The Risks and Rationale of CIBC's Entree into U.S. Banking

Canadian Imperial Bank of Commerce's first major traditional banking push in the U.S. is heavily reliant on revenue gains to make the numbers work.

What could possibly go wrong?

Quite a lot, actually, industry observers said. A challenging rate environment could stymie revenue from PrivateBancorp's asset-sensitive balance sheet. Cross-selling could prove difficult to achieve, and there is the possibility that market disruption in Chicago could cause PrivateBancorp's lenders to bolt.

Most bank acquisitions, for good reason, rely on reducing costs, such as closing branches, layoffs and consolidating back-office functions. Expense cutting is easier for investors to track and understand, standing in contrast to the vague notion that two banks can earn more together than they can on their own.

"Cost saves are much more believable from an investor perspective," said Terry McEvoy, an analyst at Stephens. "Bank investors can get squeamish when they hear revenue synergies and when they hear that you have built in revenue projections."

A revenue-centric game plan will also put more pressure on Larry Richman, the president and CEO of PrivateBancorp and future head of U.S. operations for CIBC, and his team to deliver the results necessary to justify the deal's hefty premium and $3.8 billion price tag.

The stakes are also high for CIBC, which conceded during that conference call Wednesday morning that it felt the need to buy a U.S. bank to stay relevant. The Toronto company's management cautioned that it could take nearly three years before the $17.7 billion-asset PrivateBancorp starts contributing meaningfully to the bottom line, though it should add $400 million to CIBC's after-tax net income by 2020.

"I met with over 500 business owners personally that we bank and … there's not an insignificant number that are doing business in the U.S. that are being banked by U.S. banks [or] some of our Canadian competitors," Victor Dodig, CIBC's president and chief executive, said during the call.

"Simply, if we ignored that fact we would atrophy over time on that segment," he added.

CIBC executives said during the call that cost savings would be "modest." In contrast, First Midwest Bancorp, which announced a deal this week to buy Standard Bancshares, plans to cut the Chicago-area bank's noninterest expenses by 40%.

Here is a closer look at the challenges ahead for Richman.

Low-Rate Worries

About 96% of PrivateBancorp's $13.5 billion in loans have variable rates, with 70% tied to one-month Libor, CIBC noted in a presentation. As a result, the bank's annual net interest income could increase by $19 million with a 50 basis point increase in rates; it could pack on $68 million if rates rise by 200 basis points.

PrivateBancorp "really needs higher rates … to achieve better returns," said Casey Haire, an analyst at Jefferies. A disappointing jobs report in June delayed a hike, and Britain's recent vote to leave the European Union seems to have further reduced the likelihood that the Federal Reserve will raise rates.

"There is definitely a risk" when buying an asset-sensitive bank under current conditions, said Brian Klock, an analyst at Keefe, Bruyette & Woods. "You're paying something for future earnings and that depends on interest rates that may not come."

A lingering low-rate environment could pressure Richman to book more loans to offset margin pressure, industry observers said. There will also be more of a push to boost fee income, which made up just a fifth of PrivateBancorp's revenue in the first quarter.

Analysts also pointed out on the conference call that the acquisition seems to place a high value on PrivateBancorp's low-cost deposits, which would have greater value should rates start to edge up.

Dodig was adamant during the call that PrivateBancorp could deliver returns even if rates remain depressed. "They have generated solid earnings growth in a low-rate environment already," he said, adding the bigger goal is to have a "more diversified earnings stream."

CIBC is "not building for what the Fed is going to do," Dodig said. "We are building a business model that is right for our clients."

Questions on Cross-Selling

PrivateBancorp is still a relatively small institution, equal to less than 4% of CIBC's $463.3 billion in assets, and should be able to provide a realistic return, Klock said.

Another assumption is that CIBC can market PrivateBancorp's deposit products and capital markets services to its Canadian clients. Wealth management is another area that CIBC and PrivateBancorp consider ripe for growth, with the upshot of "limited revenue synergies."

PrivateBancorp, despite its branding, generates just 3% of its revenue from wealth management. CIBC bought a U.S. private wealth management firm in 2014 that it plans to combine with the PrivateBancorp's platform.

"This is about sound, disciplined relationship building," Richman said during Wednesday's call. "This is all deepening our current client base and cross-selling more actively."

Cross-selling is often easier said than done, industry experts said. It is challenging to get banking clients to switch wealth managers, and it can take time for such a strategy to deliver the expected results.

"If you throw a nice mortgage rate at someone, they will jump on it," Haire said. "But if you start saying, 'I want to manage your money,' then that's a very different reaction. It's very personal."

Luring wealth management clients will require "a pretty strong sales effort" from CIBC, said Kevin Reevey, an analyst at D.A. Davidson, though he noted that the Chicago area has attractive demographics for that business.

CIBC noted in its presentation that Chicago has $1.16 trillion in high-net-worth assets up for grabs, versus $1.03 trillion in Canada. Those numbers are also growing at a higher rate than what is taking place in Canada.

Risk of Defections

Any merger increases the possibility that top lenders will flee to other growth-minded competitors. In this case, however, there could be a greater risk of defection given that Chicago's banking market is in a state of flux.

First Midwest is buying Standard, while MB Financial is in the process of buying American Chartered. Wintrust Financial is also in an aggressive expansion mode, agreeing this week to buy a portfolio of restaurant franchise loans from GE Capital.

PrivateBancorp, formed in the late 1980s, largely transformed itself by poaching more than 100 former LaSalle Bank employees after Bank of America bought that bank in 2007. Richman arrived as part of that exodus.

"The No. 1 concern should be the retention of the sellers' rainmakers," Reevey said. "That's a key hindrance to the buyer being able to achieve those revenue targets."

There are other Chicago-area banks, including MB Financial, with ties to the old LaSalle that could sense an opportunity to pick up talent, said Chris McGratty, an analyst at Keefe, Bruyette & Woods.

Richman was pressed repeatedly during the conference call about his ability to keep his management team intact and with key lenders on board. He declined to discuss any particular arrangements beyond his own dedication to CIBC.

"I am signed up and ready to go," he said. "I feel really good about the team and the commitment we have to working together. I'm very confident — not to speak specifically to lock-ups. I'm in. As it relates to the team, we feel really good about it."

PrivateBancorp's employees historically have been loyal to Richman, which should help CIBC keep talent, McGratty said, though he added that competitors will certainly look "to sweeten the deal" for the best employees

"Naturally there will be dislocation," McGratty said. "The questions are by how much and to whom."

Paul Davis contributed to this report.