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CIBC: Is The PrivateBancorp Purchase A Good Idea For Investors?

Summary

The PrivateBancorp acquisition helps reposition CIBC from primarily a Canadian domestic lender, opening up far greater exposure to the U.S. economy for the bank.

PrivateBancorp comes with strong wealth-management capabilities for high-net-worth clients. It has delivered consistent loan growth and comes with an experienced management team.

With PrivateBancorp, CIBC's share of profits from the U.S. will immediately double to 10%. By 2020, CIBC expects PrivateBancorp to add $400 million or 25% of total profits.

In the latest move by a big Canadian bank to bet on the U.S. market for growth and diversify beyond their home turf, Canadian Imperial Bank of Commerce (NYSE:CM), or CIBC as it is colloquially known, announced that it is expanding into the United States with an agreement to buy U.S. commercial bank PrivateBancorp, Inc. (NASDAQ:PVTB). CIBC is Canada's fifth-largest bank as measured by loans, assets, and market capitalization. The deal helps reposition CIBC from primarily a Canadian domestic lender, opening up far greater exposure to the U.S. economy for the bank. It also ends months of speculation about CIBC's strategy for diversifying outside Canada.

Canada's Big Five banks dominate the domestic banking and wealth management sectors, and are contending with the prospect of rising credit losses from energy-sector lending and sluggish economic growth due to the commodities price rout. This is pushing the banks to expand into the U.S. to seek new customers and further diversify their lending activity, as earnings growth from domestic lending slows.

CIBC's move into the United States follows a similar strategy of Royal Bank of Canada (NYSE:RY). RBC announced in early 2015 a $5-billion deal to acquire Los Angeles-based City National Bank, which focuses on commercial and high-net-worth clients. The deal was completed late last year, making it the largest deal in RBC's history.

In addition, Bank of Montreal (NYSE:BMO), owner of Chicago-based BMO Harris Bank, acquired a U.S.-based finance business from General Electric Co. (NYSE:GE) in December, while Toronto-Dominion Bank (NYSE:TD), which spent $17 billion building a U.S. retail banking network, has shifted in the last three years to buying U.S. credit-card portfolios.

CIBC announced the definitive agreement to acquire PrivateBancorp for $3.8 billion (C$4.9 billion) on Wednesday. It will finance the transaction with 60% stock and 40% cash mix. CIBC will issue 29.5 million common shares and use $1.5 billion in cash. The bank expects to maintain a common equity tier 1 (CET1) ratio at closing of at least 10%. After closing, CIBC expects to have a Basel III leverage ratio above 3.8% and liquidity ratios to exceed regulatory minimums. The bank expects to maintain its dividend payout ratio at the top end of its 40% to 50% target range, but guided to a combined-bank ROE in the mid-teens, versus CIBC's current target of 18% to 20%.

Source: CIBC website

PrivateBancorp is a Chicago-based middle market commercial bank with assets of $17.7 billion as of the most recent quarter. Approximately 96% of the loan portfolio is variable rate. PrivateBancorp's loan portfolio consists mainly of commercial loans (64%) and commercial real estate (26%). Loans have grown at a respectable compound annual growth rate of 10%, while earnings have benefited from improved credit quality over the last four years; however, management expects credit costs will gravitate back towards the industry average over time.

Source: CIBC website

The acquisition is consistent with CIBC's articulated strategy and is of sufficient size that, over time, it should meaningfully contribute to CIBC establishing a solid U.S. platform from which to drive growth and diversify earnings. The transaction size should be manageable for CIBC and therefore, while there is execution risk in any acquisition, it should be relatively low in this case.

The transaction values PrivateBancorp at $47 per common share, which is a 24% premium to its average price over the past 10 days and a sizable premium of 2.2x tangible book value and 18x next twelve-month average analyst diluted EPS estimates. PrivateBancorp reported a profit of $193 million over the past 12 months. While the price is acceptable for a wealth management business, it is expensive for a commercial bank, particularly given the limited expense synergies.

In a conference call with analysts, CIBC supported the price tag by outlining the benefits of combining PrivateBancorp's strong commercial and private banking franchise to CIBC's larger financial resources.

"With PrivateBancorp, we have found the right strategic fit for CIBC. PrivateBancorp comes with strong wealth-management capabilities for high-net-worth clients. It has delivered consistent loan growth and comes with an experienced management team that will stay put after the deal closes," CEO Victor Dodig remarked on the conference call.

Dodig also believes the bank is well positioned to benefit from rising U.S. interest rates. While the U.S. Federal Reserve Board is not expected to raise its key rate amid global economic uncertainty, it has signaled its intention to normalize monetary policy as the labor market improves.

Source: CIBC website

Larry Richman will remain CEO of PrivateBancorp and will become the head of CIBC's U.S. region. Richman will also join CIBC's executive committee.

"Our strong cultural fit is one of the most compelling things about this transaction," Mr. Richman said. "At the same time, being part of the CIBC organization allows us to continue to profitably grow our business."

The deal comes 18 months after CIBC mused publicly about the prospect of a U.S. acquisition in the $1-billion to $2-billion range. Since that time, in December 2015, CIBC sold its minority position in American Century Investments (ACI) to Nomura Holdings Inc. (NYSE:NMR), Japan's largest brokerage, for about $1-billion, which gave CIBC additional dry powder, but left it with even less U.S. exposure than its limited exposure before the sale.

It also left the bank with less wealth exposure than before the deal and pressured it to find a new source of U.S. revenue. For these reasons, from day one, the proceeds from the sale of ACI were earmarked for new expansion opportunities in the U.S., presumed by external stakeholders at the time to be in the wealth management sector.

CIBC had purchased its 41% stake in ACI from JPMorgan in 2011, and had hoped to take full control of the privately held company. However, the founders of the company, the Stowers family, had given their controlling ownership to the Stowers Institute for Medical Research, which was unwilling to part with its stake because of the steady income it provided to the institute.

The sale generated a gain of about $170 million after taxes for CIBC and lifted its common equity Tier 1 ratio by half a percentage point to 11.3% - well above regulatory requirements.

The PrivateBancorp transaction is expected to close in the first quarter of 2017 calendar year. (CIBC's 2016 fiscal year ends October 31, 2016.) To finance the deal, CIBC will use $1.5 billion in cash and issue 29.5 million common shares.

PrivateBancorp, which has 34 offices in 12 states, significantly expands CIBC's footprint in the United States, in addition to enhancing the lender's ability to serve its Canadian customers who do business there, which is the case...


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