REG - Paragon Grp Co PLC - Half-year Report <Origin Href="QuoteRef">PARA.L</Origin> - Part 2
23/05/2017 07:07
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provides a range of asset and invoice financing solutions for all business
types, the specialist sectors that were serviced by the Five Arrows Group ahead of the acquisition have been maintained.
The technology and construction sector teams have continued to develop their franchises whilst the contract hire and fleet
management solutions team have demonstrated their ability to acquire and maintain business within the public and private
sectors.
Investment within the business has been significant with an updated IT estate, including new application management
software providing a robust platform that has enhanced the customer journey and underwriting process. A rationalisation of
the operating locations has reduced costs and supports the development of a collaborative working environment across the
business.
The front line and risk management teams have been strengthened with experienced individuals who support existing working
practices with good practice from across the industry.
The ongoing investment and inevitable change within the business has been well received by the asset finance team, and this
is reflected in the improved performance in the period to 31 March 2017.
The finance lease assets of the business at 31 March 2017 were £289.0 million (note 5), an increase of 15.4% over the six
month period (30 September 2016: £250.4 million) as a result of new advances in the period of £106.6 million. The finance
lease assets generated interest income of £11.6 million in the period.
The number of loan accounts more than two months in arrears at 31 March 2017 at 0.98% remained very low (31 March 2016:
1.23%) in line with the FLA figure for business finance leasing/hire purchase of 0.7% (31 March 2016: 0.6%).
The asset finance business generates operating lease income from a fleet of vehicles with a book value of £12.6 million at
the end of the period (31 March 2016: £8.8m), with £2.9 million of new contracts initiated in the period. It also operates
a spot hire fleet with a net book value of £7.7 million at the period end (31 March 2016: £4.5 million). Operating lease
activities generated £2.1 million in the period, net of direct costs.
The Group's asset finance brokerage, Premier Asset Finance, acquired on 30 September 2016, performed well during the
period, its first under the Group's ownership, generating £1.5 million of commission income. It forms a key part of the
Group's strategy for growing its asset finance operation.
Other asset finance loan assets
The other loan assets included in the asset finance operation are set out below.
Outstanding balance
31 March2017 31 March2016 30 September2016
£m £m £m
Commercial mortgages 2.9 3.4 2.9
Factoring and discounting 20.9 9.8 16.9
Other loans 0.9 0.4 0.4
24.7 13.6 20.2
The factoring business supports customers of the asset finance business as well as servicing its own customer base and is
well positioned to trade successfully and to expand to new customers. The invoice factoring and discounting operations
generated income of £1.0 million in the period (31 March 2016: £2.0 million). The other loan balances above represent
legacy portfolios of the acquired business.
Factoring balances are agreed on a revolving basis and therefore it is not appropriate to quote an advances figure
alongside those for other loan types.
The Paragon Group of Companies PLC
INTERIM MANAGEMENT REPORT
FUNDING REVIEW
The Group's funding strategy of increasing diversification has continued during the period, with a further shift to funding
from the retail deposit markets and central bank monetary facilities. The Group's present medium term strategic funding
objective is focussed predominantly on retail deposits, with the use of securitisation on a tactical basis if market
conditions are favourable. Retail deposits are a deep and liquid market and over time have exhibited lower levels of
volatility compared with the securitisation market. This funding mix therefore represents a more stable funding base for
the Group over the longer term.
More widely, credit markets have continued to strengthen during the period, with the economy proving robust despite the
uncertainty over Brexit. Expectations of a rise in base rates receded following Bank of England guidance in February 2017,
notwithstanding a pick-up in inflation, and gilt yields approached all-time lows across all maturities.
The Group's funding at 31 March 2017 is summarised as follows:
31 March 2017 31 March 2016 30 September 2016
£m £m £m
Paragon Mortgages (securitised and warehouse funding) 8,835.0 9,818.0 9,812.8
Idem Capital (non-recourse asset backed funding) 105.2 107.3 136.8
Paragon Bank (retail deposit balances) 2,347.4 1,426.4 1,873.9
Paragon Bank (central bank monetary facilities) 345.0 - -
Business specific funding 11,632.6 11,351.7 11,823.5
Corporate borrowings 554.5 405.0 553.0
12,187.1 11,756.7 12,376.5
In addition, the FLS is used to provide £108.8 million of liquidity (31 March 2016: £nil, 30 September 2016: £108.8
million).
Retail funding
The UK savings market continues to be deep and liquid, with household balances (including cash ISAs) reported by the Bank
of England in excess of £1 trillion, and total balances at 31 March 2017 of £1,107.7 billion (30 September 2016: £1,106.1
billion). This strong supply has helped to maintain the recent trend for low savings rates with the average annual interest
on two-year fixed interest bonds, reported by the Bank of England, having declined from 1.00% in September 2016 to 0.80% in
March 2017.
Retail deposits are at the core of the Group's funding strategy, being a reliable, cost-effective and scalable source of
finance. As a consequence, the volume of the Bank's retail deposits at 31 March 2017 had reached £2,347.4 million (31 March
2016: £1,426.4 million, 30 September 2016: £1,873.9 million).
