Gerry McCaughey was hired to fix a mess. But can he learn to be bold?
CIBC: THE BANK THAT WOULDN’T GROW
Gerry McCaughey was hired to fix a mess. But can he learn to be bold?
For a man whose primary job over the past few years has been to pass along a stunning litany of bad news to investors, Gerry McCaughey is a surprisingly popular man on Bay Street. Since taking over as CEO of CIBC back in 2005, he’s paid out billions to settle a lawsuit, shocked shareholders with a string of writedowns related to the current U.S. credit crunch, and jettisoned the CIBC’s Wall Street investment bank at a substantial loss. But all this is forgiven—simply the cost of dismantling the legacy of his swashbuckling predecessor, John Hunkin, whose expansion campaign ran aground earlier this decade, and left investors more than ready for an unassuming man like McCaughey to wield the axe.
All told, the bank has written off $5.4 billion since 2001 to extricate itself from bad investments. Many analysts surveying the deepening crisis in the U.S. subprime mortgage sector suspect CIBC will have to absorb billions more before the mess is finally resolved. What’s left is a bank that has slipped to last place among Canada’s big five in terms of market value, a bank with few really encouraging growth prospects and no clear direction. All of which points to deeper questions— ones that will have to be asked, starting this week, when CIBC announces what are widely expected to be lukewarm earnings at best.
Is McCaughey’s aggressive therapy preparing CIBC for a brighter future, or reducing it to a shadow of its former self—victim of a cure worse than the disease? “Investors love it when you do big cost cuts, but they’re sophisticated enough to know you can only be the cost-cutter for a year or two until you have to do something else,” says Ohad Lederer, an analyst with Veritas Investment Research in Toronto. “Once this period of crisis ends, people are going to ask ‘what’s next?’ ”
There’s no question the bank needed whipping into shape. For years CIBC has plunged headlong into ventures that promised easy riches at the expense of long-term stability. Whenever there was a bubble about to burst,
you could be sure CIBC would be right at the centre of it. The credit crunch in the United States is just one recent example. Subprime mortgages to homeowners with poor credit are sitting in the bank’s investment portfolio like unexploded bombs. Some reports have pegged CIBC’s total exposure to the sector at $10 billion, of which 30 pc~ cent could be worthless. CIBC is expected to shed more light on the situation this week, when it reports its latest quarterly results.
For his part, McCaughey has grown accustomed to delivering this kind of bad news with expert efficiency. When CIBC’s board of directors tapped him to take the helm in August 2005, they did so in large part because he was the humble manager to Hunkin’s bold empire builder, the antithesis of his pinstriped predecessor. Hunkin had already written off several failed investments, including Amicus, CIBC’s electronic banking operation. Tasked with cleaning up the rest of the problems, McCaughey began surgery on the company’s corporate culture. He promptly settled a lawsuit launched by Enron investors for $2.8 billion over CIBC’s alleged involvement in the scandal, even though other banks facing similar suits held out, and may never pay a penny. And he’s axed hundreds of jobs while writing off the value of dud investments in the subprime debacle. The total hit to CIBC since McCaughey took charge: $3.5 billion.
A disproportionate share of the bank’s failures over the years have sprung from CIBC’s investment banking operation on Wall Street— Hunkin’s baby and the bank’s most prominent foray onto the world stage. Last month, McCaughey pulled the plug and sold the unit, along with 700 staff, to Oppenheimer Holdings in return for a stake in the brokerage. Even though U.S. investment banking contributed little to the bank’s bottom line, cutting it loose was a powerful symbolic break from CIBC’s aggressive but troubled past.
Despite McCaughey’s personal popularity, however, the market has been cool toward the redesigned CIBC, and the bank’s shares have failed to keep pace with rivals this year. The bank has refocused on the basics of retail banking, where profits are strong and predictable, and some investors think McCaughey
ought to get more credit for his discipline. “At what point is the Street going to give them credit for having a rock-solid retail franchise?” asks one exasperated fund manager. “They’ve drunk the Kool-Aid of retail banking. I don’t think it’s a passing phase.”
