PARAGON ON THE ROCKS?
In light of the announcement last week by Paragon the UK’s largest specialist buy-to-let mortgage provider that it is having the same funding issues that hit the Northern Rock; we ask the question “what happens to buy-to-let landlords if their mortgage company were to go bust?”
Buy-to-let mortgages not like they were
The recent events with Paragon and Northern Rock are nothing but instructive for landlords in that they reveal the complexities of the current buy-to-let financial markets.
The modern world of buy-to-let mortgage finance is a far cry from the good old days where a landlord obtained a loan from their bank. The bank then used funds from their depositors to lend to the landlord. This lender would proceed to collect the interest and capital repayments from the landlord for 25 years until the buy-to-let mortgage was finally paid off. At this stage the lender would release the deeds to the landlord who became the true owner of their buy-to-let investment.
Lenders slip up on funding banana skin
The lending model referred to above has largely been left behind as buy-to-let lenders have used more innovative and aggressive practices to gain an increasing share of the lucrative buy-to-let mortgage market. Lenders such as Northern Rock and Paragon are a case in point; both have relied exclusively on funding their operations by borrowing money on the wholesale money markets. They have then used these funds to advance loans to landlords as buy-to-let mortgages.
The recent credit crunch has caused the lenders in these wholesale money markets to suddenly stop lending which caused the crisis for Northern Rock. In the case of the Northern Rock it meant that they had to go to the Bank of England to finance lending they had committed to using money that they effectively did not have. Paragon’s situation is not quite as serious as they ensured that their loans were fully covered before lending the money. This means that if they advanced a 15 year repayment mortgage to a buy-to-let landlord, they had secured the funds in the wholesale market before they lent these funds.
My mortgage company goes bust
The announcement last week by Paragon the UK’s number 3 buy-to-let lender that it had to line up emergency financing of £280 million has heaped further worries on to the shoulders of landlords who were still reeling from the collapse of the Northern Rock.
Paragon does have a problem, but it has turned to its own shareholders rather than the state for a bail-out. The only rolling loan that is not matched against its mortgage assets is the £280m it needs for working capital – running costs such as wages and electricity bills. This comes up for renewal on February 27. Paragon’s banks are demanding "predatory" rates, in the words of one shareholder, that Paragon said could "cast significant doubt on the group’s ability to continue as a going concern".
Instead of accepting the banks’ terms, Paragon is proposing to raise the £280m through a rights issue from shareholders. Investment bank UBS has underwritten the full amount and existing shareholders are sub-underwriting the issue, which effectively guarantees the placing can proceed and the company will not go bust.
One shareholder noted: "Northern Rock was bailed out by the Government. Paragon is being supported by shareholders. This is a sound business model and that’s the way the market works. Northern Rock was over-trading horrifically and shareholders would not stand behind management." Paragon chief executive Nigel Terrington added: "We are not another Northern Rock."
However, with the credit markets shut, Paragon’s business model is broken. It has to scale back growth; effectively closing to new business from February, because it cannot raise new funds in the market at a workable rate. Without further funds Paragon will just go into run off where the lender just trades off its existing mortgage book taking the income from these until the loans have come to an end. On this basis it is still a viable business.
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The good news
The good news for landlords is that neither the Northern Rock or Paragon is going to go bust. In the case of the Northern Rock it now appears that it will be sold off as a single entity and as a going concern. The result for landlords is that the new owner will take on the mortgage book and landlords will just continue to pay off their buy-to-let mortgage to the new owner.
The other scenario which does not apply to either Paragon or Northern Rock but could do if a buy-to-let lender were to go bust, would be where a buy-to-let lender was put into liquidation. In this case their assets would be sold off. One of the largest assets of any lender is their mortgage book. Therefore this asset would be sold to another lender and a buy-to-let landlord would then have to continue to pay the new owner in the same way as they were with their original buy-to-let lender.
The bad news
The bad news for any buy-to-let borrower is that even where the lender goes bust; there is no escape for the landlord from their debt and their monthly mortgage payments!