Judo Capital Holdings Limited (JDO) Earnings Call Transcript & Summary

Good morning, and welcome to the Judo Bank FY '26 Results Webcast. We appreciate everybody accommodating the slightly delayed start time this morning. It has turned out to be a busy day on the market. My name is Andrew Dempster, I'm the GM of Strategy and Investor Relations at Judo Bank. I'd like to begin by acknowledging the traditional owners of the land from which we are all joining today. For our agenda this morning, we're first going to hear from CEO, Chris Bayliss, with an overview of our performance and some discussion on our portfolio. Our CFO, Andrew Leslie, will then run through detailed financials, and then Chris will return to discuss our strategy and outlook. We will then open the lines for Q&A. On that note, I'll now hand to Chris.

Thank you, Andrew, and good morning, everyone. Now look, it won't be a surprise that following our June announcement, we've spent considerable time engaging with the market. I think it's fair to say we've received numerous questions about the composition of our portfolio, whether the June event was isolated or evidence of broader deterioration and ultimately, whether we remain confident in our through-the-cycle cost of risk assumption of 50 basis points. Our goal is to answer these questions today. And to that end, we have included some additional slides in the presentation. We will, of course, also provide the usual detailed update on our financial performance and discuss the outlook. I'd like to begin with some reflections on FY '26. It's, of course, important to acknowledge the increase in provisions we announced in June. This related to 3 exposures, 1 large customer group and 2 smaller customers and resulted in higher earnings volatility than we expect from the business. The 2 smaller customers are typical losses for an SME bank, but were nonperforming at the end of the year, which just didn't give us enough time to resolve them before the end of our balance date. Since then, we've undertaken a review of the exposures and incorporated learnings into our settings and processes. We've taken targeted actions in the areas such as the detection of connected borrowers, valuation practices and credit assurance. And the business is much stronger as a result. However, look, it's important to keep FY '26 in perspective. Two specific provisions, only one of which was discussed in our June update, accounted for 25% of the year's impairment expense, and they are not representative of the portfolio, which continues to perform in line with our expectations. I want to stress also provisions are not losses. Both of these businesses are trading and the resolution process is ongoing. And in particular, the larger customer group we referred to in our June update is starting to clear their arrears, and we have a good relationship with them. Notwithstanding these provisions, as we go through our results today, you'll see we have continued to execute against our strategic priorities and deliver a step change in ROE. The fundamentals of our company remain strong. SME credit demand is robust, and we have a healthy pipeline and a strong competitive edge. Our bank is increasingly diversified and delivering significant operating leverage. We continue to execute our strategy and have a clear pathway to delivering ROE in the low to mid-teens. Now to our financials. We've had another year of above system growth in lending with growth in the regions and Agri outperforming the rest of the book, driven by the investments we've made over the last few years. Pleasingly, deposits have funded all lending growth, supported by our competitive pricing and the launch of our new at-core products, which have exceeded our expectations. NIM has improved 20 basis points and is now above 3%, consistent with our long-run assumptions and expectations. CTI has improved substantially, and it still has a long way to fall despite us already having the lowest CTI in the sector now. Cost of risk was higher, as I've already discussed, but ultimately, it came out at the low end of the range we gave in June. And as I just said, a disproportionate amount of the charge was consumed by 2 customers files, which we believe have characteristics not generally present in the rest of the portfolio. And PBT, notwithstanding the higher cost of risk was still up 34%. Similarly, our ROE of 6.4% has