Paragon gets specialist rate boost

The niche banking market proved fruitful for Paragon (PAG) as the specialist lender ended its year strongly with net interest margins responding to the rise in overall interest rates, and its business mix of buy-to-let loans and commercial lending to small and to medium-sized businesses performing better than expected. Rising interest rates were a boon for the bank’s hedging position, which saw fair value gains on derivative contracts of £192mn, which was behind the big rise in reported profits. These are likely to reverse over time, but investors will take confidence from improving margins as the economy goes into recession.  

The 2.69 per cent net interest margin, up 30 basis points, was the result of a combination of rising interest rates and an expanded loan book, underpinning the gap between income and the bank’s cost of capital. Overall, the loan book increased by 6 per cent to £14.2bn. In the year-on-year growth stakes, commercial lending took the lead as higher-value business generated net interest income of £113mn, an 18 per cent rise on 2021. The performance justified the bank’s move into SME lending a few years ago and there were signs in these results that this segment of the business is starting to mature.

Credit quality remained sound, with loan arrears declining to 15 basis points from 21 basis points this time last year, albeit Paragon reported a £14mn impairment charge, against a release of £4.7mn last time. Chief executive Nigel Terrington said: “We have taken some impairments based not on the current performance of the lending book, which is excellent, but on where we think the economy might be headed next year. We might see some weakness in house prices, which will soften demand for loans.” Paragon also announced a £50mn share buyback alongside the results.

Paragon’s attraction for investors is the higher returns the company achieves on its relatively stable cost base. A cost to income ratio of 39.4 per cent in these results is the envy of the larger clearing banks, while return-on-equity of 16 per cent is at the top end of the sector. Despite flagging lending weakness next year, broker Numis still forecasts EPS of 64.2p, giving Paragon a forward rating of 7.2. That is still only average for the sector despite Paragon showing far better performance than its larger High Street competitors and shows the value of specialisation in the banking sector. Buy.

Last IC View: Buy, 554p, 11 Aug 2022