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Buy-to-let/Paragon: soaring inflation may catch lenders out

December was meant to be a month of good cheer. But UK food inflation hit an unindulgent 13.3 per cent according to new figures from the British Retail Consortium, an industry body. For the roughly 20 per cent of households in private rented property, surging food costs mean less to spend on accommodation.

That could spell trouble for specialist lenders in the buy-to-let market, such as Paragon Banking Group and OSB Group. Rising rates will boost revenues from retail deposits. But the new year looks decidedly murky for BTL mortgages, even if inflation is peaking.

Mortgage rates have fallen substantially since the disastrous “mini” Budget of September. But two-year and five-year fixed rate BTL loans remain at more than 6 per cent, according to Moneyfacts.

Lex chart showing: Buy-to-let lending volumes rose when interest rates were low during the pandemic. Rising rates create problems for specialist lenders and their share prices have been underperforming. Paragon Bank has managed to grow deposits which provide funding.

As many BTL mortgages are interest-only, lower capital repayments are out of the question. Landlords are under pressure to sell out. Changes to capital gains tax mean the bill they will have to pay will grow the longer that they wait.

That could create problems for Paragon, one of the top 10 BTL mortgage lenders in 2021, according to UK Finance. Mortgages made up close to 90 per cent of its £14bn net loan balance at the end of 2022.

Paragon was sanguine in last month’s results, saying its borrowers were experienced and remained confident. BTL loan arrears of over three months fell 6 basis points year-on-year to 15 basis points as of September 30, 2022. The group’s indexed loan-to-value is now below 60 per cent.

The lender also has the advantage of retail savings deposits. Its core equity tier one capital ratio of 16.3 per cent is ahead of high street lenders such as NatWest on 14.3 per cent and Lloyds on 15 per cent. Paragon currently trades at 0.9 times book value with a price earnings multiple of 8 times, comparable to OSB Group on 5 times and Close Brothers on 10 times.

Nevertheless, research commissioned by Paragon itself found that despite increasing demand for tenancies, landlord confidence “declined significantly” in the last quarter of 2022. With prices for food and other necessities high, a lean period lies ahead.

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