January 2025 - Yields in Review
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In this month’s edition of The LoanStreet Beat, we review the 2024 credit union loan participation market, including yield fluctuations and how supply versus demand drove pricing levels. In addition, we recap an active economic news cycle and share our observations on the current loan trading market. Enjoy, and please comment and share below!
LoanStreet Market Commentary
December showed that the US economy continues to be resilient. The November jobs rebounded from the October figures, with 227k new jobs versus the expected 220k.? Further, the October figure was revised upwards by 36k. We also received the revised Q3 GDP numbers, which were increased to 3.1% from 2.8% based on strong consumer spending. The final jobless claims of the month resulted in 211k drop in initial jobless claims, the lowest since April of 2024.???
On the inflation front, progress has mostly stalled. The latest CPI figures pointed to a month-over-month rise of 0.3%, higher than the 0.2% reported the previous month.? This brings the annual number up to 2.7% from 2.6%. Nonetheless, helpfully, shelter inflation did slow as owners’ equivalent rent rose 0.23% month-over-month, which was the smallest increase since the start of 2021. On the other hand, used car and food inflation came in above expectations. The PCE report painted a more favorable picture with the month-over-month figure coming in at 0.1%, below the forecasted 0.2%. This put the headline number at 2.4% year-over-year. The core PCE number, which excludes energy and food, rose 2.8% from a year ago, still well above the 2% target.??????????
Loan Trading Trends and Implications
The end-of-year push resulted in strong December volumes. Buyers were generally asset-agnostic as deals closed across all major asset classes. For a more in depth view into how the year progressed, see the deep dive section below.?
Going into 2025, the level of deal activity is likely to continue. We already have a strong pipeline of deals currently in review, and additional clients who have been on hold during 2024 noted they will be active in 2025. The first quarter usually brings more buyers than sellers, causing spreads to tighten, as liquidity improves due to year-end bonuses, tax returns along with slower consumer spending. That being said, sellers already appear to be more active to start 2025 compared to previous years.???????
Deep Dive: 2024 Yields in Review
At the January 2024 meeting, the Fed signaled that rates had likely reached their cycle peak.? Inflation and employment data was encouraging, and while Powell did not signal for a March rate cut, it was not completely taken off the table either. As had been signaled by the Fed throughout the year, they noted they would be data dependent.? After some hotter-than-expected labor and inflation data in February, the March meeting resulted in the Fed holding the federal funds rate at 5.25%-5.5%, where it had been since July 2023. Between January and March, the 2-year Treasury yield had risen by about 30bps.
Q2 brought more of the same, as inflation remained stubborn. During the May Fed meeting, the committee decided to hold rates and Powell acknowledged that the path to 2% inflation might be rockier than expected. That being said, Powell did note that a rate hike was unlikely. During the June meeting, when the Federal Open Market Committee (FOMC) released its latest dot plot, it pointed to only one rate cut by end of the year.? This was after the market expected five rate cuts by end of year going into 2024. This recalibration of expectations resulted in a further surge in 2- year Treasury yields, up another 25 bps from March to 4.75%. At the end of April, the 2-year Treasury reached its high for the year at just over 5%.??
The next quarter brought a reversal, particularly after the July jobs report, which showed the creation of 114k jobs vs the 185k which had been expected. Further, unemployment rose to 4.3%, the highest since October of 2021, and resulting in forecasts for a recession. The market reacted sharply, with the worst sell-off of the year due to concerns over the Fed not cutting soon enough. There were even calls for an emergency, off-cycle cut in August. With concerns over the labor market, and inflation showing signs of cooling, the Fed decided to cut rates by 50 bps in September. The decision to cut by 50 bps was scrutinized since inflation, while cooling, was still above the Fed target and came in above expectations on the September inflation report. In September, the 2-year Treasury yield hit the bottom for the year at 3.55%, but quickly rebounded in the following month.?
