Assessing Mortgage Risk and Credit Resilience in Australia's Banking Sector: A Tale of Two Trends

Australia's banking sector is navigating a paradox: while major lenders like Westpac report historic lows in mortgage delinquency rates, broader consumer and high-value loan segments show troubling signs of stress. This divergence underscores the complexity of assessing credit risk in a market shaped by macroeconomic shifts, household debt dynamics, and Reserve Bank of Australia (RBA) policy. For investors, understanding these contrasting trends is critical to evaluating banking sector valuations and risk-adjusted returns.

Westpac's Resilience: A Model of Prudence

Westpac's 90+ day mortgage delinquency rate of 0.59% in Q2 2025 marks a stark improvement from 1.36% in mid-2023, reflecting a combination of prudent lending practices and favorable macroeconomic conditions. The bank's credit impairment charge fell to 6 basis points of average loans, down from 9 basis points a year earlier, signaling reduced provisioning for defaults. This resilience is attributed to a robust jobs market—Australia's unemployment rate hit 4.1% in March 2025—and the RBA's anticipated rate cuts, which have eased repayment pressures for variable-rate borrowers.

Westpac's CEO, Anthony Miller, emphasized that “the worst of it is behind us,” a sentiment supported by the bank's reduced stressed exposures (1.36% of total committed loans) and 5% growth in housing loans. These metrics suggest that Westpac's credit quality is improving, even as it navigates a competitive mortgage market with a 1.92% net interest margin.

Broader Market Stress: High-Value Mortgages and Consumer Credit

While Westpac's metrics are encouraging, broader data from Equifax and Cotality reveals a different story. The dollar value of 90+ day mortgage arrears rose 9.2% year-on-year in Q2 2025, with mortgages exceeding $1 million—often held by high-net-worth individuals—experiencing the highest delinquency rates on record. This segment is particularly vulnerable to interest rate volatility, as larger loans are more sensitive to rate hikes and economic shocks.

Consumer credit segments also show strain. Credit card delinquencies surged 19.3%, personal loans 18.7%, and auto loans 7.1% year-on-year. These trends reflect households prioritizing essential spending over discretionary debt, a pattern exacerbated by stagnant wage growth and inflation. Fitch Ratings notes that non-conforming mortgages (often issued to lower-credit-risk borrowers) now carry a 5.32% delinquency rate, highlighting systemic vulnerabilities.

Macroeconomic and Policy Drivers

The RBA's policy trajectory is a key variable. After years of tightening, the central bank's expected rate cuts in 2025 could provide relief to borrowers, particularly those with variable-rate mortgages. However, this easing may compress banks' net interest margins, as seen in Westpac's 2 basis point decline in Q2 2025. The challenge for lenders lies in balancing risk mitigation with profitability.

Household debt patterns further complicate the outlook. While the mortgage serviceability buffer (3 percentage points above current rates) has curtailed defaults, high loan-to-income (LTI) and loan-to-value (LTV) ratios remain a concern. Cotality's analysis shows that borrowers with LTVs above 80% peaked at 2.5% in 2024 but are now trending downward, suggesting improved repayment capacity for high-risk segments.

Investment Implications: Balancing Resilience and Risk

For investors, the contrasting trends in Westpac's performance and broader market stress present both opportunities and cautionary signals. Banks with strong credit metrics, like Westpac, may outperform in a low-interest-rate environment, particularly if the RBA's easing cycle continues. However, exposure to high-value mortgages and consumer credit segments could amplify downside risks if economic conditions deteriorate.

A diversified approach is advisable. Investors might overweight banks with conservative lending standards and low delinquency rates while hedging against potential losses in high-risk segments. Additionally, monitoring RBA policy and regional housing market dynamics—such as declining demand in high-cost areas like the Gold Coast—could provide early warnings of systemic shifts.

Conclusion

Australia's banking sector is at a crossroads. Westpac's credit resilience offers a blueprint for navigating macroeconomic uncertainty, but the rising stress in high-value and consumer credit segments cannot be ignored. For investors, the key lies in aligning portfolios with institutions that prioritize long-term stability over short-term growth, while remaining vigilant to the evolving risks in a fragmented credit landscape. As the RBA's policy and household debt patterns continue to evolve, the ability to adapt will define risk-adjusted returns in the years ahead.