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Sunday share tips: Paragon Banking Group, Lloyds Bank

19 May, 2019 16:35

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(Sharecast News) - In her 'Inside the City' column for the Sunday Times, Emma Dunkley mused about how an uncertain economic outlook, low interest rates and increasing competition in the mortgage market was making it an interesting time to be a banker.

That squeeze on profit margins has, however, led to some analysts describing shares in Paragon Banking Group as "cheap", with the price floating below the book value.

But even amid such uncertain times, Dunkley said Paragon was "emitting a few rays of light", with the company still growing its lending and improving its net interest margin at a time when many of its peers were heading in the opposite direction.

The company recently renewed its focus on professional buy-to-let mortgages, which tend to have better yields than other mortgages and currently represent around 88% of Paragon's new loans.

Dunkley said Paragon was "charging ahead", with analysts picking a good set of half-year numbers this coming Wednesday.

The firm had also seen growth through acquisitions, with property development financier Titlestone and legal specialist finance broker Iceberg giving its lending books a boost, as the number of new loans more than doubled year-on-year in its first quarter.

And unlike many other specialist lenders and "challengers", Paragon had already spent some time maturing, having been established in 1985.

Thanks to that experience, analysts were expecting the company to get the approval it wants sometime in the next year to keep a smaller capital buffer against its loan book, freeing up cash to lend, in turn growing its market share further.

Dunkley did point out that strong lending growth did not necessarily mean Paragon was handing out wads of sterling willy-nilly, however, with analysts noting that its relatively low level of late payments among its buy-to-let debtors were a sign of loan quality.

Low-cost funding was also a cornerstone of the business, with deposits growing to £5.6bn in the first quarter.

Its dividend was looking good, too, having grown healthily over the last 10 years, while Paragon's shares had climbed 20% so far this year to close at 462.8p on Friday.

The current merger climate in the City was something else to look out for, Dunkley said, suggesting that Paragon could be an attractive target as peers OneSavings and Charter Court Financial Services confirm their own tie-up plans.

"It is not all rosy," Dunkley warned, adding that "if the economy takes a turn for the worse, its heavy exposure to the buy-to-let property market would probably lead to a rise in defaults - and crush profits.

"At the moment, though, with strong lending growth, cheap(ish) shares, and merger activity picking up in the sector, Paragon is at the front of the pack. Buy."

Over in the Mail on Sunday, Jeff Prestidge took a departure from the paper's usual affection for small-cap and AIM stocks, and instead turned his attention to high street banking behemoth Lloyds Banking Group.

He did preface his 'Midas' column by noting that, from a personal finance perspective, there was little to love about any of its Lloyds Bank, Halifax or Bank of Scotland brands, with most of its savings accounts "about as welcoming as the sound of a rattlesnake on a walking tour around the Grand Canyon", noting the 0.2% interest rate offered on an Easy Saver account.

Additionally, if one wanted to use a Lloyds branch, there was a good chance that it had either already been permanently closed, or that a poster had been erected warning customers of its imminent closure, with consumer advocacy group Which recently suggesting almost 150 branches in the group had either closed, or were on the brink of closing, since the start of 2018.

To top off his criticism, Prestidge mentioned the bank's "rampant mis-selling", and asked if anyone could forget its role in the "near sinking" of the UK economy in 2007 and 2008.

But for all its customer-facing faults, "or maybe because of them", Prestidge suggested that from an investor perspective, Lloyds Banking Group currently represented an "excellent opportunity" for those seeking exposure to the UK stock market, with an appetising dividend prospect served up on the side.

Of all the banks listed on the FTSE 100 index - Barclays, HSBC, Royal Bank of Scotland and Standard Chartered - he said Lloyds appeared to be the most financially robust.

As a business, it also looked "pretty vanilla" as a plain old savings and loans organisation, especially next to the like of Barclays, where shareholders have become increasingly frustrated at a focus on risky investments.

And compared to some of the sexier, more exciting opportunities, like challenger player Metro Bank, it remained a "financial colossus", with Prestidge describing that organisation as having taken its eye off the financial ball, compared to Lloyds' hard-nosed drive for profit.

He did note that some analysts weren't as pleased with Lloyds' first-quarter numbers as they wanted to be, but still described its £1.603bn pre-tax profit, up from £1.602bn, as "pretty rock solid" when considering it had to earmark another £100m for the PPI mis-selling scandal.

Its net interest margin was resilient at 2.91%, which was still above the likes of Royal Bank of Scotland which was 1.89%, with the board also continuing to slash costs wherever it can, closing branches and digitising anything its possibly can.

Costs as a proportion of income were 44.7% in the quarter ended 31 March, down from 47.8% in the first quarter of 2018.

Dividend growth of 5.25% and a yield of 5.2% was another sweetener for shareholders, who enjoyed their final 2.14p dividend on Tuesday.

No bank - or any FTSE 100 company - was without risks, though, with Lloyds chief executive Antonio Horta-Osorio noting that banks in particular were susceptible to the ebbs and flows of the economy as a whole, with a downturn likely to put the screws on the dividend.

Additionally, while the firm's new Schroders Personal Wealth financial advice venture could create a healthy new revenue stream, there were concerns that there could be another mis-selling scandal ahead, leading to another round of costly compensation.

Prestidge added that banks were still strong attractors of boardroom greed criticism - or, on Horta-Osorio's case, pension greed - as evidenced at the group's annual general meeting last Thursday.

And yet six out of nine brokers monitored by Hargreaves still classified Lloyds shares as a 'strong buy', suggesting analysts still saw the stock as undervalued.

"Although the memories of the awful financial crisis of 2007 and 2008 will linger long with many of us, Lloyds Banking Group of today is an altogether different financial beast from the one of 12 years ago," Jeff Prestidge wrote.

"As a business, it's leaner and fitter - and whatever you may think of Horta-Osorio's eyebrow-raising £6.3 million remuneration package, he's done a far better job at running the show than Craig Donaldson has at Metro.

"At 60p and with the prospect of more dividend growth in the pipeline - provided the economy does not nosedive - the shares represent good value for money."

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