MRE aggressively downgraded Australian banking sector earnings in April this year following the March half-year reporting season.

Which Bank?

Recent price weakness has created an opportunity to buy quality banks. The preferred sector exposures by Macquarie Research (MRE) are Westpac Banking Corporation (WBC) and Commonwealth Bank of Australia (CBA). MRE expect bank margins to improve sequentially in the 2nd half of 2008 and are confident that the Australian banking sector will avoid the wholesale earnings dilution experienced by international peers due to improving capital positions. In particular, MRE have upgraded their recommendation for CBA from underperform to outperform with a 12 month price target of $47.63.

Impact

MRE believe that liquidity risks have already been priced into current share prices. Strong sectoral headwinds such as slowing credit growth, ongoing structural margin decline and higher than normal impairment costs remain a concern.

MRE believe that stock-specific risks for Australia and New Zealand Bank (ANZ) and National Australia Bank (NAB) in terms of their NZ and UK exposures respectively will retard ANZ and NAB price performance in comparison to peers.

WBC and CBA have strong balance sheets and lower-risk loan portfolios which support a more stable earnings outlook despite earnings pressure from slowing wealth management and a weak NZ economy.

MRE are confident that WBC will be successful in their bid for St George Bank (SGB) with very little risk of a competitor bid and minimal regulatory or political risks. The absence of a credible regional bank combined with WBC’s conservative timetable for the realisation of synergies, a two-bank operating model and strong post-deal capital position make the deal unique.

Recommendation

MRE aggressively downgraded sector earnings in April this year following the March half-year reporting season and there has been minimal additional negative surprise since then.

MRE believe that all risks are fully reflected in the current valuations and recommend accumulating WBC and CBA followed by NAB, ANZ and SGB. MRE’s pick in the sector is WBC with a 12 month price target of $25.59 – WBC shares closed at $22.34 yesterday.