CIBC may take a "large charge" that could be as high as $2 billion US before tax if a troubled company that has insured much of its subprime mortgage exposure fails, the bank warned Wednesday.

The announcement came after Standard and Poor's cut the credit rating to investment grade CCC from A for ACA Financial Guaranty Corp., the insurer to about $3.5 billion US in CIBC's exposure to the troubled U.S. subprime market. That grade is deep into junk bond territory and means the issuer's debt is "vulnerable to nonpayment."

CIBC 3-month trading chart

CIBC said it is not known whether ACA will continue as a viable hedging company. The bank said the mark of its hedge with ACA stood at $2 billion US at the end of November.

"Although CIBC believes it is premature to predict the outcome, CIBC believes there is a reasonably high probability that it will incur a large charge in its financial results for the first quarter ending Jan. 31, 2008," the bank said.

"If the charge in the first quarter were to be $2 billion US … CIBC currently projects its Tier 1 capital ratio to remain in excess of nine per cent as at Jan. 31, 2008."

The DBRS bond rating company promptly placed all of CIBC's short-term and long-term debt ratings "under review with negative implications." The ratings agency said CIBC's "higher than expected concentration risk of counterparty exposure … does not reflect positively on the overall risk management ability of the bank.

Despite that, DBRS noted that CIBC’s Canadian retail banking and brokerage operations "remain sound and are expected to contribute to earnings stability in the future." 

On Tuesday, the New York Stock Exchange delisted the shares of ACA Capital Holdings Inc., a bond insurance company and the parent of ACA Financial Guaranty Corp.

Reports published Wednesday say ACA Capital has guaranteed about $26 billion US in mortgage securities. ACA Capital lost about $1 billion US in its most recent quarter.

CIBC is reported to be among a group, including Merrill Lynch and Bear Stearns and other banks, in talks to bail out ACA Capital.

Earlier this month, CIBC took a $463-million pre-tax charge on writedowns of collateralized debt obligations and residential mortgage-backed securities related to the U.S. residential mortgage market.

CIBC shares are trading at a two-year low on the TSX as the bank faces more exposure to the U.S. subprime meltdown than any other Canadian bank. The stock slipped $1.15 to end at $71.14 on Wednesday.