During the period the Bank launched its first cash ISA products. These formed 18% of the Bank's savings deposits at 31
March 2017.
The Bank's savings proposition provides customers with a range of transparent deposit options, offering value for money.
This also provides the Bank with a stable funding platform, with a focus on attracting term funding to manage interest rate
risk while managing the inflow of funds to match lending requirements.
The Group's straightforward approach and consistently competitive products have been recognised in the industry and by our
customers and Paragon Bank was named as 'Best Savings Provider for Existing Customers' in the 2017 Savings Champion Awards
and was commended in the 'Best Online Savings Provider' category at the Consumer Moneyfacts Awards in January 2017.
The Group conducts customer satisfaction surveys amongst those opening new savings accounts. In the six months ended 31
March 2017, 1,592 customers responded with 93% rating the overall savings process as 'good' or 'very good', while 86%
stated that they would 'probably' or 'definitely' take a second product with the Bank.
Savings balances at the period end are analysed below.
Average interest rate Average initial balance Proportion of deposits
31.03.17 30.09.16 31.03.17 30.09.16 31.03.17 30.09.16
% % £000 £000 % %
Fixed rate deposits 1.98% 2.11% 26 28 64.5% 71.0%
Variable rate deposits 1.22% 1.65% 19 15 35.5% 29.0%
All balances 1.72% 1.98% 24 25 100.0% 100.0%
The average initial term of fixed rate deposits at 31 March 2017 was 28 months (30 September 2016: 26 months).
Securitisation funding
Buy-to-let mortgage originations outside of Paragon Bank are initially funded through three revolving warehouse facilities
which totalled £550.0 million at 31 March 2017 (30 September 2016: £850.0 million, 31 March 2016: £850.0 million). As a
result of the Group's increasing focus on retail deposit funding, one facility, for £300.0 million, was closed in the
period and is currently in rundown. Further rationalisation of warehouse capacity is expected as facilities fall due for
renewal.
The use of retail deposit funding has meant that the Group has not accessed the securitisation markets in the period. The
market has strengthened significantly since September 2016, although volumes have been subdued due to the major
participants switching funding to central bank facilities. The lack of supply has resulted in a rapid compression in
margins, with levels approaching lows since the 2008 financial crisis. The Group continues to view the securitisation
market's ability to match fund long term assets as attractive and expects to access the market opportunistically in the
future.
During the period the mortgage assets held by Paragon Mortgages (No. 18) PLC and the consumer finance assets held by
Paragon Personal and Auto Finance (No. 3) PLC were sold to Paragon Bank and are now financed with retail deposits. A
further securitisation, Paragon Mortgages (No. 19) PLC was called after the period end and the notes will be repaid in the
second half of the financial year.
Funding for purchased assets
Idem Capital has continued with its funding strategy of financing smaller scale acquisitions from the Group's equity while
keeping under review the opportunities to introduce external funding when asset volumes make that economically
appropriate.
Idem Capital's external funding is provided through a special purpose vehicle company ('SPV') which entered into an
agreement to issue sterling floating rate notes to Citibank NA. This agreement was initially for £117.3 million and was
subsequently extended, with a further £69.8 million drawn after the period end.
At 31 March 2017 the funding of the Group's debt purchase assets was distributed as shown below.
31 March 2017 31 March 2016 30 September 2016
£m £m £m
Purchased assets by funding source
External funding 239.7 195.6 269.1
Retail funding 224.1 286.7 250.6
Group resources 92.0 111.2 14.2
555.8 593.5 533.9
This demonstrates increased flexibility in the Group's funding for its debt purchase activities, broadening its sources of
finance and demonstrating its ability to access third party funding on a more regular basis. The participation of Paragon
Bank in transactions offers greater flexibility in terms of deal size and asset class, where increasingly the focus will
move to more strongly performing portfolios.
Central bank monetary facilities
In the previous year Paragon Bank first accessed the facilities within the Sterling Monetary Framework ('SMF'). The Group
drew down £108.8 million under the FLS to support lending to SMEs which remained in place at the period end. This access
created a platform for further funding using Bank of England facilities, which the Group has made further use of in the
period.
Paragon Bank accessed the Bank of England's Indexed Long-Term Repo scheme ('ILTR') during January together with the TFS.
These facilities provide flexible, low-cost collateralised funding designed to reinforce the transmission of low base rates
to households and businesses. Drawings on the TFS as at 31 March 2017 were £275.0 million while £70.0 million was drawn
under ILTR. Paragon Bank expects to continue to increase its drawings under the TFS, optimising its use of such facilities,
until the final drawdown window in February 2018. The TFS funding will support new lending and not be used to refinance the
existing FLS drawings.
Increasing access to the TFS and other central bank facilities requires more loans to be pre-positioned with the Bank of
England to act as collateral for these drawings. In consequence both the loan to deposit ratio and the liquidity ratio
within Paragon Bank are expected to increase in the near term.
Corporate funding
While the Group's working capital has been primarily provided by equity since 2008, in recent years it has expanded its use
of corporate debt funding, allowing it to diversify its funding base and extend the tenor of its borrowings.
Following the period end, on 20 April 2017, the Group's £110.0 million Corporate Bond issued in 2005 matured and was repaid
in full.
