As a general rule, financial stocks abhor market volatility. Stock market volatility is almost invariably associated with a tightening of credit and reduced liquidity. Banks and most real estate investment trusts (REITs) will struggle in this environment. That said, if there is one sector that benefits from financial stress, it is the stock exchanges. Higher volatility will trigger increased volumes, which means higher revenues. In many ways, the exchanges can be thought of as financial defensive stocks, or stocks that are less negatively affected by financial stress.
Intercontinental Exchange (ICE 1.60%) is an operator of securities exchanges and a provider of financial data. It is best known for owning the New York Stock Exchange, but it also owns the International Petroleum Exchange, the New York Board of Trade, and Euronext. Intercontinental Exchange also has a mortgage business, providing services to the industry via MERS (an electronic registry) and Simplifile, which helps streamline the mortgage origination process. The mortgage services business looks poised to do well over the next year, as the mortgage origination business is booming with low interest rates.
Revenue growth decelerates, but still increases on a year-over-year basis
In the second quarter, Intercontinental Exchange's revenue increased 7.5% from the same period the year before to $1.4 billion on the back of 13% higher trading and clearing fees and a 4% increase in data revenue. ICE was able to keep a lid on expenses, which drove a 14% increase in earnings per share from $0.94 to $1.07. This is a deceleration from the first quarter, however, when revenue rose 23% and earnings per share ticked up by 38%. Average daily volumes of cash equities increased 68% year over year, which helped offset a 17% drop in interest rate products. Note that CME Group also noticed a drop in interest rate products due to low bond volatility.
Mortgages: The fastest-growing part of the business
The mortgage services business attracted a lot of attention on the earnings conference call. ICE CEO Jeffrey Sprecher had this to say about the mortgage business:
I'll now provide some additional color on mortgage services, which has recently become the fastest-growing business within the ICE platform. While strong refinancing volumes have provided a tailwind to first-half results, the secular shift toward the adoption of an electronic workflow is accelerating. Today, ICE Mortgage Services is focused on helping to automate various parts of the U.S. loan closing process. ... We believe the addressable market for further automation is in the billions of dollars, and it's one that our platform is well positioned to capture.
The Mortgage Electronic Registration System (MERS) touches every single mortgage transaction in the United States. Every transaction is registered with the relevant county recorder so the loan can be sold in the secondary market. The company has also been working with Fannie Mae and Freddie Mac on eNotes, which digitizes the promissory note. The system of mortgage closings in the U.S. is generally archaic, and digitization has the potential to lower costs and increase efficiency.
While volatility in the markets ebbs and flows, the mortgage banking aspect of ICE's business looks to be a lot more stable. This will create a much less volatile earnings stream for the company going forward. Intercontinental Exchange has a competitive moat with the New York Stock Exchange and has created something similar in the mortgage market.