again improved and will now continue to do so by about 100 to 200 basis points per annum. Moving now to portfolio composition. We continue to run our own race with a CVP of smarter judgment, faster decisions and stronger relationships. While the major banks are undeniably more competitive in SME, we continue to have a strong competitive edge. We exist to serve customers that do not fit through industrialized one-size-fits-all credit assessment processes. That said, there is very little lending we do that the major banks would say no to and around 70% of our customers come to us from the major banks. Our model means we are faster and provide more tailored structures. We price for this service. We also price for differentiated risk. The chart on the top right demonstrates this. Our margins increase with risk measured as PD. Importantly, our portfolio metrics remain aligned to our through-the-cycle assumption of 50 basis points of cost of risk based on a portfolio PD of 2% and an LGD of 25%. And the bottom right chart shows average portfolio PD over time. Despite strong GLA growth, average portfolio risk has actually been stable to lower, not higher. So the key message is that we are generating growth by applying our credit capabilities in underserved segments of the market and generating margin with our service proposition. In addition to managing risk at a transaction level, we also think about risk at a portfolio level. Since day 1, we've consistently said that we are building a portfolio that mirrors the economy with 2 exceptions. Firstly, agri. We had a risk setting that the loan book had to reach a reasonable size before we could take on the additional risk from weather and commodity prices. Agri is, however, a large part of the economy. And so over the last 3 years, we've grown in a measured way. We've opened nearly all of our locations in areas where we are comfortable with the risk dynamics. We still remain underweight to this segment at about 8% of our total portfolio versus 19% for the sector. The second key exception is lending for construction purposes. While this is, of course, a major part of the economy, our exposure to this sector is largely services to construction, supporting existing customers are building their own premises or some predevelopment sites. We also have some exposures by our warehouse business, noting this is structurally more diversified and has a lower leverage point. The other sector to call out is commercial property investment, distinct from construction. Our exposure has reduced from 20% to 17% over the last 4 years as we've maintained a conservative stance towards property valuations. So since the IPO, we've actually grown from approximately $4 billion to a lending book of $15 billion now while expanding across industries, geographies and customer segments. And so as a result, the key message is that the portfolio today is significantly more diversified than at the time of our IPO. As we have diversified and grown, we have remained an SME lender. 98% of our customers have facilities below $20 million. The growth in our balance sheet has, however, given us some optionality, and we do have a handful of larger groups, all family-owned and most of whom we have banked for many years. We know them well. We understand their businesses well, and we've been willing to grow with them. And this is exactly what we mean by relationship banking. I will discuss our larger customers in more detail on the next slide, but in summary, they are lower risk and have more property security. This naturally implies that the smaller customers are the more cash flow orientated. And this part of the portfolio is incredibly well diversified. I mean this really is our absolute bread and butter as a specialist SME lender. And while our seas approach to credit means we do not start with how much is your house worth, it is important to note that none of our lending is unsecured. We always have alternative security such as a fixed and floating charge and directors' guarantees. Our specialist model with experienced empowered relationship bankers who have small portfolios means we continue to excel in this part of the market. Now moving to our largest customers. Whilst we must respect client confidentiality, it's important to provide some context behind them. First, these are overwhelmingly long-standing relationships. Around 80% of the