Bringing up the arrears: mortgage, debt and financial resilience in the cost-of-living crisis

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Susannah Streeter: Hello, and welcome to Switch Your Money On, with me, Susannah Streeter, Head of Money and Markets here at Hargreaves Lansdown.

Sarah Coles: And me, Sarah Coles, the Head of Personal Finance. It’s really good to get the double act back together, because it’s been a really busy couple of weeks, mainly poring over the piles of debt that’s been built up by companies and nations.

Susannah Streeter: Yes, I’ve been in France, chairing a conference organised by the Paris Club, aimed at co-ordinating the restructuring of debt held by developing nations who are really struggling to pay it back. According to the IMF and the World Bank, 36 countries are currently at high risk of debt distress or in a situation of debt distress, a sharp rise compared to the situation a decade ago, when 21 nations were in a similar situation, so plenty of créanciers and débiteurs were represented – that’s creditors and debtor nations to you.

Sarah Coles: Thanks for the translation. I have to say I did need it. It didn’t tend to come up much in GCSE French. We kind of focused on really important things, like ordering baguettes. But you’re right – debt has been the big story of recent weeks, elsewhere too.

Susannah Streeter: Too right. Closer to home, Thames Water’s debt worries reached boiling point. The group’s CEO, Sarah Bentley, suddenly stepped down and soon after, reports began emerging that the company was in deep water. The Thames Water saga has put a spotlight on what is a debt-laden industry. According to the regulator, the sector’s total debt reached £60.6bn last year.

Sarah Coles: And of course speculation that it could translate into higher water bills too has gone down like a lead balloon, especially coming around the same time as the International Energy Agency warned there was a risk of higher energy bills this autumn, plus of course the Competition and Markets Authority revealing that supermarkets are making a much bigger margin on their fuel at the moment, so that’s up by 6p a litre.

Susannah Streeter: The squeeze on consumers isn’t going away any time soon, especially given what’s happening in the mortgage market. It’s having an impact on our short- and long-term finances, as well as the companies hoping to attract our cash. So this is the focus of this episode of the podcast, which we’re calling Bringing Up The Arrears.

Sarah Coles: Yes, we’ve just published the latest edition of the HL Savings and Resilience Barometer, which is a major piece of research into how the nation’s finances are faring in the face of rising bills, rocketing inflation and rate rises, so we’ll be talking to Nathan Long, a Senior Analyst who’s steeped in this work, and Helen Morrisey, Head of Retirement Analysis, who can tell us about the impact on older people.

Susannah Streeter: We’ll also be speaking to Sophie Lund Yates, our Lead Equity Analyst, about what this environment means for companies, and Emma Wall, our Head of Investment Research and Analysis, who’s gonna get the view from a fund management perspective.

Sarah Coles: So plenty to get stuck into, so let’s not hang about. Let’s bring in Nathan Long, who’s been one of the driving forces of the HL Savings and Resilience Barometer. Nathan, can you start by telling us a little bit about it?

Nathan Long: Sure, yeah. We actually set this work up in 2022 because we wanted a way to comprehensively assess the financial resilience of the nation, and we actually re-run it every six months to see whether life is getting easier or more difficult. I think, when I joined you on the pod last time, the overall theme was that we all knew that the cost-of-living crisis was gonna be bad, but we’d not really seen that coming through acutely on households as we had expected, but I’m afraid to say that really that’s no longer the case. The past six months has got an awful lot tougher.

We build the Barometer around what we call the five pillars of our finances, which we think are vital for balancing demands on your finances now and in the future, as well as guarding against risks. These are: controlling your debts, protecting your family, saving for a rainy day, planning for later life and investing to make more of your money.

Susannah Streeter: So Nathan, there have, as you say, been some pretty stark findings in the latest edition, and this is looking specifically at how costs are rising, and the squeeze on our budgets, particularly for lower earners.

Nathan Long: Yeah, that’s right, so the overall score shows that our financial resilience has been falling since the end of 2021, but for those on lower incomes, life has been even tougher, and they’re often now worse off than they were before the pandemic.

