UBS downgrades Westpac: Doubts over bank sector’s ability to outperform

Today’s decision by UBS to downgrade Westpac (ASX: WBC) to Neutral from Buy (target price $26) means ANZ (ASX: ANZ) remains the broker’s only Buy of the big-four.

Despite the strong likelihood of a ‘soft economic landing’ due to strong consumer health going into the rate hiking cycle, the broker has flagged Westpac as most sensitive to higher credit charge impact.

The broker is sceptical of the bank sector’s ability to outperform within a challenging environment.

In short, UBS suspects rising cost pressures, which implies ‘less cushioning’, could be reflected in share prices going forward.

Neutral ratings

As a result, the broker is now Neutral-rated on CBA (ASX: CBA) at $105, NAB (ASX: NAB) at $33 and Macquarie Group (ASX: MQG) at $200.

It’s only due to what UBS sees as an extreme relative valuation and discount to fair value that the broker retains a Buy and $30 target price on ANZ.

Today’s downgrade on Westpac by UBS, follows the broker’s downgrade on NAB early-May to Neutral from Buy, after a strong recent share price rally.

Meantime, CBA remains the only big-four bank on which there is not a single Buy recommendation by major brokers.

Rising rates not enough

While UBS expects rising interest rates to provide a “shock absorber” for earnings, especially with credit charges only likely to normalise in FY24, the broker believes further sector outperformance looks unlikely due to above average market ratings and macroeconomic downside risks.

While UBS believes the Australian banks earnings story remains largely intact, the broker reminds investors that during periods of low growth and high inflation, banks have historically underperformed relative to the market.

"We think the cost of equity for the Australian banks will move up as bond yields increase, risk assets reset and interest rates normalise."

Slowing GPD growth

Due to more aggressive RBA tightening and rising inflation, CBA today slashed its annual growth to 3.5% in 2022, from 4.7%.

The bank’s analysts also expect growth to slow to a below trend 2.1% next year from the previously forecast 3.1%.

Other headline projections include:

• Headline inflation to peak at 6.25% this year before returning to the RBA’s target band of 2% to 3% by late 2023.

• The unemployment rate is forecast to remain to 3.75% this year but is expected to nudge 4.5%in 2023 due to slowing economic activity ahead.

• Home prices are expected to decline by around 15% by the end of 2023.

All big-four banks were down between -4.00% and -2.48% an hour out from open today.

Westpac's share price over 12 months.