growth in our customers above $50 million has come from businesses we've supported over several years. As they've grown, we've continued to support them. This means we have a deep understanding of their operations, their management teams and their trading performance. And secondly, these customer groups are typically diversified businesses rather than single operating entities. Our largest customer group, for example, comprises 6 different trading businesses and 9 different freehold properties. Across the 6 customer groups above $100 million, there are 22 trading businesses and 33 properties. Three of these groups operate in the hospitality industry, where they generally have multiple freehold assets and are managed by highly experienced operators. And in several cases, these customers are banked for Judo for many years, including relationships that actually predate our IPO. Third, our governance framework becomes increasingly rigorous as exposures grow. New-to-bank lending above $50 million is generally restricted, reflecting our preference to support and grow with existing customers, as I said earlier. Any exceptions require senior executive approval and Board oversight. But from time to time, we also see opportunities through our established banker relationships with larger businesses, and these are subject to extremely rigorous credit assessment, and we completed only just one such transaction during the year. Fourthly, we believe our relationship-led model is particularly valuable in this segment. Our specialist bankers manage relatively smaller portfolios and work alongside experienced senior credit execs. In sectors such as hospitality, we've built up significant expertise and have long-standing industry relationships and believe we have one of the most experienced business banking teams in the country. Finally, it's worth noting that our approach to concentration has remained consistent as the balance sheet has grown. The largest single exposure has only occasionally exceeded 1% of our gross loans and advances. And as the balance sheet has continued to expand, we expect our largest exposures and the proportion of those exposures above $50 million to remain stable or trend lower as a percentage of the portfolio. The key takeaway is that these exposures are generally long-tenured relationships supported by diversified underlying businesses, strong governance and very experienced sector specialists. They remain an attractive part of the portfolio. They generate strong returns whilst maintaining conservative structures and security. I also want to make a comment on our relationship with brokers. In a market of over 22,000 brokers, we deal with less than 10%. These are dedicated commercial brokers who are largely ex business bankers of the Big 4. We have a rigorous accreditation and ongoing monitoring process. On top of that, as we've talked about before, we launched our Black Belt program last year, and it's been an absolute roaring success. These brokers represent the top 0.1% of brokers in the country, and our proposition with them is unique in the industry. And these brokers are business banking veterans with an average of 22 years' experience. So where 99.9% of brokers in Australia are paid commissions solely on volume, these brokers have to hit portfolio customer satisfaction metrics and risk metrics also. And this group of brokers has generated growth above 2x system. And throughout 2026, we did not have a single bad debt or a single specific provision associated with any of these Black Belt brokers. Now before handing back -- before handing to Andrew, I'd like to reinforce that we have multiple levers available to continue driving our ROE. 10 years into our journey compared to other listed ADI peers, we have the leading -- the industry-leading NPS, the highest PBT growth, the highest NIM and the lowest CTI. We also have the highest level of capital and the highest level of collective provisioning on a like-for-like standardized basis compared to the other listed banks. We've come a long way, and yet we just remain still only 2% of the market. So we still have significant runway ahead of us to manage growth, margins, cost, capital and deliver strong operating leverage and ultimately improve ROE by, as I said earlier, by about 100 to 200 basis points per annum. I'll now hand over to Andrew, who will take us through the financials.