Nearly 90% of lowest-income households have ‘poor’ or ‘very poor’ levels of financial resilience, and in the next twelve months it’s gonna drag them even lower. This time next year, we’re expecting 289,000 of those households on the lowest incomes will have spent their savings, be spending more than they have coming in and will be borrowing to make ends meet, so quite frankly a pretty grim situation.

Sarah Coles: That does sound really tough. What are the big challenges facing those lower earners?

Nathan Long: Part of the problem is that such a large part of their income goes on the essentials. The lowest-income households fork out around 17% of their income on food, and that compares to just over 5% amongst the highest earners. But despite spending proportionally more on food, in cash terms they spend 16% less than average. It means they’ve got far less scope to cut back. This isn’t about households facing a choice of swapping out Heinz beans for a supermarket own-brand to feed their family – it’s having to actually skip meals entirely to make ends meet. It’s one of the reasons we’re seeing people falling behind on bills. Overall, 10% of households are in arrears, notably on energy bills. However, over the next twelve months, we’re gonna see this rise to almost a third of the lowest-income households.

Susannah Streeter: Alongside those really major challenges for those on lower incomes, another theme that really does emerge from this report was around re-mortgaging. Can you set the scene for us?

Nathan Long: Yeah, sure. You mentioned earlier on that mortgage rates have been climbing. Now because so much of the mortgage market is on fixed rates, it means that there’s quite a long lag period between the higher base rates that we’re seeing feeding into more expensive mortgages. At this stage, only one in three mortgage-holders have faced a rise in their monthly costs, but as more and more households refinance, this will rise to three in five by the end of next year.

Those who need to re-mortgage while rates are higher face a huge rise in monthly payments. When a household spends a quarter of its after-tax income on mortgage repayments, we class it as being at risk of falling behind. Right now, that’s 23% of households that are in that position. By this time next year, that’s expected to rise to 26% – that’s more than one in four households that we would consider to be at risk of falling behind.

Sarah Coles: But the Barometer lets you dig a bit deeper into those people’s finances, doesn’t it?

Nathan Long: Yeah, it really does. Of the group that’s spending more than a quarter of their income on mortgage repayments, 230,000 households don’t have enough emergency cash savings. We class that as having the cash to cover at least three months’ worth of essential expenditures while you’re working. That gets even more alarming. 470,000 households are in the very difficult position of having high mortgage repayments, not enough cash squirrelled away and are spending more than they have coming in, and that number in this ‘critical risk’ group is up 220,000 compared to when we ran the same figures back at the end of last year.

Susannah Streeter: So anyone set to re-mortgage while rates are higher is likely to have an even bigger battle to make ends meet. Are there any other groups that have a struggle on their hands?

Nathan Long: Yeah, that’s something that always comes out of the Barometer. When you look into the detail, there are some really striking figures that emerge for specific groups. Let me give you an example. When you look at the people who have spent their savings, have unsustainable levels of spending and are already in debt, as well as those on lower incomes, we also see hundreds of thousands of parents – obviously, they’re stretched because they’re having to look after their children – and hundreds of thousands of renters who are wrestling with sky-high rent.

On top of that, a theme we’ve seen before in the Barometer is coming through loud and clear, so that’s that single people suffer much lower financial resilience levels than couples, and that single parents in particular have a real struggle with their financial resilience.

Sarah Coles: Thanks, Nathan. I say ‘thanks’ – that’s some pretty sobering findings there.

Nathan: Yeah, it really is, and I hope next time I’m back with an update on the Barometer I’ll have more of a positive picture to share.

Susannah Streeter: Here’s hoping, but I suspect there’s not a huge amount of good news in what Helen Morrissey has to tell us about the Barometer findings on the impact on older people as well. Helen, what’s the story here?

Helen Morrissey: Yes, I’m afraid I can’t bring much better news for you. Taking a dig into the data, we can see that 40% of the over-60s can be described as having ‘poor’ or ‘very poor’ financial resilience. Only the 20-29 age group fared worse.

