It was 5 o'clock on a warm evening in mid-July when John Hunkin sailed into Halifax Harbour with a grin on his face and an armload of bragging rights. And why not? Despite having never competed in an ocean race, he and his 48-foot yacht were the first Canadian entrants across the finish line in the biennial Marblehead to Halifax regatta, a gruelling 360-mile contest stretching from Massachusetts to Nova Scotia.
"It feels fantastic," the novice skipper told a local sports reporter, before laying the credit at the tired feet of his 12-member team. "We had such a good crew."
His other crew, the inner circle of senior bankers and lawyers who were still technically reporting to him in his last days as the head of Canadian Imperial Bank of Commerce, had little time for boating. They had their hands full with a more daunting project: trying to resolve a class-action settlement with an angry legion of investors from Enron Corp.
When they finally finished negotiations this week, the CIBC team also set a couple of records, albeit dubious ones: the bank struck a $2.4-billion (U.S) settlement, the largest agreement so far of any financial institution that was entangled with the disgraced energy trader. Gerry McCaughey, who officially replaced Mr. Hunkin on Tuesday, was in the CEO's chair less than 24 hours when he announced CIBC would have to absorb a $2.5-billion (Canadian) charge to cover its legal bills, the biggest single tab of this kind in Canadian banking history.
Investors, predictably, were outraged, and the stock was battered for two days, plummeting 11 per cent, or $8.89, to $71.75.
To add salt to the wounds, Mr. Hunkin had left the bank just days earlier with $52-million in stock and other securities. His former right hand man, David Kassie, with whom he fashioned CIBC's aggressive push into the risky world of U.S. investment banking, was ousted in 2004 with a $56-million nest egg. CIBC shareholders had trouble stomaching the notion that they would foot the bill for a $2.4-billion (U.S.) legal payment while the two executives on whose watch the Enron dealings occurred left the bank as very rich men.
The implications were ugly. Overnight, nearly 25 per cent of the bank's book value was gone, while its Tier 1 capital ratio -- a crucial measure of a bank's balance sheet strength -- fell from 10.7 per cent to 7.5 per cent, barely above the regulatory minimum.
Taken together, these are the sorts of blows that can cripple a company -- unless that company happens to be a Big Canadian Bank. CIBC has been forced to pick shrapnel out of its backside with metronomic regularity, yet each time someone sounds the death knell, the market discovers it was only a flesh wound. Given its sordid past, CIBC may be living proof that you can't kill a Canadian bank.
"Look how frigging strong these companies are," said Robert Wessel, an analyst with National Bank Financial Inc. "[CIBC]took a massive blow and they will shrug it off in a year. This issue will be gone in three quarters."
Part of the reason CIBC can withstand the Enron shock is that its finances were in excellent shape, and it had about $1.7-billion in excess capital with which to cushion the charge. It's much easier for a Canadian bank to repair its balance sheet than for any other firm because they are incredibly profitable: CIBC can earn almost the amount of the charge in a single year.
For evidence of how quickly a Canadian bank can spring back from its troubles, consider Toronto-Dominion Bank. In July, 2002, TD took an $850-million writeoff to clean bad corporate loans off its books after the collapse of WorldCom Inc. and other telecom upstarts. It still wasn't enough, and four months later TD took another huge charge, $775-million. All told, it was the biggest fiasco in Canadian banking since the real estate meltdown of the early 1990s. Investor reaction was swift and brutal, as it was with CIBC this week. TD shares fell for seven straight days after the second writeoff, shedding 9 per cent of value. And if the problems didn't cause the departure of CEO Charles Baillie, they certainly hastened it. (Mr. Baillie, unlike Mr. Hunkin, stuck around to take the heat until all the bad news was out.) And yet the whole sorry episode was largely forgotten within a year. From November 8, 2002, when it took the second writedown, to the end of July, TD outperformed every major Canadian bank in total return to shareholders except one: CIBC.
No one has tested the hypothesis of the "unsinkable Canadian bank" quite like Mr. Hunkin and CIBC, for whom Enron marks just another chapter in a long history of embarrassments. Mr. Hunkin, in fact, came to power in 1999 in an atmosphere of gloom. The previous year, CIBC had managed to step into the mire of the Asian crisis, and its profit fell 35 per cent. Merging with TD seemed like a neat way out of its morass, but Finance Minister Paul Martin killed the banks' proposal in December, 1998. Chairman and CEO Al Flood quit, Mr. Hunkin won a divisive battle to succeed him, and had the good fortune of an unprecedented bubble in technology stocks, which drove the value of CIBC's investment in Global Crossing Ltd. to more than $5-billion. Mr. Hunkin wisely chose to lock in the value of that investment, and CIBC booked $2.3-billion in Global Crossing gains over the next four years. The bank proceeded to squander much of it.
The Global Crossing windfall was largely luck and partly the result of a conscious strategy, implemented by Mr. Hunkin and Mr. Kassie, to make inroads on Wall Street. In essence, CIBC gave equity to young U.S. companies, particularly in technology and telecom. Later, the bank would win twice -- earning fees from taking them public, and cashing in on its investment.
It was good in theory but lousy in practice, and Mr. Hunkin spent his last three years in the corner suite unravelling much of what he had created in the first three. CIBC wrote off hundreds of millions in dud investments. It amputated large parts of its Wall Street investment bank. It swallowed $1.5-billion in loan losses in 2002.
