Citi downgrades Australia’s big four banks on lower rate cut expectations and valuation concerns

Global investment bank Citi downgraded its recommendations for ANZ (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank (ASX: NAB) and Westpac (ASX: WBC) this week after diminishing rate cut expectations exposed significant downside risks.

It said any chance of a cut was progressively being pushed out, leaving banks exposed to poor earnings at rich valuations.

Citi’s downgrades come a month after Macquarie Bank (ASX: MBLPC) told its clients to be “underweight everything” in the banking sector.

“The reality is that the banks have flat to negative growth coming up for this year,” it said.

“From a capital management perspective they have all got excess capital, so there will be more buybacks and dividends to come.”

Rate cut sensitivity

The market has placed a 76% chance on the Reserve Bank of Australia cutting interest rates for the remainder of 2024.

The rate has sat at 4.35% since November.

A cut is fully priced in for next year and could hurt big bank profits.

In the 2023 financial year alone, the Commonwealth reported a net profit after tax of $10.2 billion, National recorded an 8.8% jump to $7.7b, the ANZ’s profit amounted to approximately $7.13b and Westpac’s net profit jumped 26% to $7.2b.

Bank valuations

Valuations also continue to expand, with all four banks reported to be trading on a price-to-book multiple of 1.7 — a rally which according to one analyst has become “increasingly disconnected with earnings directionally and in absolute terms relative to any metric of history.”

The Commonwealth’s price-to-book ratio recently peaked at 2.7, a multiple last seen in 2015.

Its share price — which has increased 15.4% in the past six months to currently sit above $112 — has also been deemed overpriced.

“Commonwealth Bank is often regarded as the most expensive bank and its valuation has only expanded off the back of its dominant positioning in retail banking,” one analyst said.

“Nonetheless, [we] caution that the retail banking landscape is becoming increasingly challenging, marked by depressed mortgage spreads and escalating deposit competition.”

Another admitted to being “reasonably positive” on the banks, “even if the valuations are hard to get your head around”.

“It is the highest set of valuations we have seen for decades, but we have been tempted on the other side given that their earnings have held up relative to expectations,” they said.

Margin concerns

National Australia Bank has performed strongly in recent times — up 30% in the last five years versus ANZ up 3.6% and Westpac down 7.8% — due to operational improvements and faster business credit growth.

However, there are expectations that this outperformance will eventually reverse itself as system business credit slows and becomes more competitive, weighing on margins.

Analysts are most positive on Westpac as they believe management has stabilised the business, while ANZ offers a “better level of earnings resilience” compared to its retail small-to-medium enterprise banking peers.