When we look at retirement specifically, only 38% of the over-60s households are now on track for a moderate retirement. This compares to 40% this time last year. As a comparison, 46% of the 40–49-year age group were on track, though this has also fallen from 48% last year.

Sarah Coles: So why is it that we’re seeing the over-60s in such a tight spot?

Helen Morrissey: Soaring inflation means that the amount of money needed for a moderate retirement has absolutely soared from £20,800 per year to £23,300 per year. This comes at a point where people’s budgets are stretched so tight that they’re less likely to have anything left over at the end of the month to put away for the future because they’re just so focused on making ends meet today. Now younger age groups will have the time to rebuild their finances, but the over-60s don’t, and so this is gonna cause them issues. They’re having to save more but they’ve got far less time to do it, and even the massive 10.1% increase in state pension we saw in April isn’t really gonna make a dent.

Susannah Streeter: Helen, you mentioned some big differences there between the resilience of the over-60s and households of people in their 40s, for instance. Why do you think this is?

Helen Morrissey: There’s a few different factors at play here, I think. The mid to late 40s tend to be peak earning time for many people. However, after this time we see more people opting to go part-time or perhaps leaving the workforce for early retirement or to look after a loved one. All these things can have a big impact on the amount of money coming in and many of these people will have taken these decisions believing they had already saved enough for retirement, but inflation has spiked and now people are finding that they need to save a whole lot more.

Sarah Coles: That sounds like a really tough position to be in, so what options do people actually have? They’ve got some difficult decisions, haven’t they?

Helen Morrissey: Yeah, so some people will be in a position where they can put more aside to try and fill these gaps. However, others face potentially having to cut back on their retirement aspirations wherever they can. We could see people deciding to work for longer if they are willing and able to do so, but for those who have retired early, we could see them eyeing up a return to the workforce, for instance, to supplement their income.

Susannah Streeter: Okay, thanks, Helen. You’re right – quite a gloomy outlook for this group – but as ever with these things, it is best to know of course where you stand, so you have the best possible chance of getting through tougher times.

But it’s not all doom and gloom, because Sophie Lund Yates has been looking at some companies set up to serve customers through tough times. Sophie, you’ve been taking a look at consumer goods giant Unilever this week. Their products aren’t known for being the cheapest, though, are they?

Sophie Lund Yates: No, but they are staples and some of the best-loved brands on the supermarket shelves. Everything from Dove to Magnums and Domestos comes from this consumer goods giant. The strong potency of the group’s brands is why it’s been able to increase its prices by over 10% in recent times, and that’s only resulted in volumes dropping by a fraction. That helps underpin margins when costs are increasing, and the sheer scale of Unilever – it has quarterly revenue of about 15bn euros – means it has more resilience than others, even during a cost-of-living crisis.

Sarah Coles: But the company itself, it’s been through some tough changes too, hasn’t it, with changes at the top?

Sophie Lund Yates: Yes. In terms of where Unilever is carrying extra risk at the moment, it is important to point out that there’s a lot of change happening with senior leadership. There’s a new CEO, the chairman is also being replaced as well as some other top jobs. This is partly in response to activist investors upping their stake. Investors are looking for a turnaround given Unilever’s disappointing performance in recent times, because growth has been fairly sluggish and there’s a lot of work to be done to move up a gear, which is not easily done in a business of this size. Ultimately, Unilever has an excellent portfolio and there are a lot of strengths, but mapping the exact trajectory for growth is a bit tricky at the moment.

Susannah Streeter: What about companies, Sophie, that provide budget options, particularly on the High Street? Primark springs to mind here.

