Founded in 2015, Judo is an Australian bank dedicated exclusively to lending to Small and Medium Enterprises (SMEs). Its goal is to be Australia’s most trusted SME business bank, by operating a relationship-centric model, focused on recruiting quality business bankers. It has grown very quickly over the past five years.
Judo T2s are rated BB (S&P) and remain attractively priced relative to other high-yield opportunities and the A$ Tier 2 universe. If anything, the bonds have cheapened up a little post FY23 results and we currently view them as an opportunistic buy. We expect credit spreads to contract on these lines by 100-200bs relative to the opportunity set. For comparison, Judo T2s are pricing at a trading margin of c.500bps (see green dot in charts below) versus the major bank A$ Tier 2 (5yr call) of c.190bps. This translates into a yield to call of close to 9%. The only comparable that comes close on a yield to call basis is AMP with a trading margin c.450bps and we know the challenges AMP have had in relation to their business model.
Judo is also the only pure play bank exposure to SME lending, a segment for which the growth outlook is relatively more positive versus Australian mortgages. While the FY24 net interest margin (NIM) outlook implies some headwinds, the business fundamentals remain strong, and Judo continues to demonstrate strong volume and net interest income growth. Management are targeting a lending portfolio of A$15-20bn with a low to mid-teens return on equity (ROE). This will translate into stronger cash earnings and improved debt-serviceability. Finally, Judo’s balance sheet management has been exceptional, and the company has ultimately become one of the standouts in the nonbank sector. The long-term funding stack of 70-75% from term deposits, 15-20% from senior/subordinated, and equity at 10% puts the business in a position of strength to absorb any unforeseen funding challenges. Management noted the current dividend policy is to reinvest all cash flows and excess capital into the business. This is a positive for creditors as it means the cash stays within the business and not leaked.
FY23 Results
Judo reported cash earnings of A$73.4mn up significantly from A$9.1mn in FY22. On the capital front, common equity tier 1 (CET1) was 16.7% down from 20.5% in FY22.
Judo delivered on its FY23 guidance and has also reiterated that it remains confident in achieving its prospective metrics at-scale targets.
- Lending portfolio: A$15-20bn
- Net interest margin (NIM): above 3%
- Cost to income ratio (CTI): approaching 30%
- Cost of risk: 0.5% p.a. of lending assets
- Return on equity (ROE): low-to-mid-teens
In relation to volumes, Judo’s loan book grew by 46% on FY22 to A$8.9bn (or 8x system growth) driven by growing banker portfolios, continued recruitment of high-quality relationship bankers and national footprint expansion. Importantly, Judo’s business metrics at scale of lending portfolio A$15-20bn remain unchanged. On costs, expense growth grew by 45% on FY22, however Judo were able to improve the cost to income (CTI) ratio to 54.1% from 76.3% through improved operating leverage and efficiency. FY24 expense growth should materially slow to broadly half the rate experienced in FY22 (+45%) as headcount begins to stabilise. Judo is well on the way to achievement of a CTI of 30%.
The FY23 NIM increased by 121bps, from 2.08% in FY22 to 3.29%, while its underlying NIM (which includes the cost of funding associated with RBA’s term funding facility (TFF), which is 10bps, but excludes the temporary impact of excess treasury assets, which are relatively low yielding) was up 74bps to 3.53% from 2.79% in FY22. On FY24 NIM outlook, Judo noted the following:
- The margin on Judo’s pipeline is stated to be c.25bp above the existing portfolio
- Ongoing focus on long term lending margin assumption of c.4.5% over 1m BBSW and
- 2024 will be a transitional year for funding and will reflect repayment of the TFF and transition to Judo’s long term funding model.
Regarding asset quality, the FY23 bad doubtful debt (BDD) charge was A$52.6mn representing 74bps of average gross loans and acceptances (GLAs). Write-offs for FY23 were very small and the BDD charge was entirely down to provision build (a favourable result given what the rest of the nonbank sector is experience regarding mortgage delinquencies and write-offs). Higher balance sheet provisions were due to loan book growth, changes in Judo’s expectations for the economic outlook, and a new A$5mn vulnerable sectors overlay. In our view, this points towards Judo’s conservatism re balance sheet and is a good sign for creditors.
Where are Judo T2s trading versus other comparables?
All A$ Tier 2 – Trading Margin
All A$ Tier 2 – Yield to call
Financials and earnings expectations
Source: Bloomberg FA
Source: Bloomberg EEO
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