Thank you, Chris, and good morning, everyone. This financial year, Judo delivered pre-provision profit of $286 million. This result represents 42% growth versus last year, well ahead of our original expectations and guidance. Growth, NIM and operating leverage were all better than forecast. Earnings were also impacted by higher impairment charges. However, despite this, net profit before tax was up 34% year-on-year. Net profit after tax increased 29% to $111 million, and EPS also increased 29% to $0.099 per share. Overall, return on equity increased 110 basis points to 6.4%. Over the next few slides, I'll walk through the key drivers of the result in more detail, starting first with NIM. This slide sets out the key drivers of net interest margin from December '25 to June '26. NIM improved from 3.03% in the first half to 3.23% in the second half, a better-than-expected result. There were 2 material positive drivers denoted by the green bars. First, deposit margins, which contributed 16 basis points to NIM with blended deposit costs improving as cheaper deposits written in the first half washed through the book. Deposit margins also benefited from the introduction of our at-call savings products, which allowed us to optimize our use of TDs during the period. Second, the treasury portfolio contributed 7 basis points to NIM due to tighter liquidity management and improved treasury yields. These large positive benefits were only slightly offset by 2 other factors. Lending margins saw a 2 bps reduction to NIM. Average lending margins declined from 4.3% to 4.2% over BBSW, reflecting some competitive pressures and changes in the lending mix with a greater contribution from warehouse lending, which carries lower margins but higher ROE. Front book lending margins were 4.2% compared with 4.3% in the first half. Other cost of funding, including funding mix and the cost of wholesale funding was a 1 basis point drag to NIM. While we benefited from favorable warehouse renewals and a higher proportion of deposit funding, this was largely offset by the full period impact of the Tier 2 issue completed in the first half and the $750 million term securitization, which settled in June. Lastly, the equity component of funding. This had a neutral impact on NIM as the rising RBA cash rate was offset by our investment term of capital. I'll now touch on our NIM expectations for FY '27. We expect NIM to be broadly stable relative to FY '26 of 3.13%. Term deposit margins are expected to normalize back towards our through-the-cycle range of 80 to 90 basis points over 1-month BBSW. At the same time, we expect lending margins to be moderately lower, reflecting both lending mix and ongoing competition. We assume continued benefits from tighter liquidity management with liquid assets as a proportion of GLA continuing to trend lower. And we continue to expect a higher portion of deposits in the overall funding stack. Taken together, these factors are expected to broadly offset each other, supporting a broadly stable NIM outlook for FY '27. Next to deposits and deposit margins. We continue to grow and diversify our deposit franchise, supporting ongoing momentum in lending. The deposit book continues to perform strongly with retail TD rollover rates increasing to 73%. As touched on earlier, blended deposit margins improved by 23 basis points in the second half to 69 basis points over 1-month BBSW. This was driven by favorable swap rate movements, which lowered the cost of term deposits originated earlier in the year as well as the successful rollout of our at-core savings products. Looking at new term deposit pricing, the average margin on TDs originated in the second half was 71 basis points over 1-month BBSW, benefiting from favorable swap curve conditions for most of the period. As expected, term deposit pricing moved back to our through-the-cycle range of 80 to 90 basis points over 1-month BBSW towards the end of the second half with margins at this level embedded in our FY '27 guidance. I'll now spend some time on our at-core savings offering, including the 2 new products that we launched in FY '26. This is a great example of how the investments made in our technology platform directly support our long-term funding strategy. We successfully launched 2 new savings products during the year, the intermediated savings account in October and the direct online savings account in February. These products were launched as part of a deliberate strategy to diversify our funding base, doubling our addressable deposit market beyond term deposits. Importantly, they give us greater flexibility in how we manage term deposit flows and pricing, optimizing overall funding costs. While still early in the life cycle of these products, we're pleased with the initial results. Customer adoption has been strong with the majority of balances coming from new to bank customers. And we expect benefits to continue to build as balances grow and customer cohorts mature over time. Looking ahead, we continue to see significant opportunities, including product enhancements and channel expansion. Our overall objectives remain unchanged: to diversify our funding base, increase funding optionality and