BANK3600

BANKING IN PRACTICE

PROJECT 2 - SEMESTER 2, 2024

The Case

Your team  is  the  Management  Board  ("team")  of  Judo  Bank  ("Judo").  Judo  is  a successful 'challenger' bank focused on servicing the banking requirements of Small and  Medium  Enterprises  ("SMEs").  Judo's  Board  of  Directors  ('the   Board')  has requested your team present a report on the challenges faced by Judo resulting from the  current  macroeconomic  environment.  They  also   request  your  team   provide strategies to mitigate the risks associated with the challenges.

Background

•   Judo bank

-    Judo launched in March 2018 and is a relationship-centric bank with a purpose- built and legacy-free technology platform,

-    Judo received its full banking licence from APRA in April 2019,

-    Judo is a 'challenger' bank - challenging the major incumbent banks in an area that has not seen a major new entrant for many years,

-    Judo listed on the ASX in November 2021 and raised $653m in equity capital to assist with its continued growth,

-    Judo  has  grown quickly in a competitive market and  receives very strong Net Promoter Scores ("NPS") from its clients; +59 Lending NPS in 2024 FY results,

-    Judo's  Prospectus, dated October 2021 (page  167), provided the following key business metrics at scale forecasts when its loan book reaches a size of between $15bn - $20bn

o Net Interest Margin above 3%

o Cost to Income ratio approaching 30%

o Cost of risk of approximately 0.5% p.a. (loan loss provisions)

o Return on Equity in the low-to-mid teens (%)

-    Judo's strong FY2024 results suggest it is on track to achieve these key business metrics (slide 4, FY24 Results Presentation).

-    Judo    released  its 2024  Full Year  Results on 20th  August 2024, and you are required to use these most-recent results for your project. You are also referred to Judo Bank's Prospectus and other attachments for relevant information such as the competitive environment, loan growth rates, interest margins, loan arrears, and loan provisions.

•    Central banks and interest rate risks

-    Since the first half of 2022, global central banks rapidly raised their benchmark rate to combat rising inflation.

-    Bank lending rates and bank funding costs have risen significantly.  In Australia, housing and business lending rates are near the highest levels in the past five years.

-    Globally, the tide appears to be turning with central banks in developed economies beginning to reduce policy rates. Domestically, the RBA is more cautious regarding rate reductions and has continued to raise concerns about ongoing inflationary pressures and their ability to bring inflation back to its 2-3% target band (thereby leading to particularly diverged opinions/forecasts from commentators).

•   Increasing competition

-    In the wake of regulators seeking to promote competition in the banking sector, competitive forces for attracting deposits and loans appear to have increased over 2023-24 (and ongoing), thereby placing pressure on bank Net Interest Margins.

-    For instance, the Council of Financial Regulators (CFR) is currently conducting a review on the role of small and medium-sized banks in providing competition. Other recent inquiries include the ACCC’s Inquiry into retail deposit products and home loan pricing. In 2022, APRA also eased banking licencing requirements via a new “Restricted ADI” class.

-    While the focus of the above inquiries has been on the retail sector, competition in the SME lending sector has also increased in recent years, supported by lower capital requirements enacted by APRA since January 2023 and the rise of the non- bank  sector  (e.g.,  private  credit  funds).  Nonetheless,  Judo  Bank  appears  to position itself in a market segment (relationship lending of $2.5 to $10 million in size) with slightly lower competition.

•   Judo Credit Rating

-    Since  September 2021, S&P has assigned an investment grade rating to Judo (BBB-/Positive/A-3).

-    In April 2024, S&P upgraded Judo's rating to BBB/Stable/A-2.

You will be provided with a Risk Appetite Statement and a sample of Judo's recent loan book. Please note, as Judo is an ASX-listed public company, visibility of these details may be price-sensitive. You must respect all of the terms of the Confidentiality Deed  Polls and the  Licensing  letter that you executed  prior to  receiving Judo's sample data.

Your Team's Tasks

In light of the current macro-operating environment (i.e., persistent inflation, slow GDP growth, weak retail spending, uncertainty in RBA interest rates policies), your team is required to complete the following tasks (with the relevant / forecast period up to June 30, 2025):

1.        Discuss the outlook for small business lending in Australia (for the remainder of FY 2025) with reference to the current economic environment.

2.        Describe Australia’s  current  interest  rate environment and  relate this to the aggregate credit market exposure you expect Judo to achieve by financial year end 2025.(aggregate credit market exposure refers to the overall size, or growth, in Judo’s loan book).

3.        Based on your analysis, propose a target net interest margin for Judo as at year end FY25. Relate this proposed net interest margin to Judo's targeted metrics at scale.

4.        Incorporating the factors in Tasks 1, 2 & 3, suggest the average interest rate for Judo's SME lending as at year end FY25.

-         Judo's  lending  rates  are  calculated as  Customer Rate = Judo Base Rate + Customer  Margin.  The  Judo  Base  Rate  is  derived  directly  from  BBSW,  and  the Customer Margin is individual to each lending transaction.

-         Therefore, in this task, you should discuss both expected BBSW movements and an average customer margin.

5.       Your proposed customer margin and average interest rate will be a reflection of the evolving characteristics of Judo’s loan book. Referring to the characteritics and credit quality metrics contained in the Appendix to Judo’s FY24 Results Presentation, discuss how you might structure Judo’sloan book to achieve the proposed lending rate and customer margin in Task 4.

