Here’s why Intercontinental Exchange bought Black Knight Financial

Intercontinental exchange (NYSE: ICE), which has been primarily known as an operator of stock, bond and commodity exchanges, has established a presence in the mortgage lending industry. Instead of extending credit, Intercontinental Exchange has chosen to focus on mortgage origination infrastructure.

She recently reached a purchase agreement Dark Knight Financial (NYSE: BKI), which relies on Intercontinental Exchange solutions for the origination of mortgage loans. Black Knight shareholders will receive $85 in cash or stock for each share they own. The $13.1 billion deal has been approved by both boards of directors, but still needs regulatory and shareholder approval.

Here is the strategic logic of the transaction.

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Exchanges and Mortgages

Intercontinental Exchange has its roots in securities trading; however, he has built a mortgage business over the past few years. It owns the Electronic Mortgage Records System (MERS), which tracks service and property data. He bought Ellie Mae, who owns one of the big loan origination systems (LOS) called Encompass. Intercontinental Exchange considers the current mortgage origination system to be obsolete and its mission is to develop workflow solutions to make the mortgage origination process more efficient.

Black Knight: Maintenance and Trading Software

Black Knight Financial offers a suite of software solutions that address areas that Intercontinental Exchange does not. Its Mortgage Services Platform (MSP) is a software-as-a-service offering that enables mortgage managers to manage their service portfolios. Optimal Blue is a product and pricing engine that allows 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 an overlap in LOS, as Encompass and Empower directly compete. Both are market leaders, 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 that the companies are planning a long and detailed antitrust review. In order to gain government approval, Intercontinental Exchange may be forced to divest one of the lending systems.

Could this be the start of a full loan swap?

An 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. This is still largely done in an email auction where a small subset of potential buyers bid on each loan individually. This is because mortgages are not like stocks, where a share of, say, You’re here is the same as the other. Each mortgage has its own set of characteristics (loan amount, borrower, credit, etc.) and very few are standardized. Since Intercontinental Exchange has a long history in trading all kinds of financial instruments, it may be the one who will crack the code to create a global 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 an internal rate of return of 10%. Intercontinental Exchange views mortgage business as a way to generate recurring revenue, which can help offset the cyclical nature of exchange business earnings. It also makes the company the leading solution provider for the mortgage industry.

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Brent Nyitray, CFA has no position in the stocks mentioned. The Motley Fool holds positions and endorses Tesla. The Motley Fool recommends Intercontinental Exchange. The Motley Fool has a disclosure policy.

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