Paragon shares slipped by almost 10 per cent yesterday, wiping £28 million off its value, amid fears that the mortgage lender could be hit by a Northern Rock-style funding crisis.

The lender’s stock fell 24½p after two analysts’ notes suggested that Paragon would have to slash its new business growth if the credit markets did not loosen up by February.

Nigel Terrington, Paragon’s chief executive, insisted that there was no reason for the market to panic. “Whilst the capital markets remain disrupted, we believe that liquidity will return in due course,” he said.

However, analysts at Daniel Stewart told investors to expect further volatility in the share price.

Hedge funds short-selling the lender’s shares took some profits yesterday after a week of consecutive falls. Data Explorers said that 17.3 per cent of the company’s stock was on loan yesterday, down from 18 per cent on Friday, suggesting that fewer shares were being shorted.

Nevertheless, there were small increases in stock on loan at Alliance & Leicester and Bradford & Bingley, two rivals of Paragon, indicating that speculators foresaw further pain for the mortgage sector. Paragon’s shares have fallen by more than 67 per cent since their 52-week high of 692p in November last year, including a 46½p at 727½p to close at 254p.

Paragon’s fall was exacerbated by a note last Thursday from Keefe, Bruyette & Woods (KBW), which said that the lender had sufficient funding to continue its current rate of growth until February 2008. After that, Paragon would have to turn to the credit markets for cash. If wholesale lending has not returned to normal by then, KBW said that Paragon would have two choices: sell books of loans to rival lenders, or close to new business. If the latter happened, It is likely that Paragon would be snapped up by private equity buyers, KBW said.

Daniel Stewart said that in a “nightmare scenario” Paragon faced the prospect of “much lower loan book growth or effectively shut the door to new lending and put the existing business into run-off . . . While the credit markets are effectively still closed this is a possibility, but we do not anticipate it happening.”

Mr Terrington was constrained in his defence of the company yesterday because of its closed period before its full-year results on November 20. One of the lender’s largest shareholders said that they supported the company and described Paragon’s management as “very competent”.

Paragon funds 90 per cent of its lending by selling mortgage-backed bonds with maturities of up to 40 years. Ten per cent of the company’s lending is funded by a £2.3 billion line of credit from a banking syndicate. Paragon uses this funding while it warehouses mortgages, which it then securitises, enabling it to pay off its own lenders. There is concern that investors’ appetite for mortgage-backed securities, which dried up during the credit crisis, might not return quickly enough, causing a shortfall in Paragon’s new business funding.

The mortgage-backed securities market received a boost yesterday when Lehman Brothers announced the securitisation of a £225 million book of prime mortgages from Alliance & Leicester.

Pension cuts

Millions of workers in final-salary pension schemes could face cuts in their retirement incomes under proposals being considered by Mike O’ Brien, the Minister for Pensions Reform. The Government is thinking of reducing the upward revaluation allowance for inflation built into pension calculations from the present rate of 5 per cent to 2.5 per cent.

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