Narrow-moat Canadian Imperial Bank of Commerce (CM) reported OK fiscal third-quarter results. Top-line growth wasn’t stellar, with adjusted revenue up 4% and expenses up close to 5%, leading to minimal EPS growth. The bank continues to emphasize that it is investing in the franchise, modernizing infrastructure, building out distribution channels, and hiring personnel in business areas it would like to grow, such as Canadian commercial banking.
Credit costs were relatively stable, a key area to watch for CIBC, as provisioning remained within $200 million to $300 million. Projections for lower natural gas prices played a role in causing higher provisioning in the oil and gas book, while management also noted some weakness in the Canadian agriculture portfolio. The Canadian residential mortgage book remained strong, though, as key credit metrics remained stable. We don't see any real warning signs for the bank at this point. Diluted earnings per share are now down 1.5% year to date, and the bank needs adjusted EPS of $3.14 in the fourth quarter to come in flat for the year, which would be the second-strongest quarter the bank has had in at least two years. As such, we now project EPS declining 1% for 2019. The adjusted return on equity came in at 15.6% as this metric continues to drop. Management admitted that interest-rate cuts will be another headwind to revenue growth, although underlying balance sheet growth should help offset this.
After updating our projections with the latest quarterly results, we are maintaining our fair value estimate of $125 per share. This is 11.2 times our estimated 2020 earnings and 2 times tangible book value as of July 2019.
Our base-case scenario assumes that the net interest margin for CIBC drops slightly in 2019, and remains roughly stable thereafter. We see average loan growth of roughly 1%, assuming a downturn sometime during the middle years of our forecasts, and deposit growth also averaging 1%. Our forecast has increases in provisioning and charge-offs, as we view some deterioration in the housing market as likely, but our base case forecasts a soft landing. CIBC is more exposed than its other Canadian counterparts, and we have adjusted our forecast accordingly, but even so, we see the bank being able to deal with the increased provisioning costs of the future. We believe further moves to increase efficiency, such as through digital initiatives, should translate to improved efficiency ratios. We have noninterest income growing at a CAGR of 1%, a muted rate given the expectation of an economic slowdown. In sum, our forecasts lead to a CAGR of close to 0% for operating income, and an average return on tangible equity of 16%. We use a 9% cost of equity.
