LoanStreet Monthly Newsletter — July 17, 2025
In this month’s edition of The LoanStreet Beat, we dive into spread-based pricing and why it might be worthwhile to incorporate it into your participation tool box. We note the advantages of such an approach as well as why it hasn’t been incorporated in the current marketplace.
Below, we will start with a recap of the active economic news cycle and share our observations on loan trading.
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LoanStreet Market Commentary
Headline economic data continue to paint a favorable picture for the US economy. Inflation continues to surprise to the downside, while the June headline number accelerated to 2.7% due to higher food and energy prices, core CPI increased 0.2% MoM, compared to the 0.3% estimate. Further, employment remains strong, with nonfarm payrolls jumping 147k, well above the 106k which was expected. The June job report also showed a drop in the unemployment rate from 4.3% to 4.1%.
Looking past the headlines, there are some concerns hiding within the data. Part of the reason the unemployment rate dropped was due to the drop in the participation rate. The portion of the population that is not “participating” in the labor market is not included in the unemployment rate, thereby reducing the number of the unemployed in the denominator of the unemployment rate. The latest readings on personal income and spending have come in well below expectations, signaling the US consumer might not be as financially secure as the headlines suggest. For inflation, there are signs that tariffs are starting to have an impact as evidenced by price increases for apparel and furniture. Depending on tariff negotiation developments, there could be further price pressures in the coming months.
Loan Trading Trends and Implications
Loan pool participation activity remains strong going into the summer months, a period that has historically seen weaker activity levels. The key to the continuous activity is the fact that the market remains balanced between buyers and sellers. Sellers continue to be attracted to participations as execution remains favorable and loans continue to sell at a profit. As for buyers, weaker origination numbers (and reasonable deposit growth or stability) mean credit unions are turning to participations to supplement their asset growth.
One trend we have noticed while evaluating credit union loan portfolios is sellers cutting rates on their loans despite the fact that Treasury rates have remained relatively stable. For buyers who base their buy-side decisions on spreads to benchmark yields, their absolute yield expectations have remained largely the same, making these lower-coupon loans less attractive. Moving forward (assuming stable benchmarks), this means sellers cutting loan rates need to accept lower returns on sales, buyers of these loans need to lower absolute yields, or a combination of both.
We saw a similar conflict at the beginning of this year, where low origination volumes limited available supply of participations while at the same time buyers were tied to the yield levels they received in Q4 of 2024. After a few weeks of back and forth, buyers had to concede and accept lower yield levels in order to be competitive on the deals which are available.
This dynamic is likely to repeat: if lower coupons are needed to maintain origination levels, buyers will need to lower their return expectations or risk losing out on available deals. From a sellers point of view, it’s important to monitor yield levels that are currently clearing the market. While lower coupons might drive origination volume, moving the loans on the secondary markets might be a challenge until buyer expectations catch-up.
Deep Dive: Rethinking Participation Loan Pricing
When institutions evaluate loan participations, whether it’s as a seller or as a buyer, they typically focus on the price at which the pool is being sold. This makes sense, as sellers typically have to cover some sort of origination cost while buyers need internal approval for purchase based on a given price. As we wrote in last month’s edition of the newsletter (Yield Over Price), market participants should consider focusing more on the yield than the price. An extension of this, would be evaluating the yield in relation to a benchmark, a spread, and selling/buying at that specific spread rather than a price/yield. Currently, the credit union market does not typically respond to changes in benchmark rates during the sales process or, in other words, both parties are market-risk agnostic.
Let’s start by looking how the spread on an auto loan pool might have changed from the time the deal went live to closing. If a deal was launched on June 16th, the 2-year Treasury yield was at roughly 3.95%. If that same deal closed two weeks later, on July 1st, the 2-year Treasury yield was 3.78%, a drop of 17 bps. This means that on a relative basis, the buyer gained 17 bps just by going through the due diligence process prior to closing.
What might be considered a more exacting way of pricing deals, is based on a fixed spread rather than a fixed price (or absolute yield). In the example above, because the benchmark yield dropped 17 bps, the price (keeping the servicing fee constant) would then increase by as much as necessary to drop the absolute yield on the loan pool by 17 bps and thereby keeping the spread of the risk-free rate the same. From both parties’ perspective, they are still receiving the same spread-yield above benchmark as they did on June 16th. Updating the price to reflect market changes would not make the deal any less attractive to either party than what was originally agreed. Given that the due diligence process on a deal takes a couple of weeks, locking in the spread alleviates concerns of the market moving against either party during the due diligence.
However, while this spread-based pricing makes sense in concept, there is a complicating issue with implementing it in practice: approvals. When we conducted a survey of the fixed-spread pricing with our clients, this concern was widespread. Generally speaking, when a seller is planning on selling a pool or a buyer is in interested purchasing one, both parties need to get internal approvals which are typically tied to a given price, servicing spread and expected absolute yield. Survey respondents thought it would be difficult to receive approval for a yield spread and a floating price. Generally, respondents (sellers and buyers) were satisfied with taking market risk during the due diligence period even if there were ways to mitigate the price change through the use of collars such as limiting how much the price can move in either direction.
Given the recent volatility in the Treasury market, implementing a strategy based on a fixed-spread is an important consideration. Ironically, the volatility also makes changing the current market structure more difficult to implement, as prices can swing drastically during the review period. That said, incorporating a floor and ceiling on the price along with a threshold at which the spread moves – for example the pricing only moves when the benchmark moves in 10bp increments instead of every bp – could make this market change easier to digest.
Monthly Economic Data Summary
- Based on the 6/27/2025 report, the PCE gauge of inflation was up 0.1% MOM and up 2.3% YOY, in line with estimates.
- From the same report, core PCE, which excludes food and energy, was up 0.2% MOM and 2.7% YOY. Both inline 0.1% above estimates.
- On 7/15/2025 we received the latest CPI gauge of inflation, the headline was an increase of 0.3% MOM, matching estimates, while the YOY was up 2.7%, above the 2.6% estimate.
- The latest job report for June showed a 147k increase in nonfarm payrolls, above the 106k which was estimated.
- The latest used-vehicle Manheim Market Report for June showed a rise of 6.3% from a year ago.
- The Case-Shiller home price index showed national home prices increasing MOM by 0.6% while increasing YOY by 2.7%. These are lagging data and reflect the CS indices for 04/25.
- Based on the CME market watch tool, the expectation is for the first rate cut of 2025 to happen in September.
This article was authored by Matt Rudzinski, VP of Capital Markets
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Disclaimer
LoanStreet is not a Registered Exchange, Financial Planner, Investment Adviser, or Tax Adviser. The information provided herein is for general informational purposes only, and does not, and is not intended to, constitute legal, financial, investment, or tax advice.