October started with a strong job report for the previous month, coming in at 254k vs the forecasted 150k. Further, unemployment fell back down to 4.1% and average hourly earnings came in above expectations. All this data suggested that the economy was continuing to grow, putting pressure on inflation, and therefore giving the Fed little reason to cut rates – a so-called “no landing”. Data from October and November was murky due to the impact of hurricanes and job strikes, but overall the Fed was confident enough to cut rates another 25 bps in December.
Interestingly, after all of this volatility during the year, the 2-year Treasury ended up almost exactly where it began 2024, closing at 4.24% after starting the year at 4.25%. The year started with the expectation for five cuts, we ended up with four.??
We enter 2025 with a strong labor market and questions over where inflation will go. On the one hand, shelter inflation, the primary driver of higher inflation over the last couple of years, is showing signs of cooling. On the other hand, consumers continue to spend and the threat of inflationary tariffs will keep the Fed on their toes.?
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As can be seen on the chart from Bloomberg below, the longer end of the yield curve diverged from the shorter end around early August. At that point, due to the July labor report, the market expected the Fed to start cutting rates. Since the shorter end of the curve is more sensitive to what the Fed does, the 2-year yield dropped by a wider margin compared to the 7 and 10-year yields. As yields started to pick back up again in late September, that difference between the 10 and 2-year remained positive and ended the year at a ~32bps spread. This increased spread allows banks to generate higher income from lending long-term while benefiting from lower short-term borrowing costs, helping to improve net-income-margins which have suffered over the last year.?
How has the volatility in the Treasury yield market impacted participation yields? Let’s take a look at how volumes and yield levels have changed throughout the year on some of the most commonly traded assets; auto, unsecured and residential loans.
Auto??
Auto has remained the most traded credit union asset via participations. We started 2024 with loss-adjusted spreads around 250 bps -- well above historic levels.?This wide spread could be attributed to the large downward move in the 2-year Treasury yield from Q4 of 2023. As loan rates don’t adjust as quickly as the treasury market does, buyers comparing yield levels on participations vs originations, were still comparing rates to end of 2023 levels. Because of this, spreads increased as benchmark rates dropped while buyer expectations on yields remained roughly the same as they did in Q4 2023. Over the following months, this spread tightened as buyers reevaluated their expected yields and credit unions dropped loan origination rates. Further, as loan originations volumes started to stagnate, overall buyer demand increased, resulting in more competition for available loans. This competition for loans compressed loss-adjusted spreads to about 150 bps. In Q4, while demand for loans remained strong, there was also ample supply, despite slow auto origination volumes. In addition, buyers expressed concerns over losses, necessitating offsetting spreads, i.e., as the uncertainty around future auto performance increased, spreads also increased to offset these concerns.?
Unsecured???
Performance concerns kept loss-adjusted spreads at elevated levels, around 300-350 bps for most of the year. Even as sellers offered pools at more conservative underwriting guidelines, buyers were requiring wide spreads in order to consider a purchase. Towards the end of the year, spreads compressed slightly, mostly due to an increase in buyer interest given a slowdown in organic origination volumes and attractive returns relative to other asset classes.?
Residential?
For residential, we started with strong demand for HELOC pools, although willing sellers were tough to find. Fixed rate 30-year mortgages have seen limited demand throughout the year. Although lower coupon discount pools did find some traction towards the end of the year. ARM pools found more success, particularly in the second half of the year. Overall, the residential market was mixed and largely dependent on individual buyer needs rather than the broader market. For example, some buyers with very specific buy-boxes were willing to take lower yields. That said, many buyers were already over-allocated to residential loans and were not willing to purchase, no matter how attractive the offered yield was.??
In summary, 2024 was a volatile year for participation pricing. The year was driven by three underlying storylines; slowdown in origination volume, volatility in benchmark yields and concerns over loan performance. We predict that these factors will continue to drive the market in 2025. Because of this, it is important for buyers and sellers to have processes in place that will allow them to quickly capitalize on opportunities as they arise.????
Monthly Economic Data Summary
This article was authored by Matt Rudzinski, VP of Capital Markets
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