"They tried to execute a business strategy in a wildly different market that didn't succeed, which in turn bred a culture of taking even more risk," explained Mr. Wessel.
Meanwhile, Mr. Hunkin's grand scheme to add millions of customers by putting mini-branches in U.S. grocery stores was bleeding cash and had to be closed, leading to another writedown of $240-million. Even Global Crossing turned into a tainted victory when the telecom company went into bankruptcy protection -- though not until the bank had taken its profits.
Then came the scandals, which -- until this week -- caused only limited financial damage: an $80-million (U.S.) settlement with U.S. and Canadian regulators over Enron; $125-million to settle allegations it gave money to hedge funds to facilitate illegal trading in mutual funds; Faxgate, where the bank mistakenly faxed confidential information on customers to a junkyard in Virginia. One long-time bank executive suggested the problem is cultural, and while the individuals at CIBC, including Mr. Hunkin, are both competent and "nice people," they never seemed to be able to make things work as a team.
"Collectively, again, they failed the task," said the banker. "Are there any villains here? I doubt it. [But]you wonder what happens."
Despite its reputation, as one analyst famously phrased it, as the bank "most likely to walk into a sharp object," CIBC consistently -- some would say amazingly -- continues to dust itself off and get up again. The bank's stock, at least before the Enron charge, has managed to navigate various hazards on the way to becoming one of the industry's best performers over the past five years.
Look no further than the Enron scandal. Irate investors already seem to be putting the news behind them, and are prepared to believe that the expensive missteps of Mr. Hunkin and Mr. Kassie won't be repeated now that the disaster-prone duo has left Commerce Court.
Yes, CIBC has the fewest options of any of its peers, and yes, it is strategically hamstrung. The bank had already forsaken growth ambitions before the Enron settlement, and chose instead to return cash to shareholders by buying back stock or pumping up its dividend. The next big deal for the bank, in all likelihood, will be selling out to a rival, assuming Ottawa ever allows bank mergers -- hardly a sure bet.
But it should be noted that CIBC began a makeover in 2002. About 70 per cent of the bank's capital is now devoted toward lower-risk retail banking, where profit is more predictable. CIBC World Markets, however, continues to be a strong player in the domestic mergers and financing industry, and the bank boasts one of the country's largest wealth management operations.
"People are beating up the bank now for past problems but the risk profile of the bank has shifted in the past few years," said Murray Leith at Vancouver brokerage Odlum Brown Ltd. "It's a much cleaner bank, going forward."
Mr. Hunkin declined to comment on the Enron deal or his compensation when reached this week at his home in Nova Scotia. In an interview this summer, as he prepared to pass the reins to Mr. McCaughey, he acknowledged the bank had experienced difficulties, and that he had accepted responsibility as a CEO should.
"I don't even think that we bent," Mr. Hunkin said of the bank's Lazarus-like ability to bounce back from its defeats. "We sure as hell didn't break."
That said, he admitted he was looking forward to taking the summer off -- his first lengthy vacation in years -- and doing some sailing near his home in Chester.
Next Wednesday, incidentally, the Chester Yacht Club is playing host to its annual race week. And who is picking up the tab as the event's title sponsor? CIBC.
CIBC's tale of woes
A long list of black eyes
CIBC has stepped on a financial land mine every few years as far back as anyone can recall. While every bank takes a hit now and then, CIBC has a habit of making big bets that go horribly wrong, and in recent years, has been more prone than rivals to running afoul of regulators and U.S. class-action law suits.
Dome Petroleum
Every bank got burned when rising interest rates and falling oil prices brought down Dome Petroleum in the early 1980s. But CIBC had the biggest exposure at $900-million in loans, a third of which were unsecured. Part of the debt repaid when Dome Petroleum was taken out by Amoco.
Third World Debt
Sovereign nations can't renege on their debts, can they? It turned out they could. CIBC led a parade of banks that took a 1989 hit on Third World exposure, when it wrote off $1.2-billion in loans to less-developed countries.
Olympia & York
Paul Reichmann was a long-time, valued CIBC customer. So valued, the O&Y founder didn't even have to open the real estate company's books to his lead lender. When reality caught up to O&Y in 1992, CIBC had to set aside $1-billion to cover soured real estate loans. The banker who signed off on much of that O&Y exposure, Al Flood, was later promoted to CEO.
Amicus
A product of the dot.com boom, the electronic banking network was CIBC's beachhead in the U.S. retail market. But the unit kept bleeding red ink, and as the tech euphoria faded, CIBC pulled the plug in 2002 and took a $366-million hit.
Mutual Fund scandal
One week before CEO John Hunkin retired, CIBC struck a $125-million (U.S.) settlement with authorities over allegations that it helped a handful of hedge funds do marketing timing trades in U.S. mutual funds, where the pros' buying and selling came at the expense of long-term investors.
Enron
Recall how the energy company got into broadband. Enron set up a subsidiary called EBS Content Systems. CIBC came in as a partner, putting $115-million into the Enron unit. That allowed Enron to book at $110-million profit. However, Enron had secretly agreed to guarantee the whole $115-million investment. A U.S. class action lawsuit called the EBS transaction, and dozens of CIBC deals on the same theme, a "contrivance" that inflated Enron's profits. When the true nature of these deals was spelled out in 2001, Enron collapsed.
Text compiled by Andrew Willis/The Globe and Mail
Derek DeCloet