* Westpac says Q3 NIM 11 basis points lower than previous half
* NIM result "disappointing" and "negative" - analyst
* Higher 90-day delinquencies in mortgage loans - Westpac
* Shares fall almost 3 pct in steady broader market (Recasts, adds analyst quote, shares, delinquencies increase and background)
By Paulina Duran
SYDNEY, Aug 24 (Reuters) - Australia's Westpac Banking Corp WBC.AX , the country's second-biggest lender, on Friday reported a steep drop in quarterly margins on higher funding costs and cautioned that mortgage delinquencies were on the rise in most states.
The drop in net interest margin (NIM), a key gauge of profitability for banks, comes at a time of subdued credit growth in the country, where tighter lending and hikes in short-term interest rates are squeezing housing loan earnings.
Westpac said its NIM, the difference between interest paid and earned, shrank 11 basis points to 2.06 percent in the quarter ended June, compared to 2.17 percent at the end of the six months to March and the lowest since the first half of 2015.
Shares of the lender fell almost 3 percent to its weakest in two months in a broader market .AXJO that was mostly steady.
"The NIM outcome is disappointing," Morgans banking analyst Azib Khan said. "They are really calling out the negative here," he said, adding that higher funding costs were hurting the broader banking sector.
Growth in Australian home loans fell to a four-year low of 5.6 percent in June, while short-term funding costs had more than doubled from their levels in August 2017.
According to Moody's Investment Service, many small and midsize banks have raised their home loan rates in the face of higher wholesale costs and slower loan growth.
But Australia's four major banks, which dominate about 80 percent of the home loan market, have held off so far, partly due to intense public scrutiny amid a powerful national inquiry that has led to damaging revelations of widespread misconduct in Australia's financial sector.
Two of the 'Big Four' – Commonwealth Bank CBA.AX and Australia and New Zealand Banking Corp ANZ.AX - have in fact lowered some mortgage rates to attract borrowers. RISING
Credit ratings agencies have warned that borrowers, hit by the rising costs of living, could struggle to cover principal and interest payments for a record amount of home loans taken out in 2014-2015 that are set to become due soon.
Westpac noted delinquencies were rising across most states, with the overall percentage of loans that are 90-days overdue three basis points higher during the June quarter.
It also flagged higher stressed exposures in its corporate property and retail portfolio over the same period.
Westpac's home loan book, however, grew at 6 percent for the 12 months June, faster than the other three major banks.
"Whilst the NIM outcome is weak there is an offsetting outcome which is the strong loan growth," Khan said.
Westpac said total stressed assets fell slightly in the third quarter and it also reported lower impairments in its smaller mining and New Zealand dairy portfolios.
Its common equity Tier-1 capital ratio dipped to 10.4 percent at the end of June from 10.5 percent at end-March.
It did not disclose profit or revenue numbers in its disclosures. The bank will report full-year results in November. (Additional reporting By Rushil Dutta in Bengaluru; Editing by Himani Sarkar)