Australian Bank Stocks Show Resilience Amidst Rate Cuts
Australian bank stocks are proving analysts wrong with a robust performance, continuing to thrive despite declining interest rates and many brokers holding a negative outlook on the sector. Surprisingly, while 53% of major bank stock recommendations are classified as sell ratings, the banking sector has managed to outperform the broader market through 2025. This comes after a significant sell-off in February due to disappointing earnings results, which were primarily affected by weaker-than-expected net interest margins. Analysts had anticipated that interest rate reductions would heavily impact bank profitability, but the growth trajectory has defied expectations.
The Power of Historical Context
Citi Insights highlights that such resilience isn’t a novel occurrence. Historically, during rate-cut cycles, banks have often displayed relative strength when other sectors see sharper declines in earnings. A notable instance was the 2011-2012 period, where banks outperformed despite sustained rate cuts following the end of the resources boom and falling commodity prices. Analysts referenced economist Rudi Dornbusch’s famous quote about timing in economics, noting that changes often occur later than expected only to happen rapidly once they commence.
Banks Navigate Through Strategic Deposit Repricing
A crucial element of the banks’ continued success has been their adept handling of deposit costs. In response to two 25 basis point rate cuts in February and May 2025, major banks have reduced term deposit rates by about 65 basis points on average. Additionally, savings account rates have been lowered selectively by 25 basis points. For instance, Westpac decreased its base savings rate to 40 basis points while enhancing its bonus rate, effectively reducing overall funding costs by approximately 40 basis points, despite the minor nominal reduction.
This strategic repricing of deposits has aided in stabilising net interest margins in the short run. However, adjusting mortgage rates remains a complex issue due to political considerations and competitive pressures in the business lending space.
Support from Provision Buffers
Furthermore, banks are benefiting from their robust collective provision buffers established during the pandemic. These provisions can be "released" when banks determine that the risks of loan defaults have lessened, allowing them to free up capital for other purposes, including enhancing lending or supporting growth initiatives. For example, NAB revealed that its collective provisions represent 1.42% of its credit risk-weighted assets compared to just 0.96% in late 2019, indicating a considerable increase in provisions since pre-COVID-19.
Valuation Cautions
Despite the favourable operational environment, analysts are wary of the stretched valuations within the sector. Some prominent banks are trading at over 30 times earnings with limited growth outlooks, presenting what analysts refer to as a “positive carry on short positions.” The combination of high valuations alongside anticipated earnings challenges stemming from rate cuts and economic slowdown raises concerns, particularly looking ahead to FY2026.
Investment Perspective
Citi analysts adopt a generally bearish stance on the sector, favouring ANZ for its valuation support, followed by Westpac, Commonwealth Bank, and NAB, all of which are classified as “Sell” rated. They caution that while banks might find near-term stability in earnings, transitions could occur rapidly. A significant risk for investors wagering against banks is that this crowded trade might endure longer than anticipated, driven by economic uncertainty that fuels demand for perceived stability.
Currently, credit growth appears vigorous; however, indicators hint at a potential slowdown as the cumulative effects of rate cuts begin to manifest through 2025 and into the following year.
Conclusion
While Citi’s arguments hold water, price action remains paramount in the investment world. Commonwealth Bank has experienced a remarkable rally, trading above $190 for the first time in its history, with a year-to-date increase of 24% and a remarkable 48% rise over the past year. Curiously, analysts have maintained sell ratings throughout this upswing.
In summary, despite a backdrop of negative sentiment, Australian banks exhibit resilience, but investors should tread carefully amid potential valuation pitfalls and economic headwinds.