Sophie Lund Yates: Yes, so I have been looking at Associated British Foods, or ABF, which owns Primark of course, but it also has an eclectic mix of food-based businesses. These brands include Jordans, Dorset Cereals, Kingsmill, Twinings, Ovaltine, as well as animal feed and nutrition, and speciality ingredients like yeast and pharmaceutical ingredients are all part of the portfolio. Many of these items on offer are cheap and cheerful and therefore a bit more attractive in today’s market, or at the other end of the spectrum, they’re well-known brands which offer some of the same benefits like Unilever. The real bonus is the speciality stuff, which are a good thing to have on the books during difficult times because there simply aren’t many alternatives on the market.

I should say that the food arms of ABF are small when in comparison to Primark, but it still offers some diversification, and sales at Primark were up about 13% in the third quarter, supported by price hikes.

Sarah Coles: You talk about price hikes, but obviously Primark in particular, that’s focused down the budget end of the scale, so shoppers on a budget, they’re under real pressure, aren’t they?

Sophie Lund Yates: Yes, they are. The value-chain is trying its best not to pass along the full extent of rising costs, to avoid alienating its core customer base. This feels like the right move overall and group margins are set to pick up slightly this year.

To help combat these issues, the group's hinging hopes on increasing volumes, which for now are moving in the right direction. While it's a tough environment for retailers, there are some Primark-specific strengths. As consumers look for lower-priced options as inflation erodes their income, the group's market share's been increasing in the UK and sales have risen in Europe and the US. One of the things I’d say is that debt is a little bit higher than is ideal at £2.6bn, and that was at the last count. That’s not at a point where it’s a huge worry, but it would be good to see that coming down.

Susannah Streeter: Okay, Sophie, thank you, and we’re gonna stick with the cheap and cheerful end of the market for your final company too, especially given the number of yellow-sticker bargain hunters around right now, probably listening to this podcast as well.

Sophie Lund Yates: Yes, you never need to ask me twice to chat about bargains! Of course, B&M Bargains is one of the well-known chains offering lower-priced goods. It’s had an impressive set of results in recent weeks, with like-for-like sales up 9% as customers actively continue to seek ways to trim their spending.

Sarah Coles: Of course, it offers a bit of a mixture doesn’t it, including some real essentials?

Sophie Lund Yates: Yes. While most of us don’t associate B&M with groceries, its food offering is one of the areas that’s performed well. This is a clear-cut example of the extent of changing customer behaviour. And another area that’s interesting is that the group’s general merchandise has also done well. This is significant because general merchandise is usually a lot harder to shift when people don’t feel they’re flush with cash, and so this suggests that B&M’s ability to cross-sell extra goods, when people may have come through the doors for something else, is very strong. This also bodes well for gross margins and, ultimately, profits.

I would say that this better performance hasn’t translated into a valuation bump, with the shares shedding some weight around the days of the results, and I think a large reason for that is a lack of forward guidance in the latest results, which has left the market a bit concerned. There’s uncertainty around how long the sales outperformance can last, with conditions highly unpredictable, and zooming-out a bit longer, the stock’s had a strong year to date, which does actually increase the risks of ups and downs, especially when you throw in the lack of guidance.

Susannah Streeter: Okay, Sophie, thank you very much. It’s good to see some companies are still able to thrive in this environment, although you can see it’s a risky time, even for them. Anyway, talking about thriving, we’ve really loved reading the emails you’ve sent to podcast@hl.co.uk so far, and we would really love to hear more.

Sarah Coles: Yes, please do let us know any of your investment questions or anything you’re particularly excited or concerned about at the moment, or indeed any sector that’s caught your eye. This is your podcast, and so we’d love to hear from you.

Susannah Streeter: But now it is time to get a Fund Manager’s view on what could be ahead. Emma Wall, our Head of Investment Analysis and Research has been speaking to Charlotte Yonge of Troy Asset Management.

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Emma Wall: Hi, Charlotte.

Charlotte Yonge: Hi, Emma.

Emma Wall: Thanks for coming on. We’re talking in difficult times, aren’t we, let’s be honest? Not according to the market, but for consumers and for corporates, this is a challenging year. Inflation, incredibly sticky. We’ve just had the news that actually the UK remains the only one of the G7 in which inflation seems to be rising. How does one begin to navigate a market like this, where markets are quite optimistic, but so much of the macro is so pessimistic?

