LoanStreet Monthly Newsletter — June 18, 2025
In this month’s edition of The LoanStreet Beat, we dive into loan pool premiums and how they impact the yield on a pool. In particular, we will focus on why certain pools are being sold at higher premiums than others and why they could still make for a smart purchase.
Below, we will start with a recap of an active economic news cycle and share our observations on loan trading.
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LoanStreet Market Commentary
Economic data continues to defy the odds and post numbers which support a strong labor market along with cooling inflation. The May job’s report showed growth of 139k jobs, higher than the expected 126k, although it is important to note that there was 95k in downwards revisions for the previous two months. Further, the participation rate fell to 62.4%, a three-month low, which is not a good sign as workers are dropping out of the job market. This drop in participation rate artificially kept the unemployment rate steady MoM, as those not looking for work are not counted as unemployed. Lastly, average hourly earnings rose 0.4% MoM, compared to the 0.3% which was expected, suggesting employers need to be competitive to attract talent.
On the inflation front, the latest CPI reading came in at 0.1% MoM, below the estimate of 0.2%. Core inflation, which strips out food and energy, was up only 0.1% MoM, well below the 0.3% estimate. Despite concerns over the impact of tariffs, inflation continues to drift lower.
When it comes to soft data, consumer sentiment increased for the first time in six months and came in well above expectations. From the same survey, future inflation expectations also dropped. This is a reversal from previous months when hard data would paint a rosy picture of the economy while the soft data would not be as optimistic.
Despite the generally strong month of data, concerns over labor should still be recognized, as jobless claims have ticked up. When it comes to inflation, the impact of tariffs might still be muted as companies resist raising prices as tariff negotiations continue. Should the terms of the negotiations not be favorable, they still might have an impact on pricing and whatever final levels of tariffs may take time to propagate into final products purchased by consumers. Lastly, elevated geopolitical conflicts risk slowing growth, disturbing supply chains and increasing oil prices.
Loan Trading Trends and Implications
Similar to last month, participation activity remains robust with strong sell-side supply matched by continuous buy-side demand for assets. The one key difference is that sellers are starting to lose their leverage as buyers are demanding higher yields. Sellers are able to continue to sell loans at a gain, but that margin is shrinking compared to earlier in the year. This change in pricing power is consistent with historical seasonal trends especially as it relates to deposit flows, i.e., summer tends to result in deposit outflows reducing excess cash for participation purchases.
Over the last few months, sellers were able to participate out their loans at very favorable pricing which resulted in new sellers coming to market. These new sellers are now in competition with each other as buyers can afford to be more selective with the ample supply of loan participations. Because of this, sellers need to be more competitive on price which is somewhat shrinking their profit on sale. This will likely continue until sellers start backing out due to more limited gain on sale, at which point, spreads on pools will need to tighten once more — and the market will cycle again.
That being said, the overall market continues to be balanced. Pools listed on our marketplace close out within weeks and buyers are asking for more volume. Sellers just need to recognize that they are competing against many other sellers and need to price their pools accordingly, or risk having a stale pool that sits out on the marketplace for an extended period of time.
Deep Dive: Yield Over Price
At a time when rates are coming off of their peaks, loans originated during the peak period will often be priced at relatively high premiums simply because they offer better returns than other current alternatives. The challenge we frequently run into is that buyers set arbitrary caps on the premium they are willing to pay, limiting their options on the buy-side. To be sure, high premium pools do come with their own risks, mainly prepayment risk, but it’s key for participants to look at the entire picture, not just a single number when making their purchase decision.
Price / Yield Relationship
We will first start with a basic concept in fixed income which is the relationship between yield and price. As yields go down, prices go up, and vice versa. As an example, let’s say you own a 8% fixed rate auto loan. That loan will be worth a lot more in an environment when benchmark yields (alternative investments) are offering yields of 3% than when the benchmark is at 6%. Assuming the loan carries an annual loss assumption of 50bps and loss-adjusted spreads are at 150bps, the price in the 3% environment would be roughly 106% while you would only get 100% in the 6% environment. The rough back of the envelope math is that you take the difference in the benchmark rates and multiply it by the duration of the product, roughly 2 for auto loans. This of course assumes that credit risk and loan spreads have remained the same while benchmark yields have changed, which is unlikely.
In the scenario outlined above, if you are able to purchase the 8% auto loan at a price of 105%, when benchmark yields are at 3%, your relative value is greater than buying the loan at 100% when benchmark yields are at 6%, despite the difference in premium.
