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Brick by bearish brick

How concerned should we be that arrears on mortgage payments in the UK have just hit their highest level since 2010? In one sense the figure hardly seems chilling – just £2.05bn is overdue on the UK’s stock of £1,630bn-worth of residential mortgages. What’s to worry about?

That it’s part of a pattern. Interest rates rise, borrowers struggle with payments, arrears accrue, borrowers default, homes get re-possessed, forced sales depress house prices, owners’ equity vanishes. The pattern repeats and a cycle gets locked in. Result – misery. We know this happens. We have been here before.

The most recent time mortgage arrears rose at such an alarming pace was in 2008 as the US sub-prime mortgage crisis sent the world spinning into a financial crisis that took many of the UK’s leading mortgage providers with it. In the 18 months to the end of 2008 mortgage arrears doubled to over £2bn and names such as Northern Rock, Bradford & Bingley and HBOS effectively ceased to exit.

Which is not to imply we are about to witness even the shadow of that collapse being repeated. But it looks as if we are about to see the period – we might even label it ‘an era’ – of token interest rates coming to an end. Quite feasibly, we will also see interest rates rise at a pace unknown to almost a generation of borrowers. It is one thing to add, say, two percentage points to a 6 per cent loan, quite another to add the same amount to a 3 per cent loan. Finances that can cope when interest payments rise by a third may be overwhelmed when payments rise by two-thirds.

A related concern is that over 80 per cent of the approximately 153,000 UK mortgage accounts in arrears have no formal payment concession in place with the lender. That proportion is always high but currently it is about five percentage points higher than when the UK was about to descend into the 2008-09 financial crisis. As Matthew Carter, of financial services firm Mazars, points out: “When borrowers stop paying their mortgages without making arrangements with their lenders it’s a sign they are getting into real financial distress.”

True, mixed with alarming signals in the latest quarterly data on mortgage lending is some reassurance – the £13.3bn of outstanding balances in arrears is just 0.8 per cent of all outstanding mortgages, the lowest proportion since logging the data began in 2007. Yes, but all that really tells us is that total mortgage lending is rising faster than arrears are accruing, and that might not last.

Meanwhile, the chart addresses a related question, especially pertinent to Investors’ Chronicle readers – does the rise in mortgage arrears tell us something about the outlook for housebuilders’ shares? Answer, it’s a definite maybe, but first some explanation of the chart. Both sets of data – for housebuilders’ shares and mortgage arrears – have been re-based to an index of 100 starting in March 2007 when the financial world was oblivious to what was around the corner. Next, because there is no pure index for housebuilders, the chart line shows the unweighted average price for shares in Persimmon (PSN), Barratt Developments (BDEV), Taylor Wimpey (TW.) and Redrow (RDW). Then, in order to keep the chart lines moving in broadly the same direction, the data for mortgage arrears are inverted. So, for instance, during the period 2007-09, when mortgage arrears were rising fast, the chart shows them falling, much as housebuilders’ shares were doing at the same time.

Certainly, the two variables move more or less in the same direction. In addition – and predictably – share prices bounce around much more than mortgage arrears. However, it is difficult to say that changes in arrears drive share-price movements and it would be equally tough to show that share prices are the driver. In statistical terms, the correlation between price changes in the two, although broadly heading in the logical direction, is too loose, as is the statistical ‘fit’ of the data.

Maybe the absence of a link is to be expected. After all, the whole point of share prices is to factor in the future so far as it can be glimpsed. In effect, therefore, housebuilders’ shares may adjust for higher mortgage arrears even before they have been announced. Be that as it may, their shares have been bouncing within the same band for over four years and, even in their latest dip, have yet to challenge the low point they reached in March 2020. However, if mortgage arrears continue to rise, they may well do that.

Dropping to the levels they plumbed in 2008-09 still seems far-fetched. Recall that this group of four lost almost 90 per cent of its market value in the 21 months to December 2008. Besides, the table shows that the four go into 2022-23’s would-be recession in much better they shape than they went into 2008-09’s. Their latest full-year operating profit margin and return on assets are all higher; their balance sheets are under no strain and only Redrow held net debt at the close of its latest financial year.

Housebuilders: Then and now
 PersimmonBarratt Dev'sRedrowTaylor Wimpey
Operating margin (%)
200720.616.216.310.3
202126.618.916.619.1
Return on assets (%)
200710.54.98.5negative
202116.79.29.19.3
Net debt/equity (%)
200728.0net cash30.538.2
2021net cashnet cash7.5net cash
Net debt/ebitda
20071.0net cash1.33.2
2021net cashnet cash0.4net cash
Price/earnings ratio
20075.88.59.6na
202111.610.78.411.5
Source: FactSet

As to existential threats, therefore, there seem to be none. Even so, if mortgage arrears continue rising, I would expect housebuilders' share prices to continue falling and it is way too early to think about buying for recovery when – on a worst-case view – the fall may have barely begun.

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That sounds like another way of saying that, brick by brick, I become more bearish; more inclined to the thought that UK equities will struggle to resist the downward pull exerted by US equities. That the UK economy, burdened by so many problems largely of its own making, looks so weak only adds to the caution. So it’s pleasant that the best performing holding in the Bearbull Income Portfolio, currency manager Record (REC), should dish out good results for the year to the end of March. On the back of a 38 per cent rise in revenue and a 76 per cent increase in pre-tax profits, basic earnings rose 64 per cent to 4.5p. The share price, which has been on a downward trend for almost a year, responded with a 7 per cent gain on the day to 71p.

Record’s niche is to manage the foreign-exchange risk that other firms face. As such, its assets under management are notional, but the $83bn underlying amount finished the year 4 per cent higher than at the start, which was useful. Better still was volatility in forex markets, which must help a business whose aim is to inoculate clients against the uncertainty of exchange rates (chiefly their own currency against the US dollar). That said, a world where globalisation is retreating has less need for currency hedging.

But best of all, perhaps, Record’s bosses are in the process of moving the business from being “a pure currency management specialist to having a broader offering in the alternative management space”, as the chief executive, Leslie Hill, puts it. That should bring in both new business and more profitable work. Hence her hope that by 2025 Record will be generating maybe £60mn of revenue (70 per cent more than in 2021-22) throwing off fatter profit margins that last year’s 31 per cent. That could mean around 8p of earnings three years hence. Discounting that for some risk and inflation would still mean something well clear of 6p of earnings in today’s money. In other words, the shares are trading at about 11 times that amount, hardly demanding for a stock whose rating has rarely been that low in the past five years. Meanwhile – and to be going on with – management feels able to distribute all of this year’s earnings. At the current price, this produces a 6.3 per cent dividend yield, which should rise usefully in the coming few years, assuming those extra earnings come through.

True, Record’s share price remains anchored to the sterling/dollar exchange rate (see Bearbull, 22 October 2021), so sterling’s weakness against the dollar – 14 per cent these past 12 months – has done it no favours. But at $1.22 against a 10-year low of $1.16, mean regression implies even that trend might soon reverse. Anyway, Record’s shares will surely stay in the income fund.