Canadian Imperial Bank of Commerce (CM-T) was the top-performing big bank stock in 2023, which may be surprising: CIBC faced concerns about rising loan losses and exposure to the country’s troubled housing market throughout most of the year.
The bank’s secret to success? The stock was a dud in 2022.
In sizing up what worked and what didn’t work for bank stocks this year, CIBC benefited from starting 2023 as an out-of-favour stock in a much-maligned sector, giving it the potential to rebound strongly at the first sign of good news.
Banks are essentially bets on the economy, and Canada’s economy has struggled. Heading into 2023, as the Bank of Canada raised its key lending rate aggressively in its fight against inflation, many economists believed that a recession was imminent.
Banks also faced a more specific threat from rising borrowing costs, which throttled loan growth and hampered the ability of consumers and businesses to repay their debts, including mortgages.
By the start of 2023, the Big Six bank stocks were down by an average of 14 per cent, year-over-year. CIBC performed considerably worse than this average, with a decline of 26 per cent (essentially tied with Bank of Nova Scotia, another notable laggard).
But the past year has delivered an impressive rebound. CIBC’s share price gained 15.9 per cent, as of Dec. 21, compared with a Big Six average gain of 4.2 per cent. National Bank of Canada (NA-T), the second-best performer, trailed CIBC with a gain of 8.6 per cent in 2023. None of these returns includes dividends.
Part of the reason for CIBC’s new-found status as a winning stock is that investors have approached the North American banking sector, in general, far more optimistically over the past month.
As fears of recession give way to optimism that the U.S. economy will continue to expand despite high interest rates – a rare occurrence known as a soft landing – beaten-up bank stocks have begun to look more attractive. The KBW Nasdaq Bank Index, which tracks U.S. banks, remains underwater for 2023 but has rallied 32 per cent since the end of October.
Optimism is rising in Canada, too. Many economists expect that, with inflation subsiding, the Bank of Canada will cut interest rates next year, providing some relief to homeowners with mortgages. While rate cuts can hurt bank revenue, as loan margins shrink, they also ease a bigger problem: loan defaults.
“Although rate cuts present potential revenue downside risk, the overwhelming (positive) factor driving stocks was a lessening of recessionary concerns that had been weighing on the sector all year,” Gabriel Dechaine, an analyst at National Bank, said in a note this week.
CIBC had the most to lose from a severe downturn in the housing market. Residential mortgages compose about 54 per cent of the bank’s total loans, which is more than rival banks, at a time when homeowners are financially stressed.
In its fiscal third quarter, the bank set aside $736-million to cover loans that could default, up about 200 per cent from the same period in 2022 and more than analysts had been expecting. CIBC’s tension with the federal banking regulator, related to underwriting lapses, couldn’t have eased investor concerns about the bank’s loan book.
It makes some sense, then, that CIBC may have the most to gain among the Big Six if the Bank of Canada cuts rates next year and the housing market avoids a severe downturn – a key reason why investors may be bidding up the share price in anticipation of better days ahead.
It helps that the share price was trading at a steep valuation discount prior to the stock’s 31-per-cent rally over the past two months.
Mike Rizvanovic, an analyst at Stifel Canada, said that CIBC’s price-to-earnings ratio was 18 to 19 per cent lower than peers’ in mid-November. This valuation gap has since narrowed to about 11 per cent.
“There’s a narrative about a soft landing, and that should benefit banks that have been the laggards,” Mr. Rizvanovic said in an interview.
Is CIBC poised to be the go-go big bank stock of 2024 as well?
A better outlook in the Canadian economy could prolong the rally, as credit concerns fade.
The stock’s hefty dividend could help, too, as falling bond yields make dividend stocks look more attractive. CIBC’s yield is now 5.8 per cent, down from a high of 7.4 per cent in October, but still well ahead of Royal Bank of Canada (RY-T), Toronto-Dominion Bank (TD-T), Bank of Montreal (BMO-T) and National Bank of Canada.
But CIBC is facing at least one significant challenge in 2024: The stock is no longer a dud.
David Berman