Here is an Australian Banking Sector Update from stock analyst Macquarie Research Equities:

After a week of poor performance that saw the banking sector underperform, falling 4.3% (versus a market fall of 2.7%), many analysts believe this sector is about to turn around for the better. Among the majors, CBA was down 1.9%, SGB down 3.2%, ANZ fell 4.8%, NAB declined 5.6% and WBC dropped 5.8%. For the regionals, BEN fell 4.3% while BOQ was down 6.5%. Macquarie Research Equites (MRE) believes the fears that have engulfed the sector are unfounded with worse case scenarios predicting only a 3% exposure to any levels of current credit issues. MRE believe the turnaround will begin with the upcoming reporting season by the banks allaying these fears.

Commonwealth Bank (CBA) is the first off the rank, with the annual reporting season beginning and the company announcing this Wednesday. MRE expects the company to show increased profits clearly impacted from increased wholesale funding costs, lending product repricing and rate rise benefits on sticky retail deposits should reduce the impact somewhat – although this will have more of an impact in 2H08.

Given ongoing pressure from higher wholesale funding costs, some of the majors elected to increase their variable mortgage rates by more than the change in official rates earlier this week, with CBA increasing rates by a further 5bp and NAB by a further 4bp. This brings the total increase for the majors in addition to any change in official rates to: CBA +15bp, WBC +15bp, NAB +16bp, ANZ +20bp and SGB +20bp. While pressure on consumers and businesses is increasing given increasing interest rates, MRE remains of the view that near-term risk concerning asset quality and impairments should remain modest given that unemployment levels remain low and business credit growth continues to be strong.

Overall MRE believe the banking sector is set to improve rating the sector an outperform. Of those companies reviewed the major bank preferences have remained unchanged with Westpac (WBC) still number one followed by ANZ in two, CBA then St George (SGB). Of particular importance to investors in the upcoming reporting season is the dividend announcements, with these companies traditionally providing high yielding dividends often sitting around 5% of the stock valuation. Combine this with a rising share price and the attraction is obvious.