1 question I have for the intercontinental exchange

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While Intercontinental exchange (NYSE: EIS) is best known for owning the New York Stock Exchange, but has also invested heavily in the mortgage sector. And on the fourth quarter earnings conference call, most of the analyst questions revolved around the company’s mortgage business. Last year was the best for mortgage bankers since 2003, and 2021 was set to be another blockbuster year.

I understand the company’s current focus on the mortgage value chain, but one area is missing in my opinion: all of the loan trade, or what is known in the industry as “secondary”. Why doesn’t the Intercontinental Exchange have an entire credit trading exchange? And if it doesn’t develop one, should it buy one?

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