PARAGON BANKING GROUP PLC
Fitch Ratings has upgraded
The Viability Rating (VR) has been upgraded to 'bbb+' from 'bbb'. The short-term rating has been upgraded to 'F2' from 'F3'. A full list of rating actions is below.
The upgrades reflect a long-term trend of steadily improving profitability and increased diversification in the bank's business profile. At the same time, asset quality has remained healthy and capitalisation sound. The funding profile is also improving as the bank continues to focus on growth and diversification of the deposit base.
Rating Withdrawals
We have withdrawn the group's Support Rating of '5' and Support Rating Floor of 'No Floor' as they are no longer relevant to Fitch's coverage following the implementation of its updated Criteria in
Key Rating Drivers
Paragon's ratings reflect sound profitability through the cycle, capitalisation and leverage, maintained with adequate buffers above regulatory minimums, and a consistently profitable niche franchise focused on specialist buy-to-let (BTL) lending. The ratings also consider the bank's risk appetite for segments in a lending market that Fitch considers higher risk, and a weaker, although improving, funding profile compared to peers.
Key Rating Driver 1
Paragon's franchise in the
Key Rating Driver 2
Paragon's asset quality has remained resilient throughout the Covid-19 pandemic, largely because of government support measures for the economy as a whole and for borrowers, including mortgage and SME customers. Impaired loans (Stage 3 and purchased or originated credit-impaired loans) accounted for 2.1% of gross loans at FY21 (year-end to
We expect some deterioration in asset quality from FY22 with the implications of higher unemployment from pre-pandemic levels filtering through the economy as the government measures lapse. However, we do not expect the share of impaired loans to rise to more than 3% in the next 12-18 months, and expect credit losses to remain manageable given the secured nature of the loan book and moderate loan-to-value ratios.
Key Rating Driver 3
Paragon's underlying profitability is stable and sound, with some volatility through the pandemic as large expected credit losses were front-loaded in FY20 and partly released in FY21 as the modelled increase in loan impairment did not take place. The reduced business activity seen in the first part of FY20 picked up in the second half of FY20 and in FY21. Margins also held up well, supported by stable asset yields and much lower funding costs.
We expect loan impairment charges to remain low in the next few quarters as economic growth remains strong, and as unemployment remains subdued. However, there are pressures on affordability and inflationary pressures on costs. Furthermore, rising base rates could have negative implications on funding costs, while mortgage margins remain competitively priced.
Key Rating Driver 4
Capitalisation metrics remain sound with a common equity Tier (CET1) ratio of 15.4% at end-FY21 providing adequate buffers over total capital requirements of 8.8% (before CRDIV buffers), aided by sound internal capital generation. Buffer requirements, including Pillar 2A, have been reduced in the last two years. Fitch expects additional capital to be released as the bank moves to an internal ratings-based approach for calculating the risk weighting of the BTL portfolio assets. Paragon continues to use the standardised approach for calculating its risk-weighted assets as it awaits approvals from the regulator to move to the IRB approach.
We expect the bank will gradually manage its CET1 capital ratio to a targeted 14.5%-15%, either through growth or returning capital to shareholders. The Basel III leverage ratio of 6.9% is strong relative to peers.
Key Rating Driver 5
Paragon's funding profile has improved since it began its strategy to ultimately fund around 80% of its balance sheet with retail deposits, largely gathered online. Its loan-to-deposit ratio decreased to 145% at FY21 from 580% at FY16, but we believe its deposit base remains price-sensitive. Securitisation funding has declined relative to deposits and Term Funding Scheme with additional incentives for SMEs drawings, with deposits accounting for 68% of total funding at FYE21.
Paragon's on-balance-sheet liquidity is good, with large cash placements mainly at the
Paragon's Short-Term IDR of 'F2' is the lower of the two options for a 'BBB+' Long-Term IDR as the bank's funding and liquidity score of 'bbb' does not justify a higher rating.
Key Rating Driver 6
The bank's dividends match those of the holding company and management expects the holding company's double leverage to remain well below 120%. In addition, we consider liquidity management across group companies to be adequate, with capital fungible across the group.
Rating Sensitivities
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Paragon's ratings are sensitive to the headroom of the CET1 ratio over the current regulatory minimum of 8.8%, which could decrease if the bank either grows very fast or engages in excessive share buybacks or dividends, therefore reducing its CET1 ratio below its target 14.5%-15.0%. This would also likely cause our assessment of its risk appetite to be downgraded.
We do not notch down the holding company's ratings due to moderate double leverage. However, an increase in double leverage to or above 120% could indicate the structurally weakening position of holding-company bondholders relative to Paragon's counterparties, and could therefore result in a downgrade of the holding company's ratings. This could also be the case if the fungibility of capital and funding between group companies decreases materially.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Upgrades of the IDRs and VR are unlikely, given our assessment of the group's business profile, including its limited franchise in a large domestic market and a business model which focuses on higher risk, niche segments in its loan book. However, the ratings could be upgraded if the bank shows an improved funding profile, while maintaining capital levels significantly higher than its stated current targets. An upgrade would also require satisfactory performance by the group's new business lines throughout the economic cycle.
OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS
We have assigned a GSR of 'ns' in light of the bank's low systemic importance as well as legislation in place that is likely to require senior creditors to participate in losses for resolving Paragon.
We rate Paragon's senior unsecured debt one notch below the Long-Term IDR as the bank does not have an MREL requirement and we do not consider the level of qualifying junior debt to be sufficient to protect senior creditors in the event of default.
Paragon's Tier 2 debt is notched down twice from the VR to reflect the incremental loss severity that results from its subordinated status.
OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:
The group's senior debt rating is primarily sensitive to changes in the IDR and would be downgraded if the IDR was downgraded.
The group's subordinated debt rating is primarily sensitive to changes in the VR, or to a change in our notching of the bank's Tier 2 debt, which is sensitive to an adverse change in Fitch's assessment of loss severity in default.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
The group's senior debt rating would be upgraded if the IDR was upgraded.
The group's subordinated debt would be upgraded if the VR was upgraded.
VR ADJUSTMENTS
The operating environment score of 'aa-' is at the lower end of the range because it is constrained by the
The Asset Quality score has been assigned below the implied score due to the following adjustment reason: Underwriting Standards and Growth (negative).
The Capitalisation & Leverage score has been assigned below the implied score due to the following adjustment reason: Internal Capital Generation and Growth (negative).
Best/Worst Case Rating Scenario
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from '
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
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