Investors in National Australia Bank (NAB) may need to reevaluate their dividend expectations, according to Morningstar analysis, after a key profit indicator for Australia’s second largest bank came in below expectations on Thursday.

In its first half fiscal 2023 report, NAB reported $4.1 billion in cash profit, an increase of 12.3% on the second half of 2022. Profit before bad debt expenses was up 18.5% on the same period last year.

But concerns surrounding the bank's net interest margin (NIM) drove a selloff, with shares ending the session 6.4% lower on Thursday, to be at their lowest level in almost a year.

Net interest margins measures the difference between the interest the bank pays to depositors versus the interest it charges on loans.

NIM is a key profit driver for banks and - following the recent cash rate hikes - analysts had forecast NAB a to reach a higher NIM as it passed on the rising rates to lenders but withheld the increase from depositors.

NAB’s NIM for the first half of 2023 grew to 1.77%, compared with a low point of 1.63% a year earlier. However NIM was down from 1.79% recorded in NAB's December quarter 2022 trading update.

NAB says NIM growth was partially offset by higher funding costs and home lending competition from other banks.

Morningstar banking analyst Nathan Zaia says the figure came in below Morningstar’s forecast.

“It appears margins peaked sooner and lower than we anticipated on intense competition to retain home loan customers and customer deposit competition,” he says.

“The business and private banking division delivered much better margin expansion than the retail bank, testament to National Australia Bank’s market position as major bank peers have been vocal about growing in this part of the market."

Morningstar reduced its fiscal 2023 and 2024 NIM forecast by 10 basis points to 1.75%, but held firm on a $30 fair price estimate for the wide-moat bank.

The change in NIM forecast, after accounting for other margin changes, has also resulted in Morningstar lowering its 2023 full-year dividend forecast for NAB to $1.68 from $1.70, implying a 68% full-year payout.

“The bank is well-capitalised, and we view dividends within the 65%-75% payout target as maintainable,” Zaia says.

It comes as 4-star ANZ (ANZ) on Friday delivered a 23% increase in first half cash profit to $3.8 billion and further improvements in its NIM to 1.75%, up from 1.68% the previous half. 

But ANZ chief executive Shayne Elliott says the next six months will be more difficult than the last.

"Competition in retail banking is as intense as it has ever been, both in Australia and New Zealand," Elliott says.

ANZ remains one of Morningstar's top picks in the sector, with shares trading at a double-digit discount to its fair value estimate of $31.00 per share.
Zaia says ANZ's record half-year profit was not enough to see shares make material headway towards fair value.

"We don’t think the bank needs to deliver large growth to justify the current share price," he says.

"The record first-half profit is a culmination of margin tailwinds coinciding with negligible bad debt expenses."

ANZ's NIM growth also came in under Morningstar's forcast, which Zaia partly attributed to higher funding costs.

Following the results, Morningstar bumped its full-year dividend forecast for ANZ to $1.62, an increase of 8%.

4-star Westpac (WBC) will release its half year results on Monday.