The Federal Reserve wrapped up its most recent policy meeting on Sept. 18, and its Federal Open Market Committee (FOMC) decided to lower the federal funds rate (the rate commercial banks use when they borrow and lend to one another overnight) by 50 basis points. That was double the 25-basis-point adjustment the Fed normally uses, and it’s likely to be a tailwind for the economy because it reduces borrowing costs for consumers and corporations.
According to the Fed’s own forecast, there could be a further 50 basis points slashed off the federal funds rate before the end of 2024, with even more cuts coming in 2025. Here’s why such rate drops spell great news for shares of Upstart (NASDAQ: UPST) and Redfin (NASDAQ: RDFN). It’s also why Robinhood (NASDAQ: HOOD) stock investors should be concerned.
Upstart: Falling interest rates could boost demand for credit
Upstart developed an algorithm powered by artificial intelligence (AI), which it uses to determine the creditworthiness of loan applicants and help originate loans for partner banks and credit unions in exchange for a fee. The company benefited from surging demand for credit when interest rates were at historic lows in 2021, and that sparked investor interest that sent its stock price to a record high of $401 back in the fall of 2021.
Interest rates surged in 2022 and 2023 as part of efforts to get inflation under control, and the rate was sitting at a 23-year high before the Fed’s recent cut. Demand for credit subsequently collapsed, and the appetite for risk among Upstart’s bank partners dried up, which meant Upstart had to finance some loans using its own money. That combination of headwinds created unacceptable risks in the eyes of investors, and Upstart’s stock price plummeted to a low of just $13 in 2022.
When it became clear this year that the Fed wouldn’t be raising rates any further, many of Upstart’s past financing partners returned to the platform. It even signed two new ones in the second quarter of 2024 (Ares Management and Centerbridge Partners). The company also originated 143,066 unsecured personal loans in Q2, which was up 34% from the year-ago period, so demand for credit appears to be coming back.
The analysts’ consensus forecast is that Upstart is on track to generate $567.9 million in revenue in 2024, which would be flat compared to 2023, and it would still be below its peak annual revenue of $907 million in 2022. However, analysts expect the company’s revenue to come in at $725.9 million in 2025, which would be a 27.8% increase. That number might climb even higher, depending on how aggressively the Fed cuts rates throughout the year.
Upstart successfully pulled through arguably the toughest environment for its business in the company’s history. With favorable conditions on the horizon, now might be a great time to buy the stock.
Redfin: Lower rates should reignite the housing market
Redfin operates a portfolio of real estate services including brokering, mortgage lending, and closing services. The company was another victim of the interest rate surge because it triggered a significant slowdown in the housing market. According to the most recent data, U.S. existing home sales are still around 41% below their recent peak from 2021.
Simply put, high interest rates suppress the borrowing power of potential homebuyers, and they make homeowners reluctant to sell for fear of giving up their existing lower fixed rate.
Redfin employs 1,719 lead agents who helped represent 0.77% of all U.S. home sales in Q2 2024. The company charges a listing fee of as little as 1%, which is far lower than the industry standard of around 3%. Redfin’s goal is to accumulate market share by closing a high volume of sales, and it’s saving sellers a lot of money in the process.
Redfin is on track to generate a shade over $1 billion in revenue this year, which would be a small increase compared to 2023. It will take time for falling interest rates to feed through to its business, but the Fed is forecast to continue cutting until 2026 (based on current projections), which would almost certainly reignite the housing market.
Redfin stock is up 30% this year, but it’s still down 86% from its all-time high, which was set during 2021. As long as interest rates continue to fall, Redfin’s recovery is likely to roll on.
Robinhood: Falling rates could lead to shrinking revenue
Robinhood is a popular online brokerage platform (especially among younger investors) and facilitates the trading of stocks, options, cryptocurrencies, and other financial assets. It had 21.3 million monthly active users in Q2 2021, but three years later, that number is down to just 11.8 million as of Q2 2024.
Robinhood’s transaction revenue (which it earns from processing client trades) has followed a similar trajectory. It came in at $327 million during the recent quarter, which was up year over year but still well below its quarterly peak of $451 million from Q2 2021.
In other words, Robinhood’s core business has struggled to build momentum over the last few years, which is a key reason its stock trades about 72% below its all-time high.
Unlike Upstart and Redfin, Robinhood actually benefited from higher interest rates. As of Q2 2024, the company had $4.5 billion of its own cash on hand, and it was holding another $4.5 billion in custody on behalf of its clients. That money is stored in interest-bearing bank accounts. Robinhood’s margin lending book hit a record high of $5 billion in Q2, which is also a driver of interest income.
The company’s net interest income came in at a record $285 million in Q2 2024, and it has soared 319% from Q2 2021. So, in essence, rising interest rates have been the primary driver of Robinhood’s total revenue growth over the last three years. That places the company in a precarious position, because if rates fall for the next couple of years as expected, its net interest income is going to fall.
Based on Robinhood’s past results, it’s unlikely to generate enough growth in its core business to offset that decline in interest income, so investors who own the stock might be in for a tough time in a falling rate environment.
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Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Redfin and Upstart. The Motley Fool recommends the following options: short November 2024 $13 calls on Redfin. The Motley Fool has a disclosure policy.
Interest Rate Cuts Are Terrific News for These 2 Stocks, But Terrible News for Another was originally published by The Motley Fool
