Last month, the Federal Reserve reduced its benchmark interest rate by 50 basis points (0.5%), the first reduction since early 2020 when it cut rates to near zero at the start of the pandemic. It also marked the end of the Fed's most aggressive interest rate hiking cycle since the 1980s.
The higher interest rates that prevailed since early 2022 weighed on many companies -- including some in the lending industry. Consumers have been racking up huge amounts of credit card debt, and Upstart (NASDAQ: UPST) and Lending Club (NYSE: LC) are two personal lenders that could benefit significantly.
Higher interest rates have also weighed on real estate companies. Notably, AGNC Investment (NASDAQ: AGNC) has struggled for the past several years as higher rates raised its borrowing costs and hammered the book value of its mortgage-backed securities portfolio.
With interest rates falling, these three stocks could be smart buys today.
A "historic refinancing opportunity" could await Lending Club and Upstart
The consumer lending business follows the cyclical nature of the economy. Throughout 2021, fiscal policy was loose, consumer balance sheets were strong, and credit was easy to access. As a result, consumer lenders like Upstart and Lending Club saw strong demand for their loans.
However, tides shifted as inflation soared and the Fed began hiking interest rates to get price growth back in check. With the costs of personal loans rising, demand from borrowers waned. Meanwhile, the investors who had been buying that type of debt from lenders pulled back heavily, waiting for more certainty about the path of interest rates. As a result, Upstart's loan volume plummeted from $11.8 billion in 2021 to $4.6 billion in 2023.
Things are turning around, though. Upstart has found more partners to buy its loans -- what it needs now is for consumer demand to come back. And with U.S. consumers sitting on a huge amount of credit card debt, this could be the time for personal lenders to shine.
According to the Federal Reserve Bank of New York, consumer credit card balances hit $1.14 trillion at the end of the second quarter. Not only is credit card debt at an all-time high, but it also comes while interest rates on credit card loans, currently averaging around 23%, are near their highest levels on record.
If interest rates decline meaningfully, Upstart and Lending Club could see a surge in personal borrowing as people look to refinance and consolidate their debts at lower interest rates.
Lending Club Chief Executive Officer Scott Sanborn has called this a "historic refinancing opportunity." The company has been preparing for it, developing tools to help consumers monitor and manage their debts and allowing members to easily sweep their credit card balances into single payment plans.
With further interest rate reductions expected during the next couple of years, this looks like an excellent time to buy Upstart and Lending Club.
AGNC Investment stands to benefit from lower borrowing costs
Real estate companies have had a tough go of it recently, particularly those that rely on leverage. That category includes AGNC Investment, a mortgage real estate investment trust (mREIT) that uses leverage to buy and hold agency mortgage-backed securities (MBS).
Unlike other real estate investment trusts (REITs) that buy and rent out properties, AGNC makes its money on the difference between the interest income it earns from its MBS portfolio and what it pays in borrowing costs. Because it borrows money on a short-term basis and invests in mortgage-backed securities on a long-term basis, it is very sensitive to changes in the yield curve (the relationship between interest rates and a security's time to maturity).
This sensitivity has become especially apparent during the Fed's interest rate hikes. Last year, AGNC's interest income grew by 28% to $2 billion due to higher rates. However, its borrowing costs rose more, and its interest expenses went from $625 million in 2022 to $2.3 billion. As a result, the REIT's net interest loss was $246 million in 2023, compared to net interest income of $965 million in 2022 and $1.3 billion in 2021 -- before the rate-hiking cycle began.
As the Fed cuts rates, that will help lower quickly short-term borrowing costs, while longer-term borrowing costs could stay higher.
A steepening yield curve, where the difference between short-term and long-term interest rates widens, would benefit AGNC in the form of lower borrowing costs while it is invested in higher-yielding mortgage-backed securities. With its recent investments in higher-yielding mortgage-backed securities, its average asset yield of 4.69% at the end of the second quarter was more than twice its average yield of 2.31% at the end of 2021.
The Fed has officially kicked off an interest rate easing cycle, and according to the CME FedWatch tool, market participants are pricing in a 1.5 percentage point reduction to rates during the next 12 months. Falling rates should help boost AGNC's net interest spread and the book value of its portfolio, and giving the company and the stock a much-needed boost over the next year or two.
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Courtney Carlsen has positions in LendingClub. The Motley Fool has positions in and recommends Upstart. The Motley Fool has a disclosure policy.
The Federal Reserve Is Cutting Interest Rates: 3 Stocks to Buy Today was originally published by The Motley Fool