Fiercer competition and tight margins are expected to put pressure on major Australian banks in the near term. But there are still opportunities to be found, Morningstar analysis shows, with most trading at or below their fair value estimate. 

Westpac (WBC) on Monday became the latest of the big banks to report its half-year earnings, following National Australia Bank (NAB) and ANZ Group (ANZ) late last week.

Much like with ANZ and NAB, Westpac’s first two quarters delivered strong headline net profits—which were up 22% on the previous year to $4 billion.

However, the results were overshadowed by margin headwinds, as intense mortgage and deposit competition means the trajectory is likely down heading into the second half.

Slimmer margins and a surprise move by Westpac to ditch its cost-cutting target, which aimed to bring annual costs down to $8 billion by next year, caused Morningstar to reduce its fair value estimate for Westpac by 3% to $28.00 per share.

Westpac CEO Peter King said services inflation was proving sticky, hampering cost margins.

Despite the margin squeeze, Westpac upped its dividend by 15%, or 70 cents, on the strong profits, implying a payout ratio of 61%, or 64% excluding notable items.

Morningstar has raised its full-year fiscal 2023 dividend per share forecast for Westpac to $1.42 from $1.35, implying a 70% full-year payout.

Bank margins peak sooner than expected


Banks generally profit from rising interest rates because of what's known as net interest margins (NIM)—the difference between what a bank earns from loan interest, and the interest it pays to depositors. 

But intense competition means lenders are offering greater discounts to new loan customers, and better savings rates to depositors—narrowing the spread. 

Banking analyst Nathan Zaia says Morningstar lowered its NIM forecast to 1.9% from 2.0%, which including notable items was 1.96% in the first half.

"The negative revenue impact is mitigated by higher noninterest income and a larger asset base, with our fiscal 2023 revenue forecast reduced by around 3%."

But this is more than offset by lower operating expense and bad debt forecasts, Zaia says. Morningstar's fiscal 2023 profit forecast for Westpac implies its second-half profit to come in 11% below the first half.

Morningstar is forecasting similar second-half dips for NAB and ANZ, as margin tailwinds come off and profit margins are further squeezed.

CBA on Tuesday delivered a third quarter earnings update, which showed a decline in net interest margins—which the bank says is primarily due to "continued competitive pressure in home loan pricing and customers switching to higher yielding deposits."

The undervalued Big Four Banks


Shares in all four of Australia’s big banks rallied on Monday, with NAB leading the way with a 1.96% bump. But it wasn’t enough to shrug off the declines seen across the financial services sector in recent months.

Morningstar’s Australia Financial Service Index is now down around 4% year-to-date, compared to a 1.95% rise for Morningstar’s broader Australian market index.

Two morningstar indices

All four major Australian banks are now trading in the red compared to their prices a year ago. NAB has fallen the most—hit hard after its results late last week, to sit more than 11% down on its price 12 months ago.

Based on Morningstar’s fair value estimates, however, ANZ and Westpac are continuing to screen as undervalued, while shares in NAB are in 3-star, “fairly valued” territory.

Commonwealth Bank of Australia (CBA) remains the only of the nation’s big four banks to be classified as a 2-star, “overvalued” stock by Morningstar, with shares trading around a 11% premium to their fair value estimate of $87 per share.