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(October 3, 2008) CIBC has reached a deal with a fund led by Cerberus Capital Management that the bank says will significantly reduce its exposure to the American subprime mortgage market.

Under the arrangement, the Cerberus fund will invest just over $1 billion US in CIBC’s U.S. residential real estate portfolio, which includes residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs). The portfolio was valued at $1.186 billion as of June 30, 2008.

The Cerberus fund will acquire $1.05 billion of amortizing senior notes, which have a capped return, payable in cash. CIBC will retain 100% of the potential upside on the portfolio following repayment of the notes.

“This transaction sets a floor under CIBC’s exposure to the U.S. residential mortgage market,” said Gerry McCaughey, president and CEO of CIBC. “At the same time, retaining ownership of these securities, combined with the option regarding the timing of any redemption of this note, provides us with important flexibility to benefit from a future recovery in the cash flows of these securities.”

The transaction is expected to add 13 basis points to CIBC’s Tier 1 capital ratio, which was 10.1% at the end of July, “well above CIBC’s target of 8.5%,” the bank says.

Painting a picture of a worst-case scenario, where the value of all of the portfolio’s securities fall to zero, and there are no recoveries from guarantors, the bank says the impact would be limited to a loss of 0.45% on its Tier 1 capital ratio.

“Our capital position is strong and our actions to reduce risk in our structured credit portfolio further that strength,” McCaughey said in a press release. “In addition, retaining the right to future recoveries provides the potential for further enhancement to CIBC’s performance.”

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European CFAs rally against accounting changes

(October 3, 2008) An overwhelming number (79%) of CFA Institute members based in the European Union do not support the suspension of fair value standards under the International Financial Reporting Standards, according to an overnight poll.

The CFA Institute polled its EU-based members in advance of the summit called by EU and French president Sarkozy to establish a common European position on regulation. The poll also found 85% of respondents think a suspension of fair value standards would further decrease confidence in the European Banking System.

Following the poll results, Jeff Diermeier, president and CEO of the CFA Institute, and Nitin Mehta, managing director, EMEA, CFA Institute, submitted a letter to President Sarkozy, who is seeking more flexibility in accounting rules. The letter reiterates the stance of the majority of poll respondents that any weakening of accounting rules will not improve market stability and will further undermine investor confidence.

“On behalf of investor members, we respectfully urge you and EU leaders to carefully consider whether increasing flexibility in the fair-value accounting standard will do anything to increase investor confidence in the European banking system,” the letter states. “This financial crisis is about the mis-pricing of risk and ill-considered risk management. We do fully acknowledge that fair value should be based on more factors than an isolated fire sale price. However, masking financial performance through the suspension of fair-value accounting will not address these fundamental points and will continue to impact on investor confidence.”

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Mortgage rate cap needed, U.S. profs argue

(October 3, 2008) Two Columbia Business School economists are calling on the U.S. government to push down residential mortgage rates to 5.25% as a way to further enhance stability in the financial system and loosen the credit market.

In a new report, R. Glenn Hubbard and Chris Mayer say 5.25% is close to where mortgage rates would be in a normally functioning mortgage market, and matches the lowest mortgage rate in the past 30 years.

The authors point out that falling housing values have caused the credit market to seize up, perpetuating further declines in house prices and contributing significantly to the current financial crisis.

They propose lowering the mortgage rate to stop this decline, along with other terms, including allowing all residential mortgages on primary residences to be refinanced into 30-year fixed rate mortgages at 5.25% through Fannie Mae and Freddie Mac. In order for homeowners to qualify for this deal, they would have to give up the right to refinance their mortgage if rates fell, although they would have the option of paying off their mortgage if they sold their home.

Hubbard and Mayer believe this action would result in raising the value to taxpayers of trillions of dollars worth of existing home mortgage assets already owned or guaranteed by the FDIC, the Fed, the Treasury, Fannie Mae and Freddie Mac, by putting a floor under house prices.

In addition, it would allow a further recapitalizing of the banking industry by moving an appreciable number of mortgages off bank balance sheets to the government’s balance sheet.

The authors believe this plan could be enacted quickly, as the government now controls nearly 90% of the mortgage market. They predict the cost to taxpayers would be modest; while the government could end up assuming trillions of dollars of additional mortgages on its balance sheet, these would be backed by houses and “the verified ability of millions of Americans to pay back the debt.”

(10/03/08)