Paragon Makes Recovery on Home-Grown Virtues

UniCredit, take heart: There can be life after even the trickiest rights issue.

In 2008, U.K. buy-to-let mortgage lender Paragon Group of Cos. PLC was forced into an emergency 25-for-1 rights issue at a 90% discount to its share price amid fears of a housing-market collapse.

Since then, its market capitalization has tripled to £500 million ($766 million), and is poised to go higher.

Paragon's situation isn't without irony. During the crisis, its banks cut lending and raised interest rates on Paragon's revolving loan facility to punitive levels, forcing it to tap shareholders for cash. Now, as banks rush to de-risk their balance sheets, the sale of mortgage books at a discount to net asset value represents one of Paragon's biggest investment opportunities.

Last year, Paragon made six such acquisitions—all generating in excess of a 15% rate of return—began to offer mortgage loans again, and securitized an existing book of loans for the first time since 2007.

In coming years it should benefit from increased lending demand; the supply of buy-to-let mortgage financing is just 28% of its previous 2007 market peak.

But even if house prices fall in real terms, rents are likely to rise 20% by 2016, raising residential property yields to 5.7%, from the current 5%, estimates estate agent Savills.

Risks undoubtedly remain. Paragon may misjudge the credit quality of its borrowers. Rising interest rates could cause unforeseen loan imp! airments .

Still, its mortgage book is well collateralized, with an average loan-to-value ratio of 69%. Average rent covers mortgage payments three times.

Active management of its loan books mean just 0.63% of its mortgages are more than three month in arrears, versus 1.91% for the broader buy-to-let market. Paragon's shares trade at a 30% discount to net asset value—and that could be too low, given the company is generating a 9% return on equity, which is likely to rise with future loan-portfolio acquisitions.

Paragon's road to recovery may have further to run.

Write to Hester Plumridge at Hester.Plumridge@dowjones.com