Paragon margins are expanding

The buy-to-let market ain’t what it used to be, as both landlord surveys and gloomy headlines often point out. Owing to changes in mortgage interest tax breaks and a long-mooted raid on capital gains, this was the reality long before the pandemic hit. Then the complications of rolling lockdowns and volatile house prices forced a fresh reckoning.

You would not know this from Paragon Banking Group’s (PAG) first-half figures, mind. In the six months to March, the landlord-focused mortgage provider saw new lending levels leap 45 per cent to just below the pre-pandemic run-rate, while the pipeline for new buy-to-let lending jumped 17 per cent in a year to £0.93bn.

This apparent optimism – buttressed as ever by the UK’s long-term structural housing issues – chimes with the National Residential Landlords Association’s (NRLA) latest quarterly members poll, which found confidence improved for a second straight quarter in the three months to March, albeit from last summer's very low base.

At the same time, the NRLA found the proportion looking to sell property had dropped, while a record 21 per cent said they hoped to add to their portfolios, up from 14 per cent in the space of a year. Alongside improving demand, falling attrition rates within Paragon’s mortgage portfolio suggest landlord borrowers are not bailing out.

Nor do they appear to be in economic distress. Paragon said it had seen no “material” changes in payment arrears or write-offs in its portfolio, with just £40m of the £11.1bn mortgage loan book now subject to payment holidays. That compares to a peak of £2.5bn last year, suggesting landlords took the chance to build considerable buffers for themselves and their tenants when sector support was at its most generous.

To top this off, ballooning residential property valuations and a tightening of underwriting have pushed the average loan-to-value ratio down 330 basis points over the past year, to 64.4 per cent.

“If you look at the loan book, the credit performance has been outstanding,” chief executive Nigel Terrington told us. “If you’d gone back a year ago and said this is where we’d be, I wouldn’t have believed it.”

It is possible that a lag between tenants’ financial struggles and strains on landlords is yet to reveal itself. Other anecdotal evidence and surveys of letting agents suggest many more tenants are in arrears than before Covid-19 struck.

Wary that the recovery remains unpredictable, Paragon’s coverage ratio – the proportion of loan balances it expects to write-off – has remained at 64 basis points. Relative to the size of their portfolios, bigger sources of credit strain sit in both the bank’s commercial lending division and unsecured consumer loan acquisition arm Idem Capital. Yet both look manageable.

What has been managed very well is Paragon’s own funding base. In March, in a first for the UK banking industry, the group slashed its subordinated debt interest coupon when it sold £150m in Tier-2 green bonds to expand its green mortgage product range. At the same time, its new retail savings deposit rate is down from 1.63 to 0.39 per cent in 18 months.

In turn, this has pushed the total cost of retail deposits down to 1.08 per cent, while maintaining in a healthy stream of new money. At £8.6bn, retail deposit balances are up a quarter in a year and 10 per cent since September, but remain a drop in the £800bn ocean of cash savings believed to be earning less than 0.25 per cent interest.

“There’s been a strong deposit dynamic as lots of people have been saving money, however one of the key aspects is how we’ve diversified,” said Terrington, pointing to tie-ups with so-called neobanks like Monzo and Revolut and DIY investment platform giant Hargreaves Lansdown (HL.), which direct their customer bases to Paragon’s savings products.

Against robust loan book cash generation, this nudged up the bank’s net interest margin to 2.32 per cent, a trend which management expects to continue. That will likely mean an upward revision in consensus forecast for 2.23 per cent by September, along with earnings of 45.6p per share for the full year.

Paragon’s share price, which added more than 7 per cent on the day these numbers were published, has recovered all of last year’s losses and now sits at a post-GFC high. Betting on landlord creditworthiness remains a sound business model, while its size gives its deposit-taking operations a useful structural advantage over the High Street banks – at least for now. Hold.