While Intercontinental Exchange (NYSE:ICE) is most famous for owning the New York Stock Exchange, it has also been investing heavily in the mortgage space. And on the company's fourth-quarter earnings conference call, most of the analyst questions revolved around the company's mortgage arm. Last year was the best for mortgage bankers since 2003, and 2021 should be another blockbuster year.

I understand the company's current focus on the mortgage value chain, but there's one area I think is missing: whole loan trading, or what is known in the industry as "secondary." Why doesn't Intercontinental Exchange have a whole loan trading exchange? And if it doesn't develop one, should it buy one?

Mergers and Acquisitions

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Intercontinental Exchange spans the entire mortgage production process

Intercontinental Exchange basically runs three segments. The most well-known is the exchanges segment, which includes the New York Stock Exchange, financial derivatives, commodities, and data and listing services. The exchanges segment generates 60% of Intercontinental Exchange's revenue after transaction costs. The second segment is fixed income and data services, which provides real-time pricing for millions of fixed-income investments, including all sorts of fixed-income indices and data. ICE also clears credit default swaps and provides connectivity solutions to many in the investment community.

The third segment is mortgage technology, which covers the entire mortgage value chain. Last year, ICE bought Ellie Mae, which is known for the Encompass loan origination system. Encompass assembles all of the important pieces of a loan, and is really the ecosystem where the loan goes from a lead to funded status. In addition to Ellie Mae, ICE owns the Mortgage Electronic Registration System (MERS), which tracks title and servicing and serves as the industry standard. Finally, ICE owns Simplifile, an electronic liaison service connecting lenders, settlement agents, and county recording offices.

So Intercontinental Exchange basically covers everything in the loan life cycle from when a loan is started to when it gets funded. The natural next step for ICE would be secondary, which is the sale of a loan after it is made. Most mortgage bankers are not banks, and are simply not in the business of owning mortgage loans. They handle the process of creating loans, but once a loan is made they sell it in the secondary market.

Secondary is the next area ripe for disruption

For most mortgage bankers, selling loans in the secondary market is a cumbersome business. While there are exchanges for funded loans, including Black Knight's Resitrader exchange, loans are generally sold by sending out spreadsheets to various correspondent lenders, which then bid on individual loans. The mortgage bank then allocates the loans to the respective top bidders. A big lender might sell hundreds of loans in a day.

Aside from Resitrader and a few other marketplaces, there is no huge, centralized marketplace to sell loans with a central clearing party. As an exchange with a treasure trove of data, Intercontinental Exchange seems to have a natural opportunity here.

You would think a massive exchange with an interest in the mortgage space would be working on creating a secondary market for mortgage loans -- and the right move might be to explore a merger with Black Knight. That would give ICE the secondary piece, as well as all of the secondary analytics services offered by Black Knight's Optimal Blue.

On the earnings call, Intercontinental Exchange spent a lot of time discussing the potential cost savings in the production process, which seems to be the focus for now. But the mortgage space is currently going through a period of merger mania, with the most recent bidding war for CoreLogic. The big names are bulking up, and banks like Western Alliance are making big purchases in the origination space. Intercontinental Exchange should be in the whole-loan trading business (it is, at its core, an exchange company, after all) and it could either build one or buy one. Black Knight's Resitrader is the best known platform in this space. Black Knight would be a natural acquisition for Intercontinental Exchange. .

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