The Group is rated by Fitch Ratings, which has ascribed it a BBB- rating and confirmed that rating with a stable outlook on
13 April 2017. The BB+ rating on the Group's £150 million Tier 2 Bond was also confirmed at the same time. With a strategy
to increase holding company leverage levels over time, the rating will support long dated corporate debt issuance in both
scale and pricing terms.
Further information on all the above borrowings is given in note 25.
CAPITAL MANAGEMENT
The Group continues to be strongly cash generative with free cash balances of £257.4 million at 31 March 2017 (30 September
2016: £366.5 million) (note 18) after investing cash in developing business streams across each of its three divisions.
£110.0 million of this balance was used to repay corporate bond debt after the period end. The Company sees opportunities
going forward to deploy capital to support organic growth and invest in portfolio purchases and potentially in M&A
opportunities.
Dividend and dividend policy
In pursuance of its dividend policy and in view of the strong position of the Group and its confidence in the prospects for
the business, the Board proposes an interim dividend of 4.7p per share (2016 H1: 4.3p) payable to shareholders on the
register on 7 July 2017. This represents an increase of 9.3% from 2016. The Company's dividend policy is to maintain a
dividend cover ratio of three times.
Regulatory capital
The Group is subject to supervision by the PRA on a consolidated basis, as a group containing an authorised bank. As part
of this supervision, the regulator will issue individual capital guidance setting an amount of regulatory capital, defined
under the international Basel III rules, implemented through the Capital Requirements Regulation and Directive ('CRD IV'),
which the Group is required to hold relative to its risk weighted assets in order to safeguard depositors against the risk
of losses being incurred by the Group.
PRA supervision of the Group imposes consolidated capital adequacy rules upon it. The Group maintains extremely strong
capital and leverage ratios, with a CET1 ratio of 15.9% at 31 March 2017 (30 September 2016: 15.9%) and a UK leverage ratio
at 6.5% (30 September 2016: 6.3%) (note 4d), leaving the Group's capital at 31 March 2017 comfortably in excess of the
regulatory requirement. The movements in the CET1 ratio and leverage percentage during the period reflect the impacts of
profit for the period, the Group's share buy-back programme and the actuarial gain on the most recent valuation of the
Group's defined benefit pension plan. In the medium term the Group targets a CET1 ratio of 13.0%.
The Group notes the consultation paper issued by the BCBS on 15 December 2015 regarding the proposed amendments to the
Standardised Approach ('SA') for assessing the capital adequacy of institutions. The most material proposal relates to a
potential increase in the risk weightings applicable to buy-to-let lending assets. The Group considers that the proposed
risk weightings do not properly reflect the strong credit performance of the asset class in the UK and has engaged with
both the PRA and the BCBS as part of the consultation process. The BCBS has also issued a consultation paper in March 2016,
proposing revisions to the Internal Ratings Basis ('IRB') for assessing capital, which is based on firms' own internal
calculations and subject to supervisory approval. The proposals may serve to limit the comparative advantage available to
IRB users over SA users through the use of floors.
During the period the PRA published two further consultations. The first attempts to address the issue of the SA requiring
much higher capital levels, for certain asset classes, than IRB methods, thereby potentially distorting the market. The PRA
proposes that it should take account of any such over provision in assessing capital adequacy in other areas. The second
consultation is intended to make IRB accreditation more accessible to smaller UK deposit takers.
Notwithstanding the outcome of these consultations, the Group has a wealth of data and excellent credit metrics to support
the use of an IRB approach for assessing the appropriate buy-to-let risk weightings. Other UK institutions that currently
use the IRB approach for their buy-to-let portfolios achieve materially lower risk weightings than the 35% required by the
present SA, with benchmark figures published by the PRA in February 2017 typically being in the low to mid-teen percentages
for assets in the most common LTV bands.
In addition to the potential risk weighting advantages from adopting the IRB approach, the Group sees broader business
benefits from adopting the disciplines required by IRB as a core part of its risk management structure.
The Group will be closely monitoring developments in each of these consultations as they progress and has continued to
progress its project to prepare an application to the PRA to adopt the IRB in future, which will build on the Group's
existing core competencies in credit risk and data handling and should lead to further enhancements in the internal risk
governance framework.
Gearing and share buy-backs
Given the strong capital base and low leverage in the Company's balance sheet, the Board has determined that the Group
should seek to utilise greater levels of debt to support growth and reduce its over-reliance on equity capital, improving
returns for shareholders. In pursuit of this strategy the Group issued £150.0 million of Tier 2 Corporate Bonds in 2016 and
will continue to review the opportunities available to it to access the sterling senior unsecured debt market and the UK
retail bond market to add further incremental long-dated debt to the Group balance sheet.
In November 2014 the Company announced a share buy-back programme, initially for up to £50.0 million and extended in 2015
and 2016 to £150.0 million, to be reviewed periodically to take account of anticipated investment opportunities and the
balance of the Group's debt and equity capital resources. During the period the Company bought back a further 6.6 million
of its ordinary shares at a cost of £27.0 million, which are held in treasury (note 22). This programme will continue
during the second half of the year with these shares also being initially held in treasury. Treasury shares may
subsequently be cancelled.