6.       Analyse the trend for Judo's cost of risk for the remainder of FY25. Judo’s ‘cost of risk’ is equivalent to what some banks refer to as ‘loan loss provisions’ .

-          Forecast the trend in credit risk for Judo's loan book (that is, do you forecast Judo’s lending activities will become more or less risky?).

-          Discuss Judo's relative credit risk exposure compared to its competitors in the business lending sector.

-          Relate the proposed cost of risk with Judo's targeted metrics at scale.

Your Team

Your team is represented by the following key members of Judo's Management Board,

-    Chief Operating Officer ("COO")

-    Chief Third Party Officer ("CTPO")

-    Chief Risk Officer ("CRO")

-    Chief Financial Officer ("CFO")

-    Chief Executive Officer ("CEO")

Your team must work collaboratively to ensure the tasks in the Board Proposal and presentation are consistent.

For the week  13  presentation  in class on Thursday  31st  October, each  role  must present an element of the Board Proposal.

1.    Briefing Paper - to be submitted by 9am Friday 11th  October 2024

Judo's Board has requested a Briefing Paper, in advance of the main Board Proposal.

The Briefing Paper should be completed in the context that it will set the scene for the Board prior to making decisions on strategies at the next formal Board meeting. The Briefing Paper relates to Team Tasks 1, 2 & 3.

The Briefing Paper should be in PDF format, 1.5 line spacing, and 12-point font. Only the in-text references will count towards the total word limit, but a full reference list needs to be provided in addition.

Word limit: 1000 words

ONLY ONE MEMBER  of your team should submit the Briefing Paper in PDF format to the Assignment portal on behalf of the Group. Your submission should include a cover page (do not use the cover page template) indicating the Team number, the student names, student numbers, and the word count for your report.

The submission must be made via Turnitin.

Please note that a late submission penalty will be applied consistent with Business School practice if your submissions are not received on time.

2.    Board Proposal - to be submitted by 9am Friday 25th  October 2024

The Board Proposal is to be developed mainly over Weeks 8 to 12.

A submission  link will  be  provided  in  the Assessment  Folder  of Canvas  for your submission, and ONLY ONE MEMBER of your team should submit the Board Proposal in either PowerPoint or PDF format on behalf of the Group.

Your submission should include a cover page (do not use the cover page template) indicating the Team number, the student names, and student numbers.

Please submit a peer evaluation form signed by the team along with your Board Proposal. A template form. is available under Assignments on Canvas. ONLY ONE signed peer evaluation form. needs to be submitted by the same member that submitted the  Board  Proposal. As  it  is  intended to  be a  helpful peer evaluation  (not a  self- evaluation),  please  allow  other  team  members  to  determine  your  contribution weighting. We would like each team to have a collegial and constructive discussion as part of the peer evaluation process, as the feedback that you can provide for each other will help you to strengthen your teamwork skills.

The  following  Board  Proposal  structure  is  provided  as  a  guide.  You  may  make amendments to this structure as you see fit, but you must strictly stick to a maximum of sixteen slides of content. Appendices may be added but may not be any more than five slides (that is, the total length of your presentation pack must not exceed twenty- one slides, inclusive of five slides of appendices). In-text references are included in this page limit, but the full reference list is not.

Item                                                                       Page

1. Title page                 1

2. Table of Contents              2

3. Executive Summary

A summary of the Board Proposal. The Executive Summary should include a summary of the target margin, proposed lending rates, the estimated cost of risk, and the key drivers of the rates and risks.                3-4

4. Outlook for small business lending:

Discuss the economic outlook in Australia. Focus on macro/micro-economic trends and their effect on the SME lending market in Australia.

As per Task 1 above                  5-6

5. Banking industry outlook:

Describe the interest rate environment and the aggregate credit market exposure Judo will have as at year end FY25.

As per Task 2 above                                7-8

6. Target net interest margin range:

Propose the target net interest margin for Judo as at year end FY25.

As per Task 3 above                           9-10

7. Lending rate pricing:

Suggest the average interest rate target for Judo's SME lending (discussing both Judo’s Base rate and customer margin) as at year end FY25.

As per Task 4 above                      11-12

8. Loan book exposures and characteristics:

Using Judo's FY24 Results Presentation (refer to Annexure) make recommendations regarding the composition of Judo’s loan book to achieve the proposed lending margin.

As per Task 5 above.                        13-14

9. Credit risk:

Analyse the trend for Judo's cost of risk for the remainder of FY25. Forecast the trend of credit risk in Judo's loan book. Discuss Judo's relative credit risk exposure compared to its competitors.

As per Task 6 above                  15-16

3.    Presentation - to be made on Thursday 31st  October , 2024

Teams will present their Board Proposal to Judo's Board of Directors (your USYD instructors) in order to gain their support for the proposed strategies.

Presentations must be succinct, and each student should present for no more than 3 minutes, giving a total presentation time of 12 minutes (for 5-member teams).

The Board Members will then ask each team questions for a further 5-10 minutes.

SUGGESTED WORKFLOW SCHEDULE

To assist with your team's planning of the tasks, we provide the following table for a suggested workflow schedule.