Paragon profits from a volatile lending market

Paragon Banking Group (PAG) handed out the Christmas goodies in its full-year results with a £50mn share buyback, a 30 per cent dividend increase and a net interest margin of 3.09 per cent that came in well ahead of what anyone had forecast. Investors took the cue to bid up the shares on the day by 8 per cent, which represented their best individual performance for the year. In short, specialist banks – in Paragon’s case with a focus on professional buy-to-let landlords – seem to be far outperforming the large high-street players.  

Interpreting the reported results was complicated as negative fair value charges related to interest rate expectations cut back reported profits. However, at the operating level, profits increased by 23 per cent to £277mn, driven by a mortgage loan book up 4.4 per cent to £12.6bn. Meanwhile, impairment provisions increased by £4mn to £18mn for the year, while operating expenses were as forecast at £170mn.

Chief executive Nigel Terrington ascribed the growth to Paragon’s focus on professional landlords, “We see professional landlords as more resilient as they operate within corporate structures that allow for the tax deductibility of their borrowing costs. The amateurs who entered the market at a time of low interest rates are struggling with cost increases.” Management also raised the target for next year’s return on tangible equity to 15-20 per cent, from 15 per cent currently, to reflect two years of above-target returns.   

Peel Hunt upped its forecasts marginally on the back of the results, with the caveat that predicting net interest margin in a volatile lending market is difficult. The broker reckons the shares, on a forward price/earnings ratio of 6, and trading at 16 per cent below net tangible assets, are undervalued. We tend to agree. Buy.

Last IC view: Buy, 541p, 6 Jun 2023