Judo Capital’s Q3 Disappointment Hurts

Small Caps | May 07 2025

Management at Judo Capital reacted to market uncertainty by downgrading near-term guidance, but analysts question whether a negative share price reaction is overdone.

-Judo Capital downgrades metrics for FY25 and FY26
-Competition and economic uncertainty weigh
-Share price selloff looks excessive to some analysts
-Potential for a capital raising?

By Mark Woodruff 

Increasing competition in Australia's business banking sector may negatively impact the ability of specialist, pure-play lender to small and medium enterprises Judo Capital ((JDO)) to keep existing clients and remain competitive on both pricing and attracting new business opportunities, suggests UBS.

Following Judo's third quarter trading update, Macquarie adds consensus forecasts had been overly optimistic, overlooking both intensifying competition and a slowdown in credit growth. 

Additionally, the analyst suggests economic uncertainty is likely to increase impairment risk, particularly for lenders that have grown rapidly in recent periods.

On the flipside, with the shares now trading around $1.43 versus $1.78 prior to the latest market update, several analysts are questioning whether the shares have been oversold on the disappointing message emanating from the quarterly update.

Morgan Stanley highlights Judo is being impacted by broad market forces largely beyond management's control.

This broker points out monthly data from the Australian Prudential Regulation Authority (APRA) between November 2024 and February 2025 revealed a clear slowdown in loan growth. In addition, recent US tariff announcements and Australia's Federal election have contributed to a more uncertain near-term operating environment for small-to-medium enterprise (SME) customers.

Prioritising relationship-led lending, supported by a cloud-based digital technology architecture, Judo is not only a SME banking specialist, but also a challenger bank to Australia's big four banks.

The suggestion made is investors should recognise SME business lending carries higher credit risk than residential mortgage lending.

Current woes for Judo

Judo is currently paying more to attract new term deposit funding than it typically would, with potential to compress the bank's net interest income (NII) and net interest margin (NIM).

As a reminder, NII is derived from the difference between interest earned on lending and investment assets and interest incurred on customer deposits and wholesale debt raised to fund these assets.

In contrast to most of the third quarter, management observed heightened volatility in the operating environment in recent weeks, resulting in a disconnect between swap rates and headline term deposit rates.

Specifically, management attributed lower guidance to "market uncertainty impacting customers, the slower initial ramp-up of warehouse lending, and balancing growth and economics".

After providing strong second-half guidance at its February first-half results, Jarden now questions management's strategic execution as the March quarter update contained downgrades to several FY25 metrics.

That said, the broker acknowledges progress is rarely linear and believes the bank is still adjusting to the demands of listed life, which began in November 2021 at an IPO price of $2.10, compared to yesterday's closing price of $1.45.

Initial FY26 pre-tax profit guidance of 50% growth was also provided (assuming stable economic conditions), but this is still an around -6% miss versus market expectation, notes Citi.

While the trading update was clearly disappointing, Ord Minnett believes the subsequent -17% sell-off in Judo shares was excessive relative to the scale of the FY26 downgrade.

Morgan Stanley agrees the third-quarter challenges appear temporary and supports the view recent share price weakness presents a value opportunity, noting Judo's share price has fallen around -30% since the first-half result, compared to a -2.5% retreat for the ASX200.

Also, this broker feels investors should take some comfort from management's aim to achieve "an appropriate balance between growth and economics".

Potential for a capital raising?

Morgans no longer expects Judo to achieve its at-scale target of low-to-mid-teens return on equity (ROE) by the end of the decade, instead viewing a 12% ROE as more realistic, which results in a lower terminal valuation by the analyst.

While earnings growth has slowed, the broker expects softer loan growth to limit risk-weighted asset expansion, supporting the CET1 capital ratio and reducing the likelihood of a capital raising.

Preferring to retain capital to fund ongoing loan book growth, management has no intention to pay dividends, leaving investors in Judo Capital fully reliant on capital appreciation for investment return.

Details of FY25/FY26 downgrades

UBS lowers EPS forecasts for Judo Capital across FY25-27 by -15%, -6%, and -4%, respectively, due to slower-than-expected growth for gross loans and advances (GLA).

The broker's reduced forecasts reflect lower volume growth but net interest margin (NIM) stability of circa 3.0% in the second half.

Management downgraded several FY25 guidance items including: GLA to between $12.4-12.6bn from $12.7-13.0bn; impairments to above the FY24 level from flat; and flagged the exit net interest margin exit NIM of 3% may come under pressure with further rate cuts.

While the profit (PBT) growth targets of 15% for FY25 and 50% for FY26 remain intact, Macquarie is becoming less convinced the former target will be achieved given elevated funding cost pressures, falling interest rates, and higher impairments.

NIM target

The 3% long-term NIM target may be hard to achieve, on Macquarie's assessment, as ongoing competition and slower-than-anticipated book growth are making it incrementally more difficult to reach at-scale metrics, especially for ROE/cost-to-income (CTI).

While Morgans now doesn't expect management to achieve its at-scale ROE target of low-to-mid teens, the analysts forecast the NIM will lift beyond 3% from FY26.

Further rate cuts and lower yield curves put pressure on the replicating portfolio (a modelling tool used to manage interest rate risk for products like transaction accounts, savings deposits, or equity capital) and unhedged capital/deposits, explains Macquarie.

Costs and credit impairment

Indicating strong cost containment in the face of lower-than-expected revenues, management expects FY25 CTI to be lower than FY24 instead of broadly stable as previously guided.

Morgans assumes FY26 cost growth and absolute costs will be greater than what was previously expected, given FY26 expense growth will be driven by heightened competition for frontline bankers, amortisation of intangibles, and incremental growth-related investments.

Regarding credit impairment, here loan losses are now expected to be "higher" than last year, raising concerns credit quality has deteriorated.

Management noted impaired loans and loans more than 90 days overdue had increased in the March quarter from the previous quarter as global economic uncertainty weighed, prompting Morgans to lift its FY25 credit impairment charge forecast and assume a quicker convergence over time on its projected -50bps write-off rate.

Positively, while loan losses were affected by "a small number of exposures in vulnerable sectors", the non-performing loan ratio only increased by around 15bps, highlights Morgan Stanley.