The Company currently has the necessary shareholder approval to undertake such share buy-backs under an authority granted
at its 2017 Annual General Meeting, when a special resolution seeking authority for the Company to purchase up to 28.0
million of its own shares (10% of the issued share capital excluding treasury shares) was approved by shareholders.
The share buy-back programme, together with the issue of debt, has reduced the amount of the Group's central funding
represented by equity at 31 March 2017 to 76.7% from 79.0% twelve months earlier (note 4c), with this trend expected to
continue.
The Board keeps under review the appropriate level of capital for the business to meet its operational requirements and
strategic development objectives. The strength of the Paragon Mortgages and Idem Capital businesses, the diversification
which has been achieved in the funding base in recent years and the further opportunities for growth and sustainability
provided by Paragon Bank, have now created the foundations on which to develop the Group's next phase of growth.
The Paragon Group of Companies PLC
INTERIM MANAGEMENT REPORT
FINANCIAL REVIEW
The six months ended 31 March 2017 saw the Group's underlying profit (appendix B) increase by 1.0% to £70.1 million (2016
H1: £69.4 million) while on the statutory basis profit before tax remained broadly similar at £69.4 million (31 March 2016:
£69.5 million). Earnings per share increased by 7.3% to 20.5p (31 March 2016: 19.1p).
RESULTS FOR THE PERIOD
CONSOLIDATED RESULTS
For the six months ended 31 March 2017
2017 H1 2016 H1
£m £m
Interest receivable 203.8 203.4
Interest payable and similar charges (90.3) (93.6)
Net interest income 113.5 109.8
Other operating income 10.2 12.5
Total operating income 123.7 122.3
Operating expenses (50.4) (49.4)
Provisions for losses (3.2) (3.5)
70.1 69.4
Fair value net (losses) / gains (0.7) 0.1
Operating profit being profit on ordinary activities before taxation 69.4 69.5
Tax charge on profit on ordinary activities (13.0) (13.6)
Profit on ordinary activities after taxation 56.4 55.9
Basic earnings per share 20.5p 19.1p
Diluted earnings per share 19.9p 18.8p
Dividend - rate per share for the period 4.7p 4.3p
Total operating income increased by 1.1% to £123.7 million (2016 H1: £122.3 million).
Within this, net interest income in the period increased to £113.5 million from £109.8 million for the six months ended 31
March 2016. The increase principally reflects the growth in the size of the average loan book, which rose by 3.6% to
£10,838.9 million (31 March 2016: £10,457.8 million) (note C).
Annualised net interest margins ('NIM') remained stable in the six months to 31 March 2017 at 2.11%, the same as that
achieved in the corresponding period last year (note C), despite the additional £5.4 million interest cost of the Tier 2
Bond issued in September 2016. NIM is expected to remain broadly flat in 2017, absorbing the Tier 2 costs. Excluding the
effect of the Tier 2 bond interest, NIM is expect to improve by between 10 and 15 basis points for the financial year.
Other operating income was £10.2 million for the six months, compared with £12.5 million in the comparable period in 2016.
The reduction principally results from lower levels of servicing in Idem Capital, with formerly administered third party
assets being acquired by the Group, partly offset by £1.5 million of commission income from the Premier Asset Finance
business acquired in September 2016.
Operating expenses for the period increased by 2.0% to £50.4 million from £49.4 million for the six months ended 31 March
2016. The cost base for the year is expected to be in the £100.0 million to £105.0 million range.
The cost:income ratio, at 40.7% (note A) was broadly similar to that in the comparable period in the preceding year
(40.4%), despite the increased size and complexity of the business and the investment made in launching new product lines.
The Board remains focused on controlling operating costs through the application of rigorous budgeting and monitoring
procedures, and expects the cost:income ratio for the asset finance business to improve as it is integrated into the Group
and starts to see the benefits of income growth from its expanded operations. The Board is targeting a medium term
cost:income ratio of 30% to 35%.
The charge of £3.2 million for loan impairment has remained stable at the levels seen in the first half of the previous
year (2016 H1: £3.5 million). As an annualised percentage of average loans to customers the impairment charge has remained
at 0.06%, similar to that for the six months ended 31 March 2016 (0.07%) (note C). The Group has seen favourable trends in
arrears performance over the period, both in terms of new cases reducing and customers correcting past arrears, whilst
increasing property values have served to reduce overall exposure to losses on enforcement of security. The loan books
continue to be carefully managed and the credit performance of the buy-to-let book remains exemplary.
Yield curve movements during the period resulted in hedging instrument fair value net losses of £0.7 million (2016 H1: £0.1
million net gain), which do not affect cash flow. The fair value movements of hedged assets or liabilities are expected to
trend to zero over time, as such this item represents a timing difference. The Group remains economically and appropriately
hedged.
Tax has been charged at an effective rate of 18.7%, compared with 19.6% for the corresponding period last year; the
reduction principally arising from the reduction in the rate of UK Corporation Tax applying to the Group in the period from
19.0% to 18.5% and the inclusion of disallowable acquisition costs in the 2016 result.
