends largely on the commercial real estate market. With office-building vacancy rates in Canada at 15.7 per cent and deeply discounted rental rates, the cash flow of commercial real estate companies has plummeted. Flood acknowledges that the problem will not be solved quickly. “The leases being signed today at low rates are going to have a long-term impact on the value of these buildings,” he said. “Value is being driv-

en by cash flow and cash flow is down.” According to Flood, commercial real estate is going to be depressed for “a minimum of five years.” But Flood claims that much of the impact on CIBC is “behind us” because of the extent of the reserves that CIBC has already set aside. Others, including the Royal Bank of Canada, the country’s biggest bank and CIBC’s main rival, have not yet set aside the same degree of reserves.

At the same time as he is training a close eye on the bank’s loan portfolios, developing a new business strategy and thawing its corporate culture, Flood is also contemplating a foray into the United States. For several years, the CIBC and other Canadian banks have looked to the south as an ideal target market for their retail banking skills. To date, none has found the right bank at the right price. But as much as the CIBC would like to acquire a U.S. retail operation, Flood is circumspect. “The probabilities are very low at this particular time,” he said, “but that does not mean we have stopped exploring. The real strength there is having the discipline to do the right thing.”

Another of the new chairman’s management challenges is changing the nature of the jobs of many of the bank’s 50,000 fulland part-time employees. “We are moving from a traditional hierarchical organization that is organized by layers of management to one that is customerdriven,” he said. To start that process of change, the bank has recruited a number of department store and consumer product retailers who are experienced at selling, and has integrated them with traditional bankers. “We would like to turn the organization over to the employees on the front line and then reduce our head office, regional offices and supervisory personnel,” Flood said. “It’s a dramatic change and it will not happen overnight, but we’re moving in that direction.”

As for his management style, Flood, emphasizes his openness and willingness to listen to others. “Having started at the bottom and worked through it myself, I understand it,” he said. (The bank is also where he met his wife, Rolande. They have four grown children, including a daughter who is also a CIBC employee.) “I have an empathy with people, I have a rapport. I understand what they are dealing with day to day, how the stress of dealing with a recession on the front lines is a challenging job for a banker at any level.”

If Flood’s actions as chairman live up to his words, the new sensitivity will be welcomed by many CIBC employees who often found Fullerton, the privileged son of an investment banker, to be aloof and autocratic. Despite Flood’s encouraging words to bank employees, however, he has a reputation among his colleagues for being hot-tempered and unreasonable at times. But perhaps, as Flood promises, the breadth of his banking background and his “hands-on experience with adversity” will give him “the depth for dealing with the unknown” that every new bank chairman should have in a highly uncertain economic climate.