The Westpac Banking Corp (ASX: WBC) share price has fallen by double digits over the last couple of months. Is this an opportunity, or are things going to get worse in FY23?
Westpac is one of the biggest banks in Australia, along with Australia and New Zealand Banking Group Ltd (ASX: ANZ), National Australia Bank Ltd (ASX: NAB) and Commonwealth Bank of Australia (ASX: CBA). Collectively, they are called the big four ASX banks.
Since the announcement of the supersized interest rate hike by the Reserve Bank of Australia (RBA) in June, the Westpac share price has underperformed the other big four banks. In June, and again in July, the RBA decided to increase the interest rate by 50 basis points (or 0.5%).
As one of the biggest banks in Australia, changes in the official interest rate can have a significant impact on bank profitability.
Let's consider how this could impact the bank margins.
Net interest margin (NIM)
One of the main ways to measure how profitable a bank is by looking at its NIM.
This measures the revenue it generates from lending compared to the cost of the money it's lending out.
One of the biggest sources of funding for banks is the cash held for customers in savings accounts and transaction accounts.
For example, if a customer has $1,000 in a savings account and it earns a 1.5% interest rate and then it's lent out at an interest rate of 3.5%, that would be a NIM of 2%.
In the Westpac FY22 half-year result, the bank's NIM was 1.85%.
However, experts believe that the NIM could rise in light of the RBA interest rate rises.
Banks are passing on the rate hikes in full to borrowers while, at the same time, are being accused of being slow in passing on increases to savers.
Bad debts to rise?
However, while rising interest rates could help bank lending margins, it could also cause pain to the households on its loan book. That could be, or has already been, bad news for the Westpac share price.
Higher interest rates mean increased interest payments for households. This comes at the same time as elevated inflation which is also hurting household budgets.
This could push some households into mortgage stress, which could lead to elevated loan arrears for banks and possibly higher bad debts.
The broker Macquarie is one of the experts to note that the loan impairment expense could rise. Macquarie is currently 'neutral' on Westpac, with a price target of $22.
FY23 expectations
Estimates on CMC Markets suggest that Westpac will generate earnings per share (EPS) of 154.9 cents and 190.5 cents in FY23. That implies a possible rise in profit of 23% in FY23, if the projections prove correct. That means the Westpac share price is valued at under 11 times FY23's estimated earnings.
In terms of the dividend, CMC Markets numbers suggest an annual dividend per share of $1.23 in FY22 and $1.29 in FY23. This implies a possible grossed-up dividend yield of 9.3% in FY23.
