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Loan demand boosting Paragon

Paragon is in a sweet spot, with demand for buy-to-let loans rising sharply; yet its shares still get an underwhelming rating
August 22, 2013

The Paragon Group of Companies (PAG) lends to what we might label 'professional' landlords (typically owning about 12 houses) for buy-to-let mortgages. These so-called professionals can often live with weak house prices because that means they can buy more properties. They also make good customers because they put decent amounts of equity into their properties - Paragon's average loan-to-value ratio is about 75 per cent.

IC TIP: Buy at 321p
Tip style
Growth
Risk rating
Medium
Timescale
Long Term
Bull points
  • Strong rise in buy-to-let lending
  • Low delinquency rates
  • Strong cash flow
  • Increasingly diverse revenue stream
Bear points
  • Modest dividend
  • Higher interest rates could increase bad debts

Business for Paragon has been strong and is set to remain so, with £220m of new lending in the pipeline. True, there are initiatives to tempt first-time buyers back into the housing market, but these will have little effect on demand for rented accommodation. Besides, the average age of today's first-time buyer is around 35 and not all of them live with their parents before they buy.

To underline the trend, recently released quarterly performance figures for the three months to the end of June showed that Paragon's buy-to-let lending grew by 164 per cent over the average of the previous two quarters. But its bosses claim to have maintained strict lending criteria, and arrears of three months or more on its buy-to-let portfolio remained at an insignificant 0.4 per cent of outstanding loans. Loan completions rose from £102m in the first six months to £135m in the third quarter alone. To meet this demand, Paragon has increased the size of its 'warehouse' facility to £450m and, with wholesale money markets nearly back to normal, Paragon has packaged up mortgages and securitised (ie, sold) them, using the proceeds to refill the warehouse facility.

Group finances look in pretty good shape, too. After acquisitions, Paragon still had £140m of 'free' cash (ie, not tied to securitisations) and broker Jefferies says it won't need any additional funding until 2017.

THE PARAGON GROUP OF COMPANIES (PAG)
ORD PRICE:321pMARKET VALUE:£975m
TOUCH:320-321p12-MONTH HIGH HIGH:357pLOW: 178p
FWD DIVIDEND YIELD:2.3%FORWARD PE RATIO:11
NET ASSET VALUE:269p  

Year to 30 SepPre-tax profit (£m)Earnings per share (p)Dividend per share (p)
201071.818.33.60
201180.820.24.00
201295.524.26.00
2013*102.726.46.72
2014*116.230.37.53
% change+13+15+12

Normal market size: 5,000

Matched bargain trading

Beta:1.1

However, business conditions were not always so favourable and, when the wholesale lending market dried up at the start of the financial crash, Paragon took steps to broaden its revenue stream. One area it has been developing under the Idem Capital label is buying books of unsecured loans. It mostly buys these - well below their pay-back value - from banks anxious to reduce the size of their balance sheets. Paragon bought £35m-worth of loans in the third quarter, taking the amount invested this year so far to £93m.

Paragon also put its expertise to work by offering to manage other lenders' mortgage portfolios. It picked up 20,400 accounts in the third quarter, having taken on board 29,000 in the first half. Management is also looking to prepare for a return of consumer lending, most likely within a banking subsidiary, which carries the prospect of raising funds from a deposit base. Currently, this would be an expensive way of raising money because wholesale borrowing costs are lower than rates paid on retail deposits, but it could be useful if wholesale market seize up. The overall effect of higher interest rates on the group's core buy-to-let operation could mean a rise in bad debts.