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Judo Bank boss ‘paranoid’ about ‘unprecedented’ risks

“We have a situation here where if interest rates move, as theory says they should, to deal with inflation, you have a huge problem in the household sector that will spill over into the SME economy,” Healy warns.

The comments come after a nasty 10 days for bank investors. In that period, Commonwealth Bank fell 16 per cent to $87.66 on Friday, its lowest level since April last year. CBA is down 7 per cent this week, including more than 3 per cent on Friday. Westpac has performed even worse, falling 21 per cent over the past 10 days, since the Reserve Bank went harder-than-expected lifting the cash rate by 50 basis points.

Healy says a lot of the problems are of the RBA’s own making. “If you are going to pump the system with excess liquidity, you are going to create inflationary problems,” he told finance reporters on Friday. “The fundamentals of economics transcend geographies, and the idea that we can conduct ourselves like the rest of the world and be exempt from the consequences doesn’t stack up.”

It is not the average borrower that brings the market down, it is the marginal borrower.

Healy, on Friday

The Judo house view on the rate trajectory is similar to major banks: it sees the cash rate going to 2.5 per cent this year, and maybe pushing to 3 per cent. But Healy says there’s a real risk it will have to move higher than this.

“I am nervous about the psyche that says, ‘she’ll be right, don’t worry about it’. You are better being prepared for the worst and hoping it doesn’t happen, than saying ‘we don’t expect issues to emerge and we will all be OK.’”

There is some reason for relative optimism. Although the global prospects of recession are very high, he says Australia is better placed due to its natural resources and agriculture, commodities that the world needs.

Unemployment also remains very low, which Dr Lowe said this week will help to support consumption. The RBA governor also pointed to the extra $250 billion in savings during the pandemic as providing a buffer against rising rates.

Yet Healy says wage inflation will eventually bite on small businesses, and force staff layoffs, pushing unemployment higher.

Judo Bank’s Joseph Healy says the level of household debt is eye watering, making the RBA’s inflation fight much tougher. David Rowe

With the Fair Work Commission’s minimum wage increase of 5.2 per cent this week the biggest increase in 16 years, “the inflation psychology is locked in the minds of employees and people are expecting 5 to 8 per cent wage increases, and business are going to have to deal with that – and you are dealing with it in a world of very low unemployment where it is hard to hold on to talent,” he says.

“At what stage, [given] rising prices through wages and other influences, do employers say ‘I am going to start cutting back because I can’t afford this because my margins are being squeezed’? That is what theory says will happen, so I don’t take a lot of comfort in the low unemployment as being sustainable.”

He also says Dr Lowe’s focus on aggregate savings presents “a fallacy” by looking at averages, rather than risks in the tail of borrowers. “It is a bit like saying to a non-swimmer, ‘It is safe to cross the river because it is one meter deep on average’, only to find it is three meters deep in the middle.”

“It is not the average borrower that brings the market down, it is the marginal borrower. It is the highly leveraged household borrowing at 6 to 7 times net income who bought two or three properties as investments … that is the Achilles heel.“

After the US Federal Reserve’s bumper 75 basis point rate rise this week, Healy says the United States typically takes its medicine quickly, but he’s concerned Australia will respond to the inflation breakout too slowly.

“The risk if you don’t accept short-term pain if you have long-term pain,” he says. “But in Australia, the issue is complex because the level of household debt is eye watering. And while the central bank is independent, there comes a point when politicians will find the amount of pain to be inflicted is intolerable from a political perspective.”

Although the outlook for the banking sector is bearish, Healy says Judo Bank will hit all of its prospectus forecasts, made a year ago. Its lending book should be $20 billion by 2026, which will make it the largest SME bank after the big four.

“We are very confident of at least meeting, if not exceeding, the key metrics that we have outlined in the prospectus,” he said on Friday. These include a net interest margin above 3 per cent, a cost-to-income near 30 per cent and return on equity in the low to mid-teens. Judo has 450 staff and plans to hire 100 more in the next 12 months.

With the stock depressed, Healy says the market may not understand that rising rates provide a tailwind for profitability – if it can keep credit risk under control. Its business loans can be repriced every 30 days; 91 percent of its lending is on a floating rate linked to BBSW. But most deposits are locked at a nine-month duration. This means “a rising interest rate environment is a sugar hit to us,” he says.

A 50 basis point lift in the cash rate will lift Judo’s net interest margin by between 25 and 30 basis points. “Rising rates are not good for our customers or the economy, but because of the way our assets and liabilities are matched, they are good for us,” he says.

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