Profits after taxation of £56.4 million (2016 H1: £55.9 million) have been transferred to shareholders' funds, which
totalled £994.2 million at the period end (31 March 2016: £964.4 million), representing a tangible net asset value of £3.27
per share (31 March 2016: £3.09) and an underlying net asset value of £3.65 per share (31 March 2016: £3.40) (note D).
The information on related party transactions required by DTR 4.2.8(1) of the Disclosure and Transparency Rules is given in
note 30.
SEGMENTAL RESULTS
The Group analyses its results between three segments, which are the principal divisions for which performance is
monitored:
· Paragon Mortgages includes revenue, in the form of interest and ancillary income, from the Group's first mortgage
operations, other than the mortgage lending of Paragon Bank, and from other assets remaining in legacy consumer
portfolios.
· Idem Capital includes revenue generated from assets purchased by the Group's debt investment business, Idem Capital
Holdings Limited, other than those financed by Paragon Bank and from third party consumer loan administration activity.
· Paragon Bank includes revenue generated from the Group's regulated banking business, Paragon Bank PLC and its
subsidiaries including its asset finance operation.
The underlying operating profits of these divisions are detailed fully in note 6 and are summarised below.
Six months to Six months to
31 March2017 31 March2016
£m £m
Underlying profit / (loss)
Paragon Mortgages 33.6 44.7
Idem Capital 22.3 25.5
Paragon Bank 14.2 (0.8)
70.1 69.4
Paragon Mortgages
Trading activity during the year in the Paragon Mortgages division was very strong, however much of the new business
generated by the division was funded by Paragon Bank and is included in that segment. The segment contributed £33.6 million
to underlying Group profit (2016 H1: £44.7 million), the reduced profit level resulting from lower levels of new lending on
its own account, given the Group's greater focus on retail funding, together with the sale of seasoned assets to Paragon
Bank in the period. The segment also had higher allocated funding costs following the Group's Tier 2 bond issue in
September 2016.
Idem Capital
The Idem Capital division's portfolios performed strongly in the period to 31 March 2017 and, while the division benefitted
from new investments made during the year and firm cost control, the transfer of previously acquired assets to the Paragon
Bank division towards the end of the comparative period resulted in Idem Capital's underlying profit contribution reducing
to £22.3 million (2016 H1: £25.5 million).
Paragon Bank
The increasing maturity of Paragon Bank, the acquisition of the asset finance business in the previous year and the
purchase of assets from the Paragon Mortgages segment have resulted in this segment achieving an underlying profit of £14.2
million (2016 H1: loss of £0.8 million). This includes £7.2 million of profit arising in the asset finance business. The
loss recorded in the period ended 31 March 2016 included acquisition costs of £2.5 million. Paragon Bank has invested
heavily both in the development of the risk and compliance structure required for regulatory purposes and to provide the
foundations for organic growth across its product lines. As these product lines grow the Bank will naturally increase the
utilisation of the present fixed cost base improving its overall cost effectiveness.
ASSETS AND LIABILITIES
The Group's balance sheet is summarised in the table below:
SUMMARY BALANCE SHEET
31 March 2017
31 March 2017 31 March 2016 30 September 2016
£m £m £m
Intangible assets 104.6 87.0 105.5
Investment in customer loans 10,940.2 10,853.1 10,737.5
Derivative financial assets 1,044.0 939.9 1,366.4
Free cash 257.4 152.7 366.5
Other cash 916.2 742.6 871.1
Other assets 68.9 70.8 71.4
Total assets 13,331.3 12,846.1 13,518.4
Equity 994.2 964.4 969.5
Retail deposits 2,347.4 1,426.4 1,873.9
Borrowings 9,839.7 10,303.3 10,502.6
Pension deficit 38.4 24.0 58.4
Other liabilities 111.6 128.0 114.0
Total equity and liabilities 13,331.3 12,846.1 13,518.4
The Group's loan assets include:
· First mortgage assets, with new originations and legacy assets in Paragon Mortgages, new originations in Paragon Bank
and purchased assets in Idem Capital;
· Second mortgages, with new originations in Paragon Bank, legacy assets in Paragon Mortgages and purchased assets in
Idem Capital;
· Car finance loans, with new originations in Paragon Bank and legacy assets in Paragon Mortgages;
· Asset finance loans, included in the Paragon Bank segment; and
· Other unsecured consumer lending with purchased assets in Idem Capital and legacy assets in Paragon Mortgages.
An analysis of the Group's financial assets by type is shown in note 14. Movements in these balances are discussed in the
business review section. Movements in the Group's loan asset balances are discussed in the lending review section.
Movements in derivative financial assets arise principally as a result of the effect of changes in exchange rates on
instruments forming cash flow hedges for the Group's floating rate notes. These movements do not impact on the Group's
results.
Cash flows from the Group's securitisation vehicle companies and the acquired portfolios remain strong. These, together
with debt raisings, financed further investments in loan portfolios, the capital requirements of Paragon Bank and credit
enhancement for mortgage originations. Cash was also utilised in the share buy-back programme, which commenced during
December 2014 and where £127.7 million (including costs) had been deployed by 31 March 2017. Free cash balances were £257.4
million at 31 March 2017 (31 March 2016: £152.7 million) ahead of the repayment of the Group's £110.0 million Corporate
Bond in April 2017.