Charlotte Yonge: It is that disconnect between what’s actually going on in the real economy and what investors are pricing in, and for us, we’re more invested in types of bonds that are now yielding more because people are expecting higher interest rates, and we’ve got less in equities, and I think we can talk a little bit about what equity markets are pricing in, but it’s certainly not a recession, and valuations are above their long-term averages. Really, having a bit of dry powder to be able to invest at a more attractive point, that’s our main objective at the moment, and being paid to have that in bonds that are yielding you something for the first time in 15 years.

Emma Wall: Let’s talk a little bit more about that disconnect and what’s driving equity markets. Something like seven companies have driven 60% of the performance of the S&P 500 this year – it’s been as concentrated as that. It’s very much a growth story, a reverse of what we saw last year, where we saw value stocks actually doing very well. Then we come into this year and it’s very much growth on optimism, those very sort of animal spirits over-valued by a number of metrics, driving the outperformance. How do you, because you do have an equity portion in your portfolio, where are you finding opportunity to invest within that?

Charlotte Yonge: Your point is absolutely the right one in that I think markets see 2022 as the aberration, and 2023 is sort of back to the 2010s, albeit much more narrow, in that there is a huge amount of risk appetite, but the real difference is that we have an interest rate now – we didn’t have that for the entire 2010 to 2019 period – and so, actually, there needs to be a cost of capital that’s much higher than it was. For us, it’s all about valuation, but also choosing those companies that are gonna win over the next ten years, so we’re not compromising by investing in lower-quality businesses that are on low valuations, because there are some of those, but we are just sticking to those companies that we think can win over a much longer time horizon, albeit we’ve got a little bit in them at the moment and we’d like to have more. So we do actually have some of the companies that have done really well this year: we got Alphabet, and that’s on a non-egregious valuation, it’s on about its long-term average. It’s on around 19 times. This is a business which actually, if there’s a recession, that’s not gonna be easy for an advertising-driven, digital technology company, so we’ve got much less in these businesses than we would do if we were in a different point in the cycle. We used to have 6% in Alphabet and now we’ve got less than two. I think the US is a particularly expensive market. That said, we do tend to find some really good businesses there, so you will see, of the 23% that we’ve got in equities, about half of that is still in the US. It used to be more than half, and that’s because we’re increasingly seeing the smaller number of exceptional companies, which still do exist in the UK and in Europe, they are actually trading at slightly lower valuations than in the US. For example, we’ve just added a holding in Heineken, a European company, European brewer, and that’s a business which we think is of commensurate quality to a lot of the companies that we have in the US, but this is on a valuation of a mid-teens price earnings multiple. We talk about the long-term winners: this is a family-owned, family-run business that has really proven to have that long-sightedness, able to invest for not just the next couple of quarters, but for decades to come, so being able to buy that on a valuation that is as attractive as it is now – it’s as low as it was actually during COVID – we think is a great opportunity. We talk a very cautious overall picture, but there are rifle-shot chances to buy equities like that.

Emma Wall: What else is making up the portfolio and how does that add resilience in these uncertain times?

Charlotte Yonge: The largest other exposure is to index-linked bonds, which comprise a third of the portfolio – that’s US index-linked – and people, I think quite rightly, expect those to do well in inflation. It’s worth saying that last year was a terrible year for all types of bonds, including index-linked, and that’s because those have part of their returns linked to future inflation expectations, but also part-linked to conventional interest-rate expectations, and actually interest-rate expectations went up at the same time that inflation expectations have actually stayed incredibly grounded, so the market’s effectively saying, ‘Inflation’s coming back down at 2% and it’s staying there.’ So these bonds have not benefited from that, but at the same time, they’ve had a bit of pain from interest rates going up, so that makes for a really attractive start point from here. You effectively can lock in a real yield, which is your yield before you take into account inflation, of around 1.5 to 2%, so that means your annualised return from these bonds, if you hold them to maturity, and our average maturity is around six years, you’re getting 1.5 plus whatever inflation turns out to be over the life of that bond. Let’s say inflation’s 4%, you’ll annualise 5.5%, which we just think is a really attractive bird-in-the-hand return. You’re not taking a lot of risk for that return.

