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A CIBC sign is shown in the financial district in Toronto on Tuesday, August 22, 2017.NATHAN DENETTE/THE CANADIAN PRESS
The federal banking regulator has been frustrated with Canadian Imperial Bank of Commerce’s slow progress on fixing underwriting lapses in its mortgage portfolio and expressed its concerns to CIBC’s board of directors at a May meeting, sources say.
The Globe and Mail reported last month that CIBC has been under remediation orders from the Office of the Superintendent of Financial Institutions (OSFI) after a routine audit last year of its mortgage portfolio uncovered breaches of rules that limit levels of indebtedness for borrowers.
Over months of back and forth, OSFI’s concern with CIBC’s progress and thoroughness in diagnosing and remediating the issues escalated, in the lead-up to a May meeting when the regulator raised the issue with CIBC’s board, according to three sources familiar with the matter.
With CIBC still in remediation, a person identifying themselves as a CIBC employee wrote an anonymous letter of complaint to OSFI in mid-June. It alleged that inside the bank, CIBC’s leaders had initially sought to play down the seriousness of the mortgage underwriting issues that had been discovered, drawing out the remediation process, according to a copy reviewed by The Globe.
As CIBC works to address the regulator’s concerns, two directors from CIBC’s board have become directly involved in the process. They have held recurring meetings with groups of staff, some of them mid-level employees, to get progress updates on the remediation process – a rare level of direct contact on operational issues for board members at such a large financial institution, two of the sources said.
The two directors who have intervened most directly are Barry Zubrow, the former chief risk officer of JPMorgan Chase & Co. who chairs the risk committee of CIBC’s board, and Mary Lou Maher, the audit committee chair who formerly led quality and risk at KPMG Canada, the sources said.
The Globe is not identifying its sources because they are not authorized to discuss the bank’s confidential regulatory processes.
OSFI routinely meets with the financial institutions it supervises and has regular contact with bank boards. When problems surface, the regulator works with banks to remediate issues in strict confidence, and those interactions are not disclosed publicly.
However, the sources say that what has transpired over recent months has not been typical – either in OSFI’s frustration with the bank or in the directors’ close oversight of day-to-day remediation.
Neither chief executive officer Victor Dodig, nor senior executives who report directly to him were present at several of the meetings convened by the two board directors, one of the sources said.
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OSFI’s concerns over CIBC’s underwriting lapses surfaced at a sensitive time. The regulator is already concerned about Canada’s competitive housing market with interest rates surging higher, and recently identified the potential for a housing market downturn as the most pressing of nine key risks to the financial sector it is tracking.
OSFI has publicly said that financial institutions must be quick to recognize and address credit risks, while helping borrowers who are struggling to manage their debt during times of stress.
CIBC declined to comment for this story or to respond to detailed questions sent by The Globe. Mr. Zubrow and Ms. Maher did not respond to requests for comment.
OSFI declined to respond to The Globe’s questions, citing legal obligations that require the regulator and the financial institutions it oversees to keep supervisory information confidential. In general terms, OSFI spokesperson Shane Diaczuk said the unauthorized release of that information is “unacceptable” and “could be grounds for serious legal or supervisory consequences,” and that the regulator will consider all available forms of recourse.
In an earlier interview last week, OSFI superintendent Peter Routledge – who leads the regulator, and was present at the May meeting with CIBC’s board – declined to comment on the bank’s mortgage remediation, citing the same legal constraints. But he highlighted the “high floor for underwriting standards” set by the regulator’s guidelines for mortgage lenders, which he said helps detect issues early on.
The mortgage underwriting lapses at CIBC involve thousands of clients, many of whom had lines of credit that were secured against their homes. When these lines were combined with a CIBC mortgage, the total credit available sometimes exceeded allowed regulatory limits.
The issues discovered in CIBC’s mortgage book are largely administrative in nature, and do not involve fraud, the three sources said. They also are not expected to have a material financial impact on the bank or lead to higher loan losses.
However, they were first identified when OSFI asked to audit a sample of CIBC mortgages. Two of the sources said that about a quarter of the mortgages in that small sample were in breach of regulations – a high proportion that caught the regulator’s attention.
The discovery of those breaches are a blemish on CIBC’s track record after Mr. Dodig has spent nearly nine years as CEO working to recast the bank and its image, moving past previous missteps. CIBC has also worked hard to stabilize its mortgage business over the past five years. The bank swung from being a market leader in 2017 to a laggard two years later, only to eventually catch back up to rivals.
In that context, the year-long remediation process with OSFI is an unwelcome headache for a bank that is keen to show the market its mortgage business is performing well. And it has been a drain on resources at a time when all major banks are trying to tighten their belts. CIBC has spent tens of millions of dollars on remediation, two of the sources said.
Residential mortgages also make up more than half the bank’s total loan book, giving them a proportionally higher exposure to home loans than any of its rival banks.
After OSFI found those first underwriting lapses, CIBC hired consultants from Deloitte to help screen its mortgage book for similar issues, and to help retool the bank’s systems to prevent further problems. That led to the discovery of thousands more breaches in the following months. And even recently, further lapses have been identified, according to two of the sources.
The remediation process is still continuing and some internal estimates suggest it could take up to two more years to complete, two of the sources said.
The anonymous letter of complaint that was sent to OSFI last month also alleged that Mr. Dodig has not been transparent with investors on another matter: The profit margins that CIBC earns on some mortgages.
At a banking conference in January, Mr. Dodig was asked about speculation that profit margins on some mortgages had turned negative for a period of time. He told the audience that as interest rates shot higher last year, “you had pockets of time, end of October, early November, where you had mildly negative mortgage margins.”
Profit margins that are typically around 60 to 80 basis points – or 0.6 per cent to 0.8 per cent – were “kind of hovering in the zero range for a period of time, not for us, but for the entire industry,” Mr. Dodig said. “We’re still competing with formidable competitors. That’s now improving.”
The letter alleges that, in fact, CIBC was pricing some mortgages at negative margins for several months. Home loans priced with negative net interest margins – the difference between what it earns on loans and pays for funding – totalled tens of billions of dollars over a one-year span, the letter alleges, citing information presented to senior bank staff.
One of the sources confirmed that CIBC was issuing mortgages at negative margins for a period of several months that dated farther back than the acute period of market stress in late October and early November that Mr. Dodig mentioned in his comments.
CIBC’s profit margins on mortgages came under pressure for several reasons last year, including the bank’s strategy to hedge its exposure to rapidly rising interest rates, large in-flows of deposits to fixed-term accounts like GICs, and the push to match aggressive mortgage pricing among competitors, according to two of the sources and a third person familiar with the business.
The author of the anonymous letter alleged to OSFI that Mr. Dodig’s comments could “mislead investors” about the pressure its mortgage business has faced.