Margin Squeeze

Westpac Banking Corporation’s key regulatory capital report for the June quarter showed its asset quality and capital levels remained strong, although the big news was commentary that showed a decline in the bank’s net interest margin (NIM) to 2.06% at 30 June from 2.17% at 31 March.


The fall in headline NIM of 11 basis points (bps) over the quarter, driven principally by a rise in the bank bill swap rate and a reduced contribution from its Treasury operations, was steeper than our forecast of a 5bps fall in second-half FY19. Even excluding volatile Treasury income, the underlying NIM was still weak, falling 7bps versus our 5bps forecast. Partly offsetting these pressures was a small improvement in deposit spreads.


This outcome calls into question Westpac’s ability to manage the trade-off between margins and growth. That said, the disappointing update appears to be priced in – Westpac’s share price dropped 9% during the week of the release of the capital report, versus a fall in the S&P/ASX 200 Index of 1.5% and losses of 4–6% for its big four peers over the same period.


In an attempt to improve its NIM, the bank announced post the capital report that it would increase its variable interest rates for owner-occupier and residential investment property loans by 14bps, effective 19 September 2018, for new and existing customers.


We have lowered our EPS forecasts by 3–4% across FY18–20. The update on margins is responsible for most of this, with another 1.0 percentage point coming from the recently announced changes in pricing on its BT funds administration platform. We have pushed back our capital management start date to second-half FY19 given the weaker earnings estimates.


We maintain our Accumulate recommendation on Westpac on valuation grounds, but have lowered our target price to $30.50 from $33.10. Westpac remains third in our pecking order in the sector, behind top picks National Australia Bank (NAB, Accumulate) and ANZ Bank (ANZ, Accumulate).

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