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Macquarie Group Ltd (ASX:MQG) just downgraded these two bank stocks

Sentiment towards Australian bank stocks have improved since the start of the reporting season but the goodwill may not last as I think the sector will be hit by profit-taking over the next month or so.

My downbeat outlook is because the headwinds buffeting the sector aren’t easing, and in some cases may be getting worse.

This is despite the fact that the share prices of Commonwealth Bank of Australia (ASX: CBA) and National Australia Bank Ltd. (ASX: NAB) have both jumped after the companies posted their earnings results.

But the analysts at Macquarie Group Ltd (ASX: MQG) have noted that retail banking conditions have deteriorated in the second half of 2018 and they have moved to downgrade their recommendation on Westpac Banking Corp (ASX: WBC) and Bank of Queensland Limited (ASX: BOQ) as a result.

“Increased competition, higher funding costs and slowing credit growth have impacted banks’ retail divisional performance,” said the broker.

“While repricing [increase in mortgage rates] may provide a near-term reprieve, should banks continue to chase slowing mortgage growth aggressively, the medium-term outlook for revenue growth appears challenging.”

Some of the big banks, like Australia and New Zealand Banking Group (ASX: ANZ), have lowered the rates on select mortgage products to win market share from smaller and non-bank lenders even as funding costs rise.

Macquarie’s decision to cut Westpac to “neutral” from “outperform” and Bank of Queensland to “underperform” from “neutral” is due to their overweight exposure to some of the more challenged parts of the mortgage market.

Westpac has a large exposure to interest-only loans, while Bank of Queensland has a relatively big position in mortgage back-book rates.

Pressure from our banking regulators have prompted our banks to curtail growth in interest-only loans, and when these loans mature, they will revert to principal plus interest loans which have higher monthly repayments.

Mortgage back-books refers to borrowers who have been with their banks for more than a couple of years. These loyal customers are often given a raw deal by their banks who are more interested in enticing new borrowers with sweeter deals.

But consumers are being made increasingly aware of this tactic with both the government and regulators urging them to shop around regularly. The increase churn will hurt Bank of Queensland more than its peers as the bank has a greater proportion of loyal customers than the rest.

These issues mean Westpac and Bank of Queensland may have more difficulty in growing their earnings and protecting their precious dividends than the other banks.

Macquarie has a price target of $32 on Westpac and $10.75 on the Bank of Queensland.

Having said that, I doubt the other banks will fare very much better and I am underweight on the sector. It’s not a bad idea to sell into any share price rally as I think I can buy these stocks back at a lower price towards the end of calendar 2018.

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Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, Macquarie Group Limited, National Australia Bank Limited, and Westpac Banking. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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