Emma Wall: What about cash and gold, because they’re two other components which, in the past, you’ve pulled that lever, haven’t you, when you’re feeling more cautious about the outlook? Is that something you’re doing at the moment?

Charlotte Yonge: Yes, we still have a good exposure to gold, just over 10%. We do think that we are unfortunately still in an era where you need some gold. Gold is effectively a protection against a few things, but most importantly, it’s a protection against inflation, and monetary policy, fiscal policy, both devaluing paper currencies, it is that currency that can’t be devalued because it can’t be printed in the same way that the dollar can or that sterling can, so we really have it as that hedge against inflation and monetary instability. It’s also a pretty good hedge against geopolitical instability as well, and last year was a record year for central bank purchases of gold, which just goes to show that central banks are still seeing this as that alternative currency. Increasingly, they want to own gold rather than the dollar, and that’s a sign of geopolitical tension, increasing nationalism as well.

Emma Wall: Charlotte, thank you very much.

Charlotte Yonge: Thanks very much, Emma.

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Sarah Coles: That was Emma Wall, speaking to Charlotte Yonge of Troy Asset Management on the 6th of July, and please bear in mind that these are the views of the fund manager and are not individual stock recommendations.

Susannah Streeter: You’re listening to Switch Your Money On from Hargreaves Lansdown, and now it is time for the stat of the week.

Sarah Coles: Yes, and this time I’ve been digging deeper into the Barometer, which has so much incredible detail behind those overall findings. Susannah, how much do you think the average household spends keeping a roof over their head each year, so that’s like the essentials, like the mortgage, rent, bills, council tax, that sort of thing?

Susannah Streeter: Oh, I don’t know, and it’s me in the hot seat this week. It’s like being in that big, black Mastermind chair. Okay, after so many bill hikes and rate rises, it has to be something pretty awful like £1,000 a month, so £12,000 a year?

Sarah Coles: Actually, you’re impressively close: it’s just under £11,500. It’s no wonder that even the essentials are a struggle for so many people.

D’you know, we’ve carried that gloomy theme right through to the last gasp of the podcast, haven’t we?

Susannah Streeter: We have, but it has inspired me to go bargain hunting again. I don’t know if it’s just me, but I am being bombarded by emails about reductions right now. Of course, it’s not a saving though, is it, if you don’t need it in the first place? I do have to keep reminding myself about that!

Sarah Coles: Yes, you’re to delete those emails and save all of the money rather than a fraction of it. But enough of the gloom – we’ll definitely need to focus on a booming industry next time, although if you drop us an email at podcast@hl.co.uk, you can let us know what you’d like us to explore next.

Susannah Streeter: Yes, please do just that. It is all from us for now, but before we go, we need to remind you that this was recorded on July 10th 2023, and all information was correct at the time of recording.

Sarah Coles: Nothing in this podcast is personal advice. You should seek advice if you’re not sure what’s right for you. Unlike the security offered by cash, investments rise and fall in value, so you could get back less than you invest.

Susannah Streeter: Yes, this is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment.

(Music plays).

Sarah Coles: And this hasn’t been prepared in accordance with legal requirements designed to promote the independence of investment research, and is considered a marketing communication.

Susannah Streeter: Non-independent research is not subject to FCA rules prohibiting dealing ahead of research. However, HL has put controls in place, including dealing restrictions, physical and information barriers, to manage potential conflicts of interest presented by such dealing.

Sarah Coles: You can see our full non-independent research disclosure on our website for more information. So all that’s left is for me to thank our guests, Nathan, Helen, Sophie, Laura, Emma, Charlotte and our producer, Elizabeth Hotson.

Susannah Streeter: Thank you, as usual, so much for listening. We’ll be back again soon, and remember those emails. Bye!