The National Australia Bank Ltd (ASX: NAB) share price only rose by 4.3% in 2023, it underperformed the S&P/ASX 200 Index (ASX: XJO) which climbed by over 9% last year. In other words, NAB shares did less than half as well as the index.
A lot happened during 2023, including the collapse of Silicon Valley Bank in the first few months. Remember that?
I think there are two key elements that caused the underperformance of NAB shares – higher interest rates and competition.
Higher interest rates
The Reserve Bank of Australia (RBA) increased the cash rate target numerous times in 2023. It started the year at 3.10% and it ended the year at 4.35%.
Banks have been eager to pass on the interest rate hikes to borrowers, so their interest income is benefiting from the change. However, higher interest rates also mean that banks like NAB are paying more to depositors (term deposits and savings accounts) and also paying more for the wholesale funding.
NAB's interest costs have increased as well, so its net interest margin (NIM) hasn't benefited much at all. In its FY23 result, NAB revealed its NIM had fallen from 1.77% from March 2023 to 1.71% at September 2023. It said its NIM suffered by 3 basis points (0.03%) because it paid more for paying for deposits in the second half compared to the first half.
While the NIM hasn't benefited much in recent months from higher interest rates, there is a danger that higher rates lead to an increased risk of borrowers defaulting on their loans. Plenty of borrowers may not have anticipated paying interest at this high of an interest rate.
Arrears and bad debts could mean NAB's cash flow and profit suffer, while provisions may need to increase.
Competition
NAB faces numerous large, powerful lenders, as well as plenty of smaller ones wanting to gain market share.
Names include Macquarie Group Ltd (ASX: MQG), Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), ANZ Group Holdings Ltd (ASX: ANZ), Suncorp Group Ltd (ASX: SUN), Bank of Queensland Ltd (ASX: BOQ) and Bendigo and Adelaide Bank Ltd (ASX: BEN).
They all offer similar loans, so price becomes one of the key differences for potential borrowers.
Lenders don't need a large branch network to win market share these days, thanks to digital banking. It seems strong competition is here to stay.
NAB said between March 2023 to September 2023, it was primarily competition that delivered a 7 basis point (0.07%) headwind to the NIM.
Foolish takeaway
As NAB enters 2024, the bank says that home lending competition headwinds are "expected to continue". There are also "ongoing deposit headwinds, primarily from higher term deposit costs."
Time will tell whether NAB can excel in 2024 under this environment.
