High interest rates were a massive tailwind for Robinhood's business over the last two years.
Robinhood Markets (HOOD 0.31%) stock soared to a record high of $85 shortly after its initial public offering (IPO) in 2021. Wall Street was enthusiastic about the company's stock trading platform, which was attracting hordes of young, first-time investors -- a feat no other brokerage had achieved at such a large scale.
That enthusiasm didn't last long, because Robinhood stock sank 91% to an all-time low of around $7 by mid-2022 when the S&P 500 slipped into a bear market, which deterred many of the company's clients from investing.
But Robinhood's business then caught a tailwind when the Federal Reserve rapidly hiked interest rates. The company earned truckloads of interest revenue on its own cash, its customers' cash, and on margin loans. That helped drive a recovery in its stock price, which includes an 83% gain in 2024 so far.
But the Fed slashed the federal funds rate (overnight interest rate) by half a percentage point last week, and with several more cuts likely to come, here's why that's very bad news for Robinhood.
At the height of the stock market frenzy in mid-2021, Robinhood had 21.3 million monthly active users on its platform. Those clients were piling into the market thanks to waves of pandemic-related stimulus from the government, which fueled the rise of meme stocks like GameStop.
But the party inevitably ended and Robinhood's monthly active user base is now significantly below that peak, coming in at 11.8 million in the second quarter of 2024 (ended June 30). The company's transaction-based revenue -- which it earns from its core business of processing customer trades -- came in at $327 million during Q2, which was still way below its peak of $451 million in Q2 2021.
On the flip side, net interest revenue was $68 million in Q2 2021, but a whopping 319% higher at a record $285 million in Q2 2024. That's a problem, because it means most of Robinhood's total revenue growth over the last three years has come from something it can't control: an increase in the federal funds rate from a historic low of near 0% in 2021 to a two-decade high of 5.33% by August 2023.
In Q2, Robinhood had $4.5 billion of its own cash on its balance sheet, plus a further $4.5 billion it was holding in custody on behalf of its clients. All of that money is stored in interest-bearing accounts with the company's bank partners.
Additionally, Robinhood lends money to clients so they can buy financial assets like stocks, which can enhance their returns (and potential losses). Robinhood's margin book hit an all-time high of $5 billion in Q2, enabling the company to earn $73 million in interest revenue, which was also a record.
Last week, the Federal Open Market Committee (FOMC) at the Federal Reserve decided to cut the federal funds rate by half a percentage point. Inflation is almost back to its 2% target (after a surge in 2022), and the unemployment rate is ticking higher this year, so the FOMC determined it was time to loosen its restrictive interest rate policy.
Based on the CME Group's FedWatch tool, there could be a further three-quarters of a percentage point's worth of cuts by the end of 2024, followed by another 1.25 percentage points in 2025. By that stage, the federal funds rate could be down by almost half from its recent peak of 5.33%, which means Robinhood's net interest revenue could plunge over the next year.
Despite being below its peak, Robinhood's transaction-based revenue has grown this year, but it's primarily on the back of options and cryptocurrency trading, which are the riskier areas of the financial markets. They tend to perform well when investors' enthusiasm is high, but they were the segments of Robinhood's revenue that collapsed after 2021. In other words, Robinhood can't rely on them to deliver steady, sustainable growth over the long term, let alone offset the coming decline in its interest revenue.
As a result, I predict the recent recovery in Robinhood stock could stall as interest rates decline further, so it probably isn't a good idea to buy it right now.