COULD Paragon Mortgages be the next major victim of the credit crunch? Earlier this week Paragon, one of the largest lenders in the buy-to-let market, told shareholders that unless it raised an extra £280 million over the next few months it could collapse. Below we explain the implications for investors:

WHY IS PARAGON MORTGAGES IN TROUBLE? Although Paragon announced record profits in 2007, it is facing severe difficulties raising money. Melanie Bien, director at Savills Private Finance, the mortgage broker, says: “Paragon is in trouble not because of bad loans but because its structure is very similar to Northern Rock’s. It relies entirely on the wholesale money markets to fund its mortgage business, and the cost of this funding has soared.” Bien points out that three-month Libor (the rate at which banks lend to each other) is now at a two-month high: it rose to 6.49 per cent on Tuesday. “It shows no signs of falling any time soon as the credit squeeze continues and banks hang on to cash reserves.”

HOW LIKELY IS IT THAT PARAGON WILL FAIL? Because Paragon is a pure lender – it has no savings book – it will receive no aid from the Government, and instead has turned to shareholders. The lender has announced that it may need to raise money via a rights issue – in other words, by issuing new shares to raise cash. The lender has admitted that if the rights issue does not go ahead, and if Paragon cannot find funding elsewhere, there is “significant doubt” about its ability to continue as a going concern. However, brokers say that investors who have loans from Paragon should not be concerned. “Existing borrowers are not under threat,” says David Whittaker, of Mortgages for Business, the buy-to-let broker.

WHY IS PARAGON SO IMPORTANT TO THE BUY-TO-LET MARKET? Paragon is one of the largest lenders in the residential property investment sector, funding one in every ten buy-to-let loans. Bien says: “As the third-largest supplier of buy-to-let loans, Paragon is a serious player. It has already practically withdrawn from the market, which means less choice for landlords.” This could not have come at a worse time: the range of loans on offer has already shrunk considerably. Julia Harris, mortgage expert at Moneyfacts, says that the total number of buy-to-let and residential mortgage products available fell 40 per cent in the three months to mid-October. “Most of the change can be attributed to the sub-prime market, seeing a 72 per cent reduction in the buy-to-let market and a 54 per cent cut in residential deals,” Harris says.

HOW SERIOUS ARE THE IMPLICATIONS FOR THE WIDER BUY-TO-LET MARKET? There are fears that the falling number of competitive-priced buy-to-let loans will lead to a fall in buyer numbers, while rising costs could force some investors to sell. However, Neil Young, chief executive of property investment company Young Group, says: “While it is true that lending rates have gone up and lenders are being a lot more careful, you need to look at this in the context of the wider housing market. In fact, if you look at defaults, they are much lower in buy-to-let than in the rest of the market.” Most brokers argue that larger and more established investors will not be troubled by Paragon’s difficulties. Whittaker says that were Paragon to stop funding, the effect would be felt most keenly in the HMO [houses in multiple occupation] sector. “It would take some of the sharpness out of the sector in terms of price. However, HMOs tend to be more profitable than mainstream buy-to-let, so yields are higher in any case.”

ARE WE LIKELY TO SEE A SIGNIFICANT FALL IN DEMAND FROM PROPERTY INVESTORS? Some commentators are predicting a drop in demand of as much as 20 per cent, while the Royal Institution of Chartered Surveyors predicts that buy-to-let is set to become the preserve of the wealthy. It has released figures suggesting that to purchase a buy-to-let property you would need to stump up a deposit of about £65,000 – effectively 30 per cent of the property’s value. The RICS used rental yield data and current lending conditions to establish how large a deposit a landlord would need to put down to make investing in property attractive. Five years ago, the required deposit was £10,000, or 8 per cent of the value of an average-priced property in the UK.

However, some property investors poured scorn on the RICS view. “Suggestions from RICS that buy-to-let is only for the wealthy are totally untrue,” says Stuart Law, chief executive of Assetz, the property investment company. “There are still plenty of properties on the market, even for new-build flats, for which a 15 per cent deposit is perfectly satisfactory for the lender.” Some experts questioned whether the RICS figures accurately reflected market conditions. “The RICS view is very theoretical and does not pay close attention to commercial realities in the marketplace,” says Jonthan Moore, of Mortgages for Business. “Loan to values available have increased significantly since 2002, lowering deposit requirements. The RICS says that in 2002, the borrower needed to stump up only 8 per cent of the property value – in theory – but in fact lending criteria in 2002 were much tighter, and lenders required investors to put down a deposit of at least 15 per cent.”

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