improve funding efficiency as we continue to grow our balance sheet. So let's now look at the overall funding stack. We continue to progress towards our at-scale funding mix with deposits now representing 71% of total funding. Just as importantly, we continue to strengthen and optimize our wholesale funding. During the year, we completed a $150 million Tier 2 issue, which priced 120 basis points tighter than our previous transaction. In addition, we successfully completed a $750 million capital relief term securitization, which priced 102 basis points tighter than our inaugural transaction in 2023. We're very pleased with this result. Now beyond the pricing outcome, the strategic significance of this transaction is that it provides capital relief and is highly accretive to ROE. We would like to complete these types of transactions annually as we continue to scale and optimize the balance sheet. Turning now to operating expenses. We delivered material improvement in our cost-to-income ratio during the year, which reduced from 52.4% in FY '25 to 45.3% in FY '26. This is a very strong result and demonstrates the operating leverage inherent in the business as we continue to scale. Total operating expenses in FY '26 was $237 million. The largest contributor was employee-related costs, reflecting continued investment in customer-facing roles and some in-sourcing of IT roles, normal wage inflation and growth in the business. FY '26 saw higher amortization expense, reflecting the full run rate of prior investments, which was largely offset by lower IT costs. Other operating expenses increased, driven by growth-related activity and inflation. Looking ahead to FY '27, we expect positive jaws to drive ongoing improvements in the cost-to-income ratio. We plan to invest in customer-facing capability, new products and productivity initiatives with other costs growing largely in line with inflation. Turning now to asset quality. 90-plus days past due and impaired assets increased to 2.9% of GLA at year-end, which includes the 2 larger impairments previously discussed. There are several key trends beneath the headline numbers worth highlighting. First, early-stage arrears improved significantly during the year with 30 to 89 days past due loans reducing to 0.39% of GLA, down from 1.04% a year ago. This improvement was driven by customer cures, repayments and refinancings. However, this metric can be volatile, and we're not declaring victory. Secondly, trends in asset quality are mixed across different sectors. As shown on the bottom chart, elevated impairment levels continue to be focused in a handful of industries rather than being evident across the broader portfolio. And we applied targeted management overlays to the more challenged sectors. Finally, during FY '26, resolutions were higher, partly offsetting new impaired asset formation. Next, impairment expense and provisioning. FY '26 impairment expense increased to $118 million or 88 basis points of average GLA. This primarily reflected higher specific provisions on new impairments, together with a more cautious outlook for certain sectors facing continued challenges. Our provisioning approach remains prudent. Collective provision coverage increased to 0.93% of GLA, up from 0.89% in December, whilst the average PD of the performing portfolio remained broadly stable. Collective provision coverage reflects 5 key factors. Firstly, portfolio growth and changes in mix with new originations representing a material portion of existing current exposures. Secondly, customer attrition disproportionately in higher risk categories. Thirdly, general seasoning of the loan book, including customers migrating from the collective specific provision buckets. Fourthly, updates to forward-looking macroeconomic scenarios, including incorporation of an oil shock in the downside scenario. And finally, a vulnerable industry overlay, reflecting heightened risk for sectors experiencing challenging operating conditions. Stepping back, at 1.11% of standardized credit risk-weighted assets, Judo continues to hold appropriate levels of provisioning for our loan book. Finally, to capital. We continue to maintain a strong capital position with a CET1 ratio of 12.4% at June 2026, above our target management operating range of 11% to 12%. During the second half, the movement in the CET1 ratio was impacted by 3 main drivers. Firstly, lending growth, which was the primary consumer of capital at 110 basis points. Secondly, organic capital generation, which continued to grow and contributed 40 basis points of capital in the half, supported by rising profitability. And we expect this trend to continue as operating leverage builds. And thirdly, the capital relief term securitization transaction, which contributed 60 basis points of capital. These transactions are highly accretive to ROE, demonstrating our ability to drive both capital efficiency and balance sheet scale. We have multiple levers to support growth while maintaining strong capital levels. With a CET1 target range of 11% to 12%, we now have the flexibility to consider a range of capital management initiatives in due course. Thanks again, folks, and I'll now hand back to Chris.