Movements in the Group's funding are discussed in the funding review section.
The triennial revaluation of the Group's defined benefit pension plan as at 31 March 2016 was agreed in principle with the
Trustee during the period. As a result, an experience gain has been accounted for and mortality assumptions updated,
leading to the deficit under International Accounting Standard ('IAS') 19 reducing to £38.4 million (30 September 2016:
£58.4 million). This resulted in an actuarial gain in other comprehensive income of £20.7 million before tax (2016 H1: £2.7
million loss). However gilt yields reman at low levels with a corresponding impact on the discounting factor used in the
IAS19 valuation of the liability.
The Paragon Group of Companies PLC
INTERIM MANAGEMENT REPORT
OPERATIONS REVIEW
MANAGEMENT AND PEOPLE
The Group has always recognised that its people are key to its future growth and development. The training and development
of employees together with a rigorous recruitment and selection process are a key part of the Group's organic growth
strategy and underpin the strong progress made.
During the period the Group exceeded 1,300 employees as its operations expanded to add specialist skills in both customer
facing roles and central professional services areas to further develop its future growth plans.
The Living Wage is an important part of the Group's values and people strategy and the Group supports the principle,
espoused by the Living Wage Foundation, that it is good for business, good for the individual and good for society. The
Group's pay levels meet the requirements of the National Living Wage and it received formal accreditation from the UK
Living Wage Foundation in June 2016.
Diversity has also been a focus for the Group and in January 2017 the first set of internal targets under the Women in
Finance Charter were published. These include a target of 35% female representation in senior management roles by January
2022, increasing from 26% at the time the targets were set. The Group Finance Director is the executive sponsor and
progress against the targets will be monitored by the Executive Committee. A full list of the Group's diversity targets can
be found on the 'Corporate Responsibility' section of the Group's website, and progress against these targets will be
reported in the Group's Strategic Report at the year end.
The Group conducts annual diversity awareness training for managers and additional communication events are planned in the
coming months. A voluntary and anonymous diversity survey has been completed recently with a response rate of 78%,
significantly above industry average. Actions to promote equal opportunities within recruitment, learning and career
development will continue to be an important element of the people strategy.
The Group is well advanced in its preparations to complete its Gender Pay Gap reporting by the required deadline. The first
results, based on the April 2017 pay date, will be published in this year's Annual Report and Accounts.
The Group prides itself on the high retention rate in its workforce. Its annual employee attrition rate of 5.4% is below
the national average and 31% of its people have been with Paragon for more than ten years, with 8% having achieved over 20
years' service. We believe this is due to providing quality development opportunities and creating a place at which people
want to work, which has in turn meant that knowledge and experience have been retained in each of our specialist areas. The
Group has managed an efficient operation over the past six months, increasing employee numbers by 0.4% over the period. We
believe the Group's people are well positioned to support its future growth strategy.
During the period work has continued to embed the internal mentoring programme, accredited by the Chartered Management
Institute, helping to support succession planning strategy and develop future leaders. Further work has continued with
local secondary schools, colleges and universities, with industrial placements and apprenticeships becoming a feature for
some of the Group's specialist areas.
Plans are in place to begin to draw down on the Apprenticeship Levy with formal apprenticeship programmes currently being
identified across our different business lines and specialist areas. Regulatory training programmes have been launched to
ensure employees remain competent to deliver good customer outcomes and there are usually over 100 people completing
professional qualifications at any one time across the Group.
The health and wellbeing of the Group's employees is an important element of its people strategy. During the period the
Group continued to offer lifestyle assessments and new discounted gym memberships, while promoting its employee assistance
programme with external occupational health support. In addition, mental health awareness sessions were delivered to line
managers across the Group.
The Group's statement under the Modern Slavery Act 2015 was published on its website in March 2017 and relevant policies
have been appropriately updated. All employees are currently completing an e-learning module on this subject to raise
awareness and understanding.
During the period the Board, initially through the Nomination Committee, has continued to give in-depth consideration to
the increasing demands made of non-executive directors, particularly in the financial services sector and how it might
ensure the Board has sufficient capacity to meet those requirements. In particular it is considering how best additional
retail and SME banking experience could be added to the independent element of the Board.
The Group's succession planning strategy continues to be an important area of focus, with key roles in the Group identified
from a leadership and specialist perspective. Immediate successors are in place for these roles for the short term to
provide business continuity and longer term succession plans are being developed for those with career aspirations and
strong potential. This area will remain a priority for the Board, with the assistance of the Nomination Committee, during
the remainder of the year.
RISK
In the last six months, the Group has continued to develop its ability to manage all categories of risk. This has included
enhancing its risk appetite statements, introducing a new operational risk management system and investing in new skilled
resource in areas such as cyber security and capital risk management. This ongoing investment in people and systems is
intended to ensure that the Risk and Compliance function has sufficient capability and capacity to provide effective
oversight of the Group's expanding activities.
The Group's risk governance framework is based upon a formal three lines of defence model. Within this framework the
Credit, Asset and Liability and Operational Risk and Compliance Committees, formed of senior management, report to the
board level Risk and Compliance Committee. This committee comprises the Chairman and the independent non-executive
directors of the Company.
