Intercontinental Exchange (ICE 0.18%), which has been known primarily as an operator of stock, bond, and commodity exchanges, has been building a presence in the mortgage business. Instead of extending credit, Intercontinental Exchange has chosen to focus on the infrastructure of making mortgage loans.
It recently entered into an agreement to buy Black Knight Financial (BKI), which builds on Intercontinental Exchange's solutions for assembling mortgage loans. Black Knight shareholders will receive $85 in either cash or stock for each share they own. The $13.1 billion deal has been approved by both boards but still needs regulatory and shareholder approvals.
Here is the strategic rationale for the transaction.
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Exchanges and mortgages
Intercontinental Exchange has its roots in securities trading; however, it has been building a mortgage business over the past few years. It owns the Mortgage Electronic Registration System (MERS), which keeps track of servicing and ownership data. It bought Ellie Mae, which owns one of the big loan origination systems (LOS) called Encompass. Intercontinental Exchange views the current system for assembling mortgages as antiquated, and its mission is to develop workflow solutions in order to make the mortgage origination process more efficient.
Black Knight: Servicing and trading software
Black Knight Financial offers a suite of software solutions that address areas that Intercontinental Exchange doesn't offer. Its Mortgage Servicing Platform (MSP) is software-as-a-service offering that allows mortgage servicers a way to manage their servicing portfolios. Optimal Blue is a product and pricing engine that enables mortgage originators to quote rates to borrowers and helps them get the best price for the loan in the secondary market. Finally, Black Knight also has its own LOS, called Empower.
Most of Black Knight's offerings are complementary to Intercontinental Exchange's portfolio of companies. There is one overlap in LOSs, as Encompass and Empower compete directly. Both are leaders in the market, and there is a potential antitrust issue. The companies announced in their press release that the deal is expected to close in the first half of 2023, which is a long time to complete a merger. This indicates the companies anticipate a long, detailed antitrust review. In order to get government approval, Intercontinental Exchange may be forced to divest one of the loan origination systems.
Could this be the beginning of a whole-loan exchange?
One intriguing part of the deal is that Optimal Blue owns Resitrader, which is an exchange for trading whole loans. Trading whole loans (in other words, trading one mortgage at a time) is much less automated than trading stocks, bonds, or commodities. It is still largely done in an email auction where a small subset of potential buyers bid on each loan individually. This is because mortgages aren't like stocks, where one share of, say, Tesla is the same as the other. Each mortgage has its own set of characteristics (loan amount, borrower, credit, etc.) and very little is standardized. Given that Intercontinental Exchange has a long history of trading all sorts of financial instruments, it may be the one to crack the code to making a global whole-loan exchange.
The transaction is expected to be accretive to earnings per share in the first year after the deal closes, or in other words, 2024. Intercontinental Exchange sees the deal producing a 10% internal rate of return. Intercontinental Exchange views the mortgage business as a way to create recurring revenue, which can help offset the cyclicality of earnings on the exchange business. It also establishes the company as the premier provider of solutions to the mortgage industry.
