A Bank’s Costly Love Affair with Debt

It seems it was eons ago that the New York arm of Canadian Imperial Bank of Commerce (CIBC) fell in love with complicated derivatives tied to mortgage and asset-backed debt obligations. In the late 1990s, it was so cool to be investing in such almost mythical investment vehicles. The financial reasoning behind these instruments went well over most people’s heads, while those who traded them retained the aura of being extra smart.

Of course, since then, things have drastically changed. The subprime lending disaster led to a rather spectacular fall from grace for anyone implicated in these deals, including CIBC’s New York offices, which are just about to permanently shut their doors.

Why? Simply, the bank’s love affair with the almost exciting and certainly glorified collateralized debt obligations (CDOs) has become very, very expensive. Analysts estimate that losses could go well over half a billion dollars in subprime exposure.

Naturally, heads have already started to roll, including the head (no pun intended here) of the debt division, Phipps Lounsberry. I suppose we can chalk it up to a really bad case of “miscommunication” that Lounsberry managed to gamble away half a billion dollars when the CIBC’s top dog, Gerry McCaughey, was trying to steer the bank towards much less risky waters, following the bank’s relatively recent role in Enron and other corporate scandals south of the border.

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But, it cannot be as if Lounsberry is entirely to blame. In the late 1990s, CIBC was very cutthroat in the CDO business, carving up a rather nice piece of pie for itself. However, as things escalated (not in a good way), and particularly after last week’s writedown from Citigroup to the tune of $8.0 billion to $11.0 billion, CIBC had to fess up to its own exposure.

Certainly, in comparison to Citigroup’s writedown, CIBC’s exposure of half a billion dollars should be considered relative to the bank’s size. Don’t forget that Citigroup is one of the largest banks in the world, and the largest in the U.S.

Unfortunately, the Fat Lady hasn’t sung yet; it doesn’t seem as if CIBC is yet out of the woods. The value of mortgage and asset- backed securities is spiraling down the toilet, resulting in massive floods of COD-type securities where sellers simply cannot find new buyers.

Case in point: earlier this week, CIBC announced that it has sold most of its New York operations to Oppenheimer Holdings. However, CODs were not included in the deal. The bank is still stuck with them, unable to unload them. At the moment, no bona fide buyer wants to touch them even with a 10-foot pole.