The Australian RMBS Renaissance: Riding the Wave of Declining Arrears and Rate Cuts

The Australian residential mortgage market is undergoing a subtle but significant transformation, with declining arrears, anticipated Reserve Bank of Australia (RBA) rate cuts, and housing supply shortages converging to bolster the creditworthiness of mortgage-backed securities (RMBS). For investors seeking yield without excessive risk, senior tranches of RMBS pools originated before 2023 present a compelling opportunity. This article explores the macroeconomic tailwinds driving this shift and the strategic rationale for deploying capital in this asset class.

Arrears Trends: Stability Amid Stress

Recent data from the Australian Prudential Regulation Authority (APRA) reveals a critical turning point: mortgage arrears have stabilized at historically low levels despite elevated macroeconomic pressures. As of Q1 2025, non-performing loans (NPLs) stood at 1.1% for owner-occupiers and 0.9% for investors, while early-stage arrears (30–89 days overdue) remain anchored at 0.7%. This resilience defies expectations of a surge in defaults amid high interest rates and cost-of-living pressures.

The stability stems from robust underwriting standards and borrower adaptations. APRA's requirement for lenders to stress-test loans at rates 3% above their contractual rate has ensured borrowers can withstand rate hikes. Meanwhile, offset account balances—acting as financial buffers—have grown to 10.4% of credit limits, providing a safety net for households.

Rate Cuts: A Tailwind for Borrower Liquidity

With the RBA signaling an easing cycle, the burden of mortgage repayments is set to ease significantly. The central bank's policy rate, now at 4.1%, is expected to drop to 3.0% by mid-2026, reducing monthly payments for variable-rate borrowers. For a $750,000 loan, this cut would reduce repayments by ~$250 per month—substantial relief for households.

Crucially, the timing of rate cuts aligns with the seasoning of loans. Many mortgages originated in 2022–2023 were taken out at peak rates, but as these loans age, borrowers will benefit from amortization and lower principal balances. Combined with reduced interest costs, this creates a virtuous cycle of improved cash flow and lower arrears risk.

Housing Supply Dynamics: Scarcity Fuels Stability

Housing price growth of 4–6% over the next two years, driven by supply shortages, further underpins RMBS creditworthiness. New home construction lags behind demand, with starts falling to a 20-year low of 165,000 units in 2023. This imbalance has pushed housing prices up 3.5% annually since mid-2024, reducing negative equity risks. Even in regions like Victoria, where arrears rose modestly, prices remain robust enough to protect lenders.

A key metric: only 0.1% of loans are both non-performing and underwater, thanks to rising valuations. This collateral strength ensures that even distressed borrowers are less likely to default when their homes retain value.

The Investment Case: Senior Tranches of Pre-2023 RMBS

For investors, senior tranches of RMBS pools originated before 2023 offer an optimal balance of yield and safety. These pools were structured when underwriting standards were stringent, and borrowers faced lower initial rates. Key advantages include:

1. Lower Default Risk: Loans originated in 2020–2022 had average rates below 4%, compared to 6.5% in 2023. As rates fall, these borrowers will see immediate relief, reducing arrears pressures.
2. Priority Repayment: Senior tranches rank highest in the capital structure, ensuring protection against losses from junior tranches.
3. Yield Advantage: Senior RMBS currently yield 3–4% above government bonds, a premium justified by their credit profile and macro tailwinds.

Avoid chasing higher yields in subordinated tranches or newer pools, which may contain riskier loans issued during peak rate periods. Focus on securities backed by owner-occupiers, who historically default at lower rates than investors.

Risks and Mitigants

• Labor Market Deterioration: Unemployment above 4.5% could strain borrowers. Monitor RBA's labor force projections closely.
• Supply-Side Shocks: A sudden surge in housing supply could depress prices. However, construction bottlenecks suggest this is unlikely in the near term.

Conclusion: A Structured Play on Housing Market Resilience

The convergence of declining arrears, rate cuts, and housing price growth positions Australian RMBS as a standout opportunity. Senior tranches of pre-2023 pools offer a disciplined way to capture yield while benefiting from structural improvements in borrower health and collateral quality. For investors with a 3–5 year horizon, this is a strategic bet on the Australian housing market's resilience—and a reminder that even in volatile times, disciplined underwriting and macro tailwinds can create asymmetric upside.