Thanks, Andrew. I want to start my wrap-up with the service profit chain, which remains core of how we operate the bank. Engaged employees will deliver very satisfied customers. These build your brand and in turn, deliver great results for shareholders. Our employee engagement remains strong and has improved over the year, which is pleasing when scale often does the opposite. This has actually translated into even happier customers with our lending and deposit NPS remaining sector-leading. And for me, personally, I'm delighted we've been able to improve all these metrics as we've scaled, reflecting that this philosophy is well and truly now embedded into our DNA. And the resulting ROE and EPS improvement show the model is working. ROE has improved 110 basis points year-on-year, and our EPS is up 29% year-on-year. Now this is our strategy that we continue to execute. We are growing and scaling our business, leveraging the strong foundations we have built. Growing our total addressable market remains the personal priority for me as CEO as we build out more and more diversification. Looking forward, we want to increase other operating income, reduce our cost of deposits and enable our employees to innovate and drive more productivity. There are huge opportunities for us to consider how we support much smaller micro businesses with a better lending proposition for those customers that want to borrow below $1 million. This is still a gap for us. In addition, there are opportunities to improve our working capital facility, our receivables finance proposition and whether we want to enter trade finance. Collectively, these segments are accretive to ROE through higher margins and higher fees. And we remain confident in our thesis of building a bank that can generate an ROE in the low to mid-teens at scale, and we have lots of opportunities ahead of us. In the near term, we have several strategic priorities aligned to growth, margins, operating leverage, risk management and capital efficiency. On growth, we're making ongoing investments in banker enablement, consolidating our position in the regions and having a truly sector-leading broker value proposition with our Black Belt brokers. To drive margins, we will continue to invest and enhance our deposit offerings. Combined with growth and margins, investment in productivity will continue to underpin the delivery of operating leverage. This work capitalizes on our strategic flexible technology platforms with AI solutions having an increasingly important role to play. And in terms of risk management, in FY '27, we are deploying new monitoring and early warning alert technology that will complement our existing detective controls. Lastly, we will continue to actively manage capital with all our available levers to support growth and ROE. Now turning to the economy. We understand the broader economic outlook and trading conditions for SMEs are mixed and businesses are operating with uncertainty about the future. Businesses also continue to be constrained by capacity shortfalls across the economy, in particular, skilled labor. This is an incentive for SMEs to invest in productivity-enhancing initiatives, including automation, technology and operational efficiency, which is supporting the ongoing demand for business lending. And we have a clear role to play in this productivity agenda, providing the capital SMEs customers require to invest and grow. There are also much longer structural shifts occurring as baby boomers enter the retirement phase and succession planning becomes a priority for many businesses. Now to our metrics at scale. We've spoken about these metrics for almost 5 years since the IPO, and they've been a very useful framework for demonstrating the economics of a specialist SME business bank. Today, we're either at or approaching many of these metrics. And we've always been transparent that we would achieve the metrics at different times. We are now effectively at the low end of the GLA metric, and we have achieved the NIM metric. Our focus from here is clearly on achieving that CTI, which will largely be a story of revenue outpacing costs, as Andrew said earlier, positive jaws. And on cost of risk, we remain confident in our through-the-cycle assumption of 50 basis points as we continue to scale and as our loan book seasons. Notwithstanding the potential for volatility, 50 basis points is supported by the current portfolio PD and LGD that I referenced earlier. Our ultimate goal, of course, is to deliver sustainable ROE in the low to mid-teens. And these metrics are the key levers we have as a bank. We will dynamically manage them to deliver strong growth and economics. And going forward, our guidance will consequently focus on ROE. So now to specific FY '27 guidance. With respect to growth, we are continuing to scale and we'll deliver disciplined above system growth. As I said on my previous slide, trading conditions for SMEs are mixed, so we remain eyes wide open to the risks in the environment, but we're certainly not underestimating. Our NIM is now above 3%. And as Andrew said, we expect NIM to remain broadly stable. On costs, operating leverage really is now our best friend. Whilst we continue to have -- whilst as I said earlier, we already have the lowest CTI in the sector at 45%, the nature of our cost structure means that this will continue to fall. We've already discussed cost of risk in some detail and our guidance for next year is to be broadly consistent with FY '26 in percentage terms. So all of this confirms the guidance that we gave in June for strong PBT growth to $210 million to $220 million next year. And most importantly, ROE will be circa 8% next year, another significant step closer to our at-scale target. In closing, I want to acknowledge again that the provisions we announced in June were disappointing and unacceptable volatility. We've undertaken a number of reviews and have embedded the learnings. However, I hope our presentation today has demonstrated that we have strong underlying momentum in the business. We remain agile, and we're adapting to the operating environment. As discussed earlier, we already have the highest NIM in the sector with the lowest CTI in the sector. We are very well capitalized with strong provision coverage versus our peers on a like-for-like basis. This means we have all the foundations to keep increasing scale, maintain strong margins and continuing our operating leverage to remain firmly on track to deliver sustained ROE expansion with PBT growth of 34% this year and a further 25% to 31% next year. So thank you for your time. That concludes the presentation, and we now look forward to your questions.

