Why Citi has a 'Sell' rating for every major Australia bank – CBA, Westpac, ANZ and NAB

Citi says its time to sell the Big Four banks and the recent rally leaves them vulnerable to deteriorating fundamentals, exposed valuations and a pushback in rate cut expectations.

After moving to a negative call on the sector in January, the investment bank downgraded its final neutral recommendations (ANZ and Westpac) to SELL.

Current ratings at a glance

• ANZ (ASX: ANZ) – SELL with $26.00 target price

• Commonwealth Bank (ASX: CBA) – SELL with $82.00 target price

• NAB (ASX: NAB) – SELL with $25.75 target price

• Westpac (ASX: WBC) – SELL with $22.25 target price

The 'SELL' thesis

#1 - Banks have rallied on easing financial conditions: "While there have been many narratives around what has driven the banks – i.e., rate cut expectations, regional (Asia) bank rotation, resources underperformance – ultimately it appears that broadly easing financial conditions have driven the large and liquid ASX banks higher," the analysts said. But rate cut expectations are progressively being pushed out, leaving banks exposed to poor earnings at rich valuations.

The market is currently expecting no RBA rate cuts through to year end, down from two rate cuts at the beginning of the year.

US Financial Conditions Index inverted (top) vs. ASX 200 Financials Index (bottom) | Source: TradingView

#2 Improved earnings outlook looks fraught: The idea that higher earnings could bolster bank valuations seems precarious. UBS says interest rate cuts bring additional challenges such as low-rate deposits, political difficulties with repricing loans and the deterioration in asset quality. "It is difficult to construct an earnings scenario which justifies the ~20% run in the shares," they said.

#3 Valuations remain rich: "In absolute terms, despite constrained and contracting profitability, price-to-book multiples continue to expand. The banks as a cohort are trading on ~1.7x book, a level they were trading on in 2018 when ROEs were ~200bps higher," the analysts warned, adding that "the rally has become increasingly disconnected with earnings directionally and in absolute terms relative to any metric of history."

Commonwealth Bank was flagged as a major culprit – with its price-to-book ratio recently peaking at around 2.7 - a level last seen in 2015. During this time, the company's return on equity was about 600 bps higher.

Commonwealth Bank price-to-book ratio (Source: TradingView)

Relative bank positioning

"We think the relativities between the banks are going to become increasingly divergent as strategies diverge," says UBS. While they remain Underweight the sector, its order preference is Westpac, ANZ, Commonwealth Bank and NAB.

The analysts are most positive on Westpac as they believe management has stabilised the business, evidenced by an improvement in mortgage growth and a tighter message on costs.

"Westpac has a large excess capital position compared to its peers, which can support larger buybacks and has a sector-leading dividend yield."

ANZ offers a "better level of earnings resilience compared to its retail or SME-banking peers," according to UBS. They expect a shallower moderation in its core earnings, relative to peers.

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. Nonetheless, analysts caution that the retail banking landscape is becoming increasingly challenging, marked by depressed mortgage spreads and escalating deposit competition.

NAB has performed strongly in recent years (up 30% in the last five years versus ANZ up 3.6% and Westpac down 7.8%) due to operational improvements, as well as faster business credit growth. However, the analysts expect to see this outperformance reversing as system business credit slows and it becomes more competitive, weighing on margins. There's also the risk that NAB's new CEO accelerates investment spend, making it UBS' least preferred major bank.