The Group's governance structure continues to provide an effective basis for the management of risk within which:
· The first line of defence, comprising executive directors, managers and employees, holds primary responsibility for
designing, operating and monitoring risk management and control processes
· The second line of defence is provided by the Risk and Compliance division, together with executive risk committees
(as noted above) which report to the Risk and Compliance Committee
· The third line of defence is provided by the Group Internal Audit function and the Audit Committee which are
responsible for reviewing the effectiveness of the first and second lines of defence
Significant elements of the risk environment faced by the Group during the last six months include:
· Continuing uncertainty regarding the impact on the UK economy and capital markets of the decision to leave the
European Union. This uncertainty is likely to be heightened by the UK Government's decision to hold a General Election in
June 2017
· Transitional risks arising from the ongoing integration of recent business acquisitions into the Group
· Continuing high levels of cyber-security risk given the increasing frequency and sophistication of cyber-attacks on
the financial services sector
· Potential impact of changes in the regulatory and fiscal environment for buy-to-let mortgages in the UK
· Impact of new proposals on capital regulation from the BCBS
· The need to ensure compliance with a number of significant impending key regulatory and legal changes including the
Fourth Money Laundering Directive and General Data Protection Regulation
The Group is carefully monitoring and responding to these risks as they develop and considers itself well placed to
mitigate their impact.
A summary of the principal risks and uncertainties faced by the Group is given on page 40.
REGULATION
The Group is subject to consolidated supervision by the PRA as it contains an authorised bank. In addition, a number of the
Group's subsidiaries covering a large part of its operations are authorised and regulated by the FCA. As a result, the
impact on the Group of the current rate of change within the regulatory environment, driven by domestic and European
policy, is significant. This has been particularly evident in relation to prudential risk as additional aspects of the
Basel III supervisory regime are rolled out and the BCBS consults on further changes.
The governance and control structure within the Group has therefore been developed to ensure that the impacts of all new
regulatory requirements on the business are clearly understood and that appropriate preparations are made before these
requirements are implemented. Regular reports on key regulatory developments are received at both executive and board risk
committees, assessing the potential implications for the Group, along with necessary actions to be undertaken.
Following its review of the buy-to-let market during 2015, the PRA published its Supervisory Statement 'Underwriting
standards for buy-to-let mortgage contracts' in September 2016. The statement, which was broadly in line with the proposals
contained within the original Consultation Paper, is designed to enhance underwriting standards in the specialist
buy-to-let market.
As described in the lending review, the Group's historically conservative approach to the underwriting of buy-to-let
lending is entirely consistent with the PRA's objective of ensuring that lenders conduct such business in a prudent manner,
avoiding inappropriate lending and the potential for excessive credit losses.
Phase one of the PRA statement - which came into force in January 2017 - introduced changes to ICRs and interest rate
stress tests, ensuring lenders undertake appropriate checks on applications to ensure that repayments are not only
affordable at the outset, but also for the foreseeable future. The phase two changes, which are to be implemented by
September 2017, include requirements to submit formal regulatory returns for buy-to-let lending, the segmentation of
'Portfolio Landlords', those with four or more buy-to-let properties, and further enhancements to the affordability model.
The internal policy, procedural and system changes required to meet the requirements of phase one were all introduced well
ahead of the regulatory deadline at the turn of the year. A project is currently in progress to ensure the Group meets the
remaining PRA requirements and is on track to be completed in good time for the implementation date. These further changes
are not expected to have a material impact on the operations of the business.
The FCA has introduced new measures to capture financial crime data in order to enhance their understanding of aspects such
as fraud and money laundering. As a result, the Group will be required to file its first report at the end of the current
financial year in September 2017 and processes are already in place to capture this data, and enable its accurate
reporting.
In March 2017, further requirements relating to the Senior Managers and Certification regime took effect. The
implementation of the 'full' Certification regime, along with the rolling out of the Conduct Rules, now apply to all Bank
employees, apart from those undertaking purely ancillary functions. All procedures required by the new regime in respect of
Senior Managers and Certification Regime staff have been completed, and training modules rolled out for all remaining Bank
employees to whom the Conduct Rules now apply. The Group is conscious of the extension of the regime to other financial
services firms with effect from 2018, and is taking appropriate steps to ensure it can comply with the requirements.
The Government published its draft Money Laundering Regulations during March 2017. The new regulations, which come into
force on 26 June 2017, will see changes to the approach to customer due diligence, seek ways to prevent new means of
terrorist financing, and improve the transparency of beneficial ownership of companies and trusts. This will bring the
UK's Anti-Money Laundering and Counter Financing for Terrorism regime in line with the latest international standards. The
Group had previously reviewed the original Fourth Money Laundering Directive proposals and implemented a formal programme
of work to address any changes required to operational procedures. The changes proposed by the latest regulations are not
expected to have a significant impact on the Group's existing project plan.
The General Data Protection Regulation will pass into English law on 25 May 2018, irrespective of developments in relation
to the UK's withdrawal from the European Union. This represents the most significant revision of data protection law for
some 20 years. A project is taking place, drawing on external specialist advice as required, to ensure all areas of the
Group will comply with the legislation from May 2018.