[Operator Instructions] First question comes from Matthew Wilson from Jarden.

It's great to be able to grow with your customers, but we thought that was sort of $3 million to $35 million in credit lines. Looking forward, where should we now draw the line? It does appear that SME is evolving at the margin to corporate. And whilst the averages look manageable, it's the fat tails that are getting larger that may trip you up. Can you sort of comment on that?

Yes, absolutely, I can. I think, as I said, at the scale that we're at now, the tail will start to reduce. As we said in the presentation, our over $50 million loans, which are only 19 customers are 10% of the book, and that will start to reduce now. Scale really becomes our best friend. But I think the point to make, Matt, is 98% of our customers are borrowing less than $50 million or less than $20 million and which is exactly in line with the guidance we gave at the time of the IPO. Of course, the IPO was 5 years ago now. We had a book of $4 billion now. We have a book of $15 billion now. But we very, very seldom do we onboard a brand-new customer above $50 million. The customers start below that figure, but we want to support them as they grow. We don't want to be a lender that says, I'm sorry, we can't support your growth and you now need to go to one of the major banks. And so 80% of all of the growth in those larger customers has come from existing relationships. And most of those customers we've had as customers for many, many years. In fact, one of our largest customers has actually banked with us for nearly 7 years now since before the IPO.

And then secondly, thanks for that. Has APRA's attention been raised by the impairments that took place in June, in particular, sort of, call it, loan #3, if you like? It might be 10% of the book, but one bad loan is 30% to 40% of your core profit.

Yes. I mean that loan had particular circumstances to it. I don't want to go into too much detail on that, Matt. It was not originated as a large loan. As I said, it was originated as a $15 million loan initially. And we had some aggregation issues there, which we've talked to before. The nature of that risk is not prevalent in the rest of the portfolio. And I would stress again that provisions are not losses, and these provisions were raised right at the end of the year when we did not have enough time to work with the customer in terms of resolution. That particular customer, we do have a constructive relationship with. It is just a provision. And in point of fact, they are making progress to clear the arrears. So I think they're separate issues, Matt. Our large loans are the most well secured loans in the portfolio. They're the best understood. They have the highest level of property security coverage. The entire portfolio is no more than 70%, 75% of the property value associated with that entire portfolio.

[Operator Instructions] Next, we have Tom Strong from Citi.

If we look at the 2 problematic loans that popped up in the June half, they were quite, I guess, idiosyncratic risks around customer concentration or what questions are being asked at the time of origination. Can you just tell us what kind of broader review you've done around origination practices to make sure you're sort of capturing all of these risks properly given they are quite specific and hard to extract across the book?

Yes. As I said, I mean, the 3 loans that we talked about in June, 2 of them were relatively small customers. Their losses in the ordinary course of business. It's just that they happened very late in the year, and we didn't have time to resolve them before the balance date. There was one big one, which was the one I've just addressed with Matt. And that really was an issue with aggregation. Since then, we have tightened up all of our controls around that, and we're comfortable that we have no other exposures of that nature in the book. The -- when we referenced the 2 large loans this year represented 25% of our provision coverage, there was an earlier loan, a large loan. That we've tightened up. That was a specialist asset in a scale-up type of business, and we've changed our valuation practices with regards to those types of deals. And again, we're comfortable that there are no other deals in the portfolio that have those characteristics.

Great. I mean I guess the 2 specific examples around customers related customers and valuation practices. you're confident, I guess, on the settings across origination outside of those 2 very quite specific risks.

Yes.

[Operator Instructions] Next, we have Andrew Lyons from Jefferies.

I'll just ask a question that relates to Andrew's slide just on capital. You speak in the final bullet point just around you're now in a position to -- or you sort of speak to potential to consider capital management initiatives in due course. Can you maybe just talk in a little bit more detail about what that might look like, but particularly what are the yardsticks that you need to sort of reach in relation to your capital generation to actually start considering those capital management initiatives?