This is the very dilemma that faces every troubled business eventually, when a company blows its 1
out on pie-eyed ventures, and then brings in a sombre CEO to set things right. At what point does discipline begin to look like defensiveness? When does a cleanup become a demolition? Take, for example, Michael Sabia, who took over BCE in 2002 after a disastrous expansion plan fell apart. Even though he won kudos for his restructuring, investors were never sure where BCE’s future growth would come from. The stock languished until Sabia sold off the company. But as long as Ottawa prohibits bank mergers, even
UNlt mlb PtKIUU OF CRISIS ENDS, PEOPLE ARE GOING TO ASK ‘WHAT’S NEXT?’
that ignominious end offers no escape route for CIBC’s cautious management.
The good news for McCaughey is there’s still more that can be done to fix up the bank. Investors and analysts point to the company’s efficiency ratio, a measure of how much it pays out in expenses for every dollar of revenue earned. At 6l.l per cent, CIBC is tied with Bank of Montreal as the least efficient of the big five banks. Under McCaughey that figure has been improving, and there are clearly further savings to be wrung from the bank’s operations. “You don’t have to be big to be efficient,” notes one fund manager. But even modest-sized banks still need to expand. At some point investors are sure to ask, “Where will the growth come from?”
If McCaughey has an answer to that4question, he’s not saying much. After CIBC bailed out of U.S. investment banking last month, analysts on a conference call pressed the CEO to tell them what CIBC would do with the money it’s going to save. He assured them that there are plans to reinvest that capital in the business... eventually, someday... but now is not the time for such talk, he said.
That has left analysts to speculate on the future. “They don’t really have any choice but to focus on retail banking and wealth management,” says Lederer. “Other banks have more options about where to reinvest.” There’s good money to be made in serving retail banking customers and, as a first step, CIBC has said it will open a handful ofbranches on Sundays. Meanwhile, analysts say CIBC could do more to flog mutual funds to its banking customers. Finally, if regulators ever allow Canadian banks to sell insurance through their branches, CIBC could benefit. But, as Lederer points out, the Canadian banking sector is hotly contested. There just isn’t big growth to be had at home. Having now essentially walked away from Wall Street, the bank has very few foreign avenues to pursue.
Some wonder whether McCaughey might make a bold move and buy his way into America’s retail banking sector, as his Canadian rivals have done. With the U.S. economy falling into the doldrums and smaller banks struggling to cope with the credit crunch, it could be a perfect time to snap up a regional player on the cheap when the rest of the market is paralyzed with fear. TD, for one, has taken that tack. In October it said it would
buy New Jersey-based Commerce Bank for US$8.5 billion. But for CIBC, with no existing presence to build on, that first move will come with a huge price tag and would probably make shareholders even more skittish.
Perhaps that’s why, so far, McCaughey hasn’t shown much desire to pull the trigger on acquisitions, even seemingly safe ones. In October, CIBC passed up the chance to buy RBTT Financial Group, a Caribbean bank based in Trinidad and Tobago. Analysts say it would have made a perfect fit for CIBC, which already owns Barbados-based FirstCaribbean International Bank. Instead, Royal Bank swooped in with a US$2.2-billion offer, to become one of the largest players in the region. It’s still not clear why McCaughey failed to seal the deal. But when the dust settles, and expectations rise for CIBC to hone its growth strategy, it may look back on it as a missed opportunity. As Dundee Securities analyst John Aiken wrote in a report last month, “outside of FirstCaribbean, CIBC does not have any obvious highgrowth avenues for the midto longer-term.”
To be sure, CIBC isn’t the only bank to see its international endeavours go bad. A few years ago Bank of Nova Scotia saw its operations in Argentina collapse after that country’s economy nosedived. Scotiabank took a $540-million hit, and more than a few investors wanted then-CEO Peter Godsoe to rethink the bank’s international strategy. Instead, Godsoe stuck it out and Scotia went on to do more acquisitions and foreign deals. It’s since become the second-largest bank in Canada, after RBC. In a couple of years, when U.S. markets have improved, investors may wonder why CIBC didn’t just fix its Wall Street venture, rather than bail on it. It was a flawed growth strategy, but a strategy nonetheless.
At this point, though, CIBC investors are still wary of anything that smells of risk. They had enough of that under Hunkin, thank you very much. No one dares to come out and demand McCaughey lay out a bold plan for the future, lest he actually follow through on it. “If they get their existing businesses right, that will lead to better strategic moves in the future,” says a fund manager with a sizable stake in the company, who asked not to be identified. “But for now, it’s baby steps.”
That is, until investors change their minds, and begin to wonder whether anybody ever won a race by taking baby steps. M
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