Noah Zivitz

Managing Editor, BNN Bloomberg

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Investors didn't react kindly to Canadian Imperial Bank of Commerce's latest set of earnings, but the bank is being commended by an analyst for its approach to managing credit risk.

CIBC's shares fell more than two per cent last Thursday after the bank reported fiscal second-quarter profit that was weighed down by provisions for credit losses. Its net income for the quarter that ended April 30 fell eight per cent year-over-year to $1.52 billion as $303 million was reserved for loans that could go bad, including $94 million in provisions for the Costco Canadian credit portfolio that CIBC acquired last year. On an adjusted basis, CIBC said it set aside $13 million for potential losses on so-called performing loans. And that's where CIBC separated itself from its peers.

"The bank added a modest amount to its performing [allowance for credit losses], while every other bank reported releases. While [CIBC’s] tactic led to a negative market reaction, we believe it is ahead of the curve in this regard," wrote Gabriel Dechaine, an analyst at National Bank of Canada Financial Markets, in a report to clients Sunday night.

The Canadian banks' fiscal second-quarter reporting season was marked by diverging expectations for credit quality. Decisions about booking provisions for credit losses amounts to judgment calls about how a bank's loan book will hold up.

That judgment process was put under the microscope in the most recent batch of earnings, particularly given a murky economic outlook as central banks ratchet up benchmark interest rates in an attempt to wrestle down inflation that's far outpacing desired levels. Statistics Canada's most recent consumer price index showed inflation soared 6.8 per cent year-over-year in April. That's more than triple the Bank of Canada's target of two per cent.

Dechaine said five of the Big Six banks beat profit expectations in the second quarter by an average of eight per cent; he estimates about half of the outperformance was thanks to lower provisions.

"We could point out that such an [earnings per share] driver gets lower billing in the late stages of the economic cycle. More importantly, we believe that positive credit surprises could turn into negative ones, especially if recessionary probabilities increase," he wrote, while cautioning the most recent quarter's parade of beats could turn out to be a "false signal."

Dechaine said his preferred Canadian bank stocks are CIBC and Royal Bank of Canada. He has outperform (the equivalent of buy) recommendations on both of those stocks and price targets of $84.00 and $148.00, respectively.