Most of us have learned over the last decade that lending money against property can be a very risky business. But this buy-to-let lender knows this only too well.
When the financial crisis hit it was pushed to the verge of bankruptcy. It was only saved by going cap in hand to its shareholders and slashing costs. But all of this seems a distant memory now that the good times are back.
Its share price has been rising sharply for the last two years. The UK housing market is powering ahead and confidence among buy-to-let investors seems very high, with borrowing surging in the last 12 months.
Surely this has been factored in to Paragon’s (LSE: PAG) share price? Maybe, but it would not surprise me if the shares kept forging ahead. Despite the government’s Help to Buy scheme many people still cannot afford to buy a house, and will rent instead.
There is also talk of pensioners flocking to buy-to-let once they have complete freedom over their pension pots following the recent budget changes. That’s all potentially good news for a specialist buy-to-let lender such as Paragon.
In many ways Paragon is a lot less risky than a high-street seller of residential mortgages. Its balance sheet is better financed than, say, Lloyds or RBS.
If you compare the amount of money it has lent out against the shareholders’ funds (or equity) that supports them, it is more conservatively funded than either.
It also seems to be quite sensible when it comes to lending – the loan to value (LTV) ratio on new loans averages 72.8%, with the rental income covering mortgage interest payments by 160%.
Unlike loans from high-street lenders, which are mainly financed with short-term
deposits, Paragon’s are generally financed with loan notes, where the maturity matches the money that it has lent out. Analysts expect steady profits growth from mortgages with an increasing contribution from Paragon’s growing portfolio of consumer loans.
Of course, there’s no getting away from the fact that buy-to-let lending is still a high-risk activity. Rents cannot grow faster than incomes forever. Low interest rates have supported the market – and landlords’ profits – for a long time, but the general consensus is that they will not stay this way.
That said, they could stay low for a good while yet as the Bank of England knows how fragile household finances remain. If that’s the case, then Paragon shares on 13 times 2014 earnings and growing profits may still do well.
Verdict: a risky punt