Judo Capital Lands On The Mat

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Judo Capital has shocked the market in disclosing a rapid deterioration in loan quality leading to a share price trashing. May there be more to come?

• Judo Capital shocks with significant downgrade
• Share price falls -40%
• Questions arise as to Judo’s credit assessment process
• Regaining credibility will likely take time

By Greg Peel

For an extended period of time, SME lending disruptor Judo Capital ((JDO)) has attracted a full six Buy or equivalent ratings from the six brokers monitored daily by FNArena covering the stock.

This is in stark contrast to the major banks, and the regionals, and investment bank Macquarie Group ((MQG)), all of which struggle to attract as many as two Buy ratings, if at all, with Commonwealth Bank ((CBA)) long attracting six from six Sells.

Judo’s share price declined some -30% from a February into April as investors feared a general economic downturn due to the war in Iran, risk in the private credit market, and AI disruption.

As the share price kept languishing well below price targets, brokers held onto their Buy ratings.

On Thursday the share price fell -40%.

Rapid Deterioration

Judo has updated the market on credit quality ahead of its second half FY26 result. As a result of three exposures totalling $70m-$80m management has revised up its full-year bad & doubtful debt (BDD) charge from -$100m to -$116m-122m.

Despite a better underlying performance, this has seen full year profit guidance downgraded to $163m-$169m from $180m-$190m.

The BDD charge is 30% greater than consensus expectation. The -8% downgrade to FY26 profit guidance at the midpoint implies a -15% miss to consensus.

Judo also provided FY27 profit guidance of $210-220m, which is -17% below prior consensus.

FY27 changes appear to be an attempt to rebase expectations, Citi suggests, after two asset quality-led downgrades in two months and a desire to avoid a third.

Citi assumes the reaction of the shares more likely reflects structural questions around the nature of the risk being taken, the size of individual exposures, and the pace at which they manifested given Judo updated the market around one month ago. 

Customer-specific, or a broader issue?

Management said it was surprised in recent weeks by rapid deterioration in three loan exposures across different sectors (financial planning, windows manufacturer, and construction services) and different states.

It believed the loan issues were independent and not systemic. Interestingly, Morgans notes, Judo said the exposure-at-default of the three loans totalled $70-80m, and were not evenly sized, with one larger one in the mix.

The size is somewhat surprising to Morgans given Judo says its average loan size is circa $2.5m (and typically between $2m and $15m), with Judo believing the scale of its loan book can now take on select larger exposures.

The speed at which conditions for these three specific exposures deteriorated –-none were on a watch list-– is a significant concern for Ord Minnett and the broader market, raising questions as to just how rigorous and reliable Judo’s monitoring processes are, not to mention management’s credibility.

Ord Minnett also highlights the large size of these particular loans –-the combined exposure for Judo is $80m, versus its average SME loan size of around $3m-– and questions why Judo was making such large individual loans.

The three customer groups driving the downgrades look to be idiosyncratic events, Citi notes, and management noted broad performance across the rest of the portfolio.

Nevertheless, Citi expects the market will have lingering concern regarding: management’s visibility on the book given the prior update happened in May; the level of credit risk being taken; and the quantum of exposure.

While Judo management maintains these are isolated exposures and remains confident in the lender’s underwriting standards, the fact no issues were apparent during recent customer reviews raises questions for Macquarie on customer monitoring and origination.

Of note, while Judo provided downgraded FY27 profit guidance, it provided no FY27 BDD guidance.

In Morgan Stanley’s view, the announcement raises concerns about Judo’s lending standards, business model and “metrics-at-scale” targets.

Morgan Stanley is surprised how quickly loan losses have stepped up –- operating conditions started to deteriorate only in March and credit quality remains sound at other banks.

Management’s comments that the three exposures which drove the downgrade are “very different issues” and “not a symptom of anything more systemic” call into question the effectiveness of its “4Cs” approach to underwriting and early risk detection.

[The 4Cs are character, capacity (to repay the debt), capital (what they build), and collateral.]

Perhaps lost in the wash, Macquarie notes Judo appears to have delivered a better underlying performance, with implied pre-provision profit some 5% ahead of consensus, and at net interest margin in excess of 3.2%, with consensus at 3.16%.

Looking forward, Judo expects margins to moderate to 3.15% over FY27 as term deposit pricing normalises.

Long Road Back

When Judo completed its capital relief funding transaction at the end of May, it quoted a proforma CET1 ratio of 13.2%, inclusive of a 60 basis point benefit from the transaction. This is weaker than Morgans had expected.

Judo says it “will transition to operating with a management CET1 target range of 11.0%–12.0% in normal operating conditions” and hints at “the potential to consider capital management initiatives in due course”.

At current prices, Morgans suspects this would include consideration of a share buyback. Judo does not currently pay dividends as it retains capital to support its significant loan growth aspirations.

Macquarie expects Judo to maintain CET1 above its new 11%-12% target in the near-term, but there is a risk capital could become a constraint on the pace of growth ahead if credit quality remains challenging

Judo Capital is a challenger bank with pure-play exposure to the SME business banking space, leveraging a relationship-driven customer proposition, and a rapidly growing on-line deposit franchise.

Earnings growth is expected to be at strong double-digit rates across FY26-FY28.

Judo is higher risk and more cyclically exposed than the major banks, but Morgans believes investors are compensated by higher potential returns at current prices. Hence, Morgans retains Buy, cutting its target to $1.47 from $2.15.

The -40% fall in share price is behind similar views from other brokers.

The update was disappointing, Macquarie acknowledges, and it will take time for management to win back credibility. Still, after a -40% fall in the share price, and trading at only 7x PE and 0.5x price-to-book, Macquarie thinks the elevated near-term risks are more than adequately reflected in the current de-rated valuation.

Macquarie retains Outperform, cutting its target to $1.55 from $1.85.

The spike in loan losses suggests to Morgan Stanley that Judo’s efforts to increase its loans by $1.5bn-$2bn per annum without sacrificing margins have increased risk more than its 50 basis point “metrics-at-scale” loss rate target implies.

Morgan Stanley believes it will take time to address these concerns. In a first reaction report, Morgan Stanley has retained its Overweight rating and prior $1.85 target, but we can assume the target at least may now be under review.

Although rebased, there is still a strong growth profile ahead for Judo, Citi admits. However, the nature of this downgrade –-in both scale and timing-– is likely to prompt divergent views on asset quality within the book.

Consequently, while Citi retains its Buy on valuation grounds, supported by the growth outlook and the extent of the de-rating, this broker recognises that restoring market sentiment is likely to be a gradual process.

Citi has cut its target to $1.50 from $2.20.

There had to be one…

Ord Minnett has cut its target to $1.60 from $2.40, and also cuts its recommendation on Judo to Hold from Buy despite the apparent value on offer, given uncertainty around the lender’s processes and the time it will take for management to rebuild market confidence.

There might yet be more changes forthcoming, but as of right now the consensus target for Judo Capital has dropped to $1.73 from $2.12.

At the time of writing, the shares are changing hands around 90c.

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