Yes. Thanks, Andy. I mean the first and most important one is we've now put out a target operating range for the CET1. So this is something that we announced back at the end of June. But that's an important first milestone for us, and that's 11% to 12%. So we've kind of put that on the table now as a formal range. The -- where we landed for the full year, 12.4%, that's clearly above that range. And that's really why we've made that comment around the ability now to start thinking about capital management initiatives. That could be a range of things. I mean, first and foremost, for us, we're a growth business, 42% PPOP growth. And so growth is always going to be a top of list in terms of how we think about management of the overall capital. But clearly, also for us, as the operating leverage comes through, as the ROE increases, there's an ability for us to start thinking about other capital options such as dividends and the like. But for us, the most important milestone was the 11% to 12% operating range. And I think with where we landed for the year and the levers that we demonstrated during the year, in particular, the term set, which is an important part of that annual plan. We'd like to make that an annual part of the plan for us. That just gives us a lot more flexibility now in terms of management of the capital stack.

Next, we have Andrew Triggs from JPMorgan.

Just could you elaborate, please, on the comment for the FY '27 outlook for disciplined above system loan growth? Given the pipeline looks quite robust still, is the comment about better managing risk, capital or margin, noting that in the past, I don't think Judo has always sort of known or being certain on what the best mix of those 3 things are.

Yes. Andrew, I'll take that. Thanks for the question. Look, it reflects risk, if we're honest. As I said earlier, the economy has taken some big hits recently. We think businesses are still very resilient. I think personally, I think system growth is going to drop from -- I think in many respects, the data showing it's about 10% at the moment, but I think it will probably drop to more like 7% or 8% growth. We're a high-growth bank. We're certainly not going to grow below system. But we're just going to keep our powder dry for exactly how much growth we do next year. It's certainly not capital constrained. It's certainly not constrained in terms of where we play in the market. But we just felt that it was inappropriate to box ourselves into very specific guidance on that other than making it clear that we intend to grow above system.

Next, we have Jonathan Mott from Barrenjoey.

On Page 19 of our presentation, Slide 19, where you give us the new additions and resolutions that come through. If you look at the last quarter at $183 million, annualized that, it's about 2.5% of gross loans. It's not actually that unusual. You've been there on a couple of other quarters in the past, second quarter '26, first quarter '24. So it's just a bit of natural volatility that you're seeing in the book, a few more large nonperforming loans coming through and it was just more of an unusual timing? Or are you actually calling out that you're getting more worried about the quality of the book as a whole given the economic outlook? And if you can also comment on how you're seeing it play out for the first 6 to 7 weeks of this year?

Yes. Look, it is -- I don't think there's anything particular to call out there. We've -- I mean, on Slide 19, obviously, those numbers are and have been, as I called out, we've seen more of those deals. I think that's really just a reflection of where we are. But there's nothing particular to kind of call out there apart from just noting that the volumes are a bit higher during the year. I mean we do actively manage the book. As I noted, a lot of the stock, if you like, has been -- has come from new originations. We did manage some customers out of the book that were in disproportionately higher risk categories. But that's something that we've always kind of done as we've needed to.

And as for lead indicators, Jon, our watch loans are down, our close monitoring are down, as Andrew put a data point in the slides that our 30 to 90s are down quite considerably. But look, we're plagued by the law of small numbers. We're still subscale in that regard. So we're certainly not declaring any victory. That said, I think SME balance sheets are in good shape. There are definitely some significant headwinds. It's going to impact system growth next year. But we're 2% of the market. We get to pick where we play and how we win, but we're going to be very eyes wide open, but there's no lead indicators at the moment that are causing us any material concerns.

Next, we have Jason Shao from Macquarie.

Just a question on margins. So you're talking about margins to be broadly flat in FY '27 on FY '26. And depending where you exit this half, it probably suggests that your exit run rate in second half '27 is probably close to around 3% or 5% or maybe just a bit above that, which is obviously quite a bit of a slowdown from where it was this half. Could you just comment a bit about your expectations for that decline between deposits and lending, please?