Prepayment Risk
One of the main concerns with paying a high premium, is the risk associated with higher than expected prepayment rates. The higher the premium, the larger the impact of higher prepayment rates on the yield. Below is a table which shows the yield on a given auto pool across different prices and prepayment rates.
| CPR | 100% | 101% | 102% | 103% |
|---|---|---|---|---|
| 10% | 7.17% | 6.70% | 6.24% | 5.79% |
| 15% | 7.16% | 6.65% | 6.15% | 5.65% |
| 20% | 7.15% | 6.59% | 6.04% | 5.50% |
As can be seen, the impact on the yield between a 10% and 20% CPR on a 101% premium pool is .11%, while the impact at a 103% price is .29%. Further, as the CPR increased, the impact of the premium on the yield is magnified. For example, the impact on the yield between a 101% and 103% price at 10% CPR is .91%, while the impact at a 20% CPR is 1.09%. This is because the higher prepayment rate shortens the WAL. Taking that concept one step further, we will look at the same table but for a longer term pool such as a mortgage.
| CPR | 100% | 101% | 102% | 103% |
|---|---|---|---|---|
| 10% | 6.63% | 6.44% | 6.25% | 6.06% |
| 15% | 6.60% | 6.35% | 6.11% | 5.87% |
| 20% | 6.57% | 6.26% | 5.97% | 5.67% |
Given the longer term of the mortgage pool, it is less sensitive to changes in premium but more sensitive to changes in prepayment rates than the auto pool.
Convexity
The relationship between price and yield is not always linear, which is where convexity comes into play. This is easiest to see with a mortgage pool where the borrower has the option to refinance their mortgage and is likely to do so should rates drop. As a buyer of a mortgage pool, you are taking on asymmetric risk, since the loan will likely prepay when rates fall, capping your income potential. Because of this, as the coupon on a given pool increases, the margin increase in premium decreases. As an example, let’s take a look at the pricing for agency MBS.
| Coupon | Price | Price Delta |
|---|---|---|
| 5.00% | 96.75% | — |
| 5.50% | 98.94% | 2.19% |
| 6.00% | 100.91% | 1.97% |
| 6.50% | 102.75% | 1.84% |
Putting it all together
What this means for you depends on if you are a buyer or a seller.
As a buyer, we often see buyers with sticker shock at a high premium pool, a 104% price as an example, without considering the yield at which those assets are being offered. Generally, a high premium pool will be offered at a higher yield than an equivalent pool with a lower premium but a higher servicing fee. The reason for the high premium might be related to the origination cost of a given product. Relatedly, some buyers push back when a pool is offered at a relatively high servicing fee, 250bps as an example. Generally the reason for the high servicing fee is because we are minimizing the premium, and therefore prepayment risk, in order to improve marketability. With the higher servicing fee, the seller is sharing in the prepayment risk. Further, as with the premium a higher servicing fee might be related to the high servicing cost for a given product.
As a seller, it’s important to note that better execution is generally had when premiums are lower. This does not mean that the total return needs to be muted, rather some of the gain should be moved to servicing spread. As an example, instead of listing a pool at a 106% price with 25bps of servicing, it can be listed at 103% with 175bps of servicing, for an asset with a 2 year WAL, those will be roughly equivalent returns to the buyer. Pricing with the lower premium and higher servicing, still allows you to generate a higher total return and improve marketability as it will ease the buyer’s concerns over prepayment risk.
The big picture is that both buyers and sellers should not simply focus on the premium of a given pool but look at the total return. For a buyer, a higher premium pool might make sense if the yield compensates you for the prepayment risk. As a seller, selling at a lower premium might end up in a better total return as you will be able to make up the loss in premium with a higher servicing fee and better overall execution.
Monthly Economic Data Summary
- Based on the 5/30/2025 report, the PCE gauge of inflation was flat MOM, in line with estimates, and up 2.1% YOY, below the 2.2% estimate.
- From the same report, core PCE, which excludes food and energy, was also flat MOM and 2.5% YOY. Both inline with estimates.
- On 6/11/2025 we received the latest CPI gauge of inflation, the headline was an increase of 0.1% MOM, below the 0.2% estimate, while the YOY was up 2.4%, meeting the estimate.
- The latest job report for May showed a 139k increase in nonfarm payrolls, above the 126k which was estimated.
- The latest used-vehicle Manheim Market Report for mid-June showed a rise of 4.0% from a year ago.
- The Case-Shiller home price index showed national home prices increasing MOM by 0.8% while increasing YOY by 3.4%. These are lagging data and reflect the CS indices for 03/25.
- 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
For more market commentary and to learn more about LoanStreet’s solutions, visit www.loan-street.com
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.