Overall, the Group considers that it is well placed to address all these regulatory changes.
The Paragon Group of Companies PLC
INTERIM MANAGEMENT REPORT
CONCLUSION
The Group has delivered another strong performance for the six months ended 31 March 2017, delivering improving earnings,
dividends and RoTE, the latter progressing towards our medium-term target of 15%. Importantly, this has all been achieved
whilst continuing the process of strategically repositioning the Group as a more broadly based specialist banking business,
benefitting from the structural changes emerging in the UK retail banking sector.
The Group has moved a long way in a relatively short period and is transitioning towards a more broadly based UK specialist
banking business. The Bank is now delivering strong profits, the vast majority of the Group's new funding requirements and
represents the foundation for growth going forward.
There has been excellent progress in the Group's various lending activities with clear evidence emerging of the structural
shift in the UK banking markets towards specialist lenders, whose strength and capabilities are built on a greater
understanding of the markets and customers they serve, delivering more tailored products and supported by superior
technology. The Group's buy-to-let pipeline has more than doubled across the period and points to lending volumes for the
full year exceeding our original expectations. Further, the Group is well positioned to exploit the opportunities that will
emerge from the additional PRA underwriting rules due later this year. Whilst the buy-to-let market, overall, is forecast
to be subdued, we are confident of growing our market share. Equally in the Group's other lending areas, particularly asset
finance, strong growth has been achieved, with further growth expected. We have also extended our range of products
supporting wider areas of the mortgage, consumer and SME markets, whilst maintaining our long established and disciplined
credit standards.
Although the current environment is benign, economic and political uncertainties do exist. The Group's strategic progress
in the growing specialist lending markets is being supported by a strong capital base, with a CET1 ratio of 15.9%,
increasingly deep and diversified funding sources, an exemplary credit performance and through-the-cycle experience.
With the buy-to-let pipeline having more than doubled this year, and all other areas of the Group experiencing buoyant
growth, we approach the period ahead with confidence and optimism in being able to meet our expectations.
The Paragon Group of Companies PLC
PRINCIPAL RISKS AND UNCERTAINTIES
There are a number of potential risks and uncertainties which could have a material impact on the Group's performance over
the remaining six months of the financial year and could cause actual results to differ materially from expected and
historical results. In the opinion of the directors these have not changed materially from those described in section A2.2
of the last annual report and accounts of the Company for the year ended 30 September 2016. These are summarised below.
Category Risk Description
Business Economic The UK's triggering of Article 50 of the Treaty on European Union in March 2017 has the potential to create greater economic uncertainty in the near term. This could
impact demand for loans, customers' ability to re-pay outstanding balances and security values. In the next six months, this uncertainty will be heightened by the UK
government's decision to hold a General Election in early June 2017.
Concentration The Group's business plans could be particularly affected by any downturn in the performance of the UK private rented sector and / or further regulatory intervention to
control buy-to-let lending.
Transition Failure to integrate acquired businesses safely and effectively could adversely affect the Group's business plans and damage its reputation.
Credit Customer Failure to target and underwrite lending effectively could result in customers becoming less able to service debt, exposing the Group to credit losses.
Counterparty Failure of an institution holding the Group's cash deposits or providing hedging facilities for risk mitigation could expose the Group to loss or liquidity issues.
Conduct Fair outcomes Failure to deliver appropriate customer outcomes could impact on the Group's reputation and its financial performance.
Operational People Failure to attract or retain appropriately skilled key employees at all levels could impact upon the Group's ability to deliver its business plans.
Systems The inability of the Group's systems to support its business operations effectively and/or guard against cyber security risks could result in reputational and financial
losses.
Regulation Given the highly regulated sectors in which the Group operates, compliance failures or failures to respond effectively to new and emerging regulatory developments could
result in reputational damage and financial loss.
Liquidity and Capital Funding Increased volatility in wholesale markets could reduce the Group's funding and liquidity options, restricting its ability to lend.
Capital Proposals by the BCBS to change capital requirements for lending secured on residential property could have adverse financial implications for the Group.
Market Interest rates Reduction in margins between market lending and borrowing rates or mismatches in the Group balance sheet could impact profits.
Pension Obligation Pensions The obligation to support the Group's defined benefit pension plan might deplete resources.
The Group has considered and responded to all of these risks, mitigating the exposure as far as is practicable to ensure
that its risk profile remains within the Board's stated risk appetite.
The Paragon Group of Companies PLC
DIRECTORS' RESPONSIBILITES
The directors confirm that, to the best of their knowledge:
· the condensed financial statements have been prepared in accordance with International Accounting Standard 34 -
'Interim Financial Reporting', issued by the IASB and as adopted and endorsed by the European Union;
· the Interim Management Report includes a fair review of the information required by Section 4.2.7R of the Disclosure
Guidance and Transparency Rules, issued by the UK Listing Authority (that being an indication of important events that have
occurred during the first six months of the current financial year and their impact on the condensed financial statements
and a description of the principal risks and uncertainties for the remaining six months of the financial year); and
· the Interim Management Report includes a fair review of the information required by Section 4.2.8R of the Disclosure
Guidance and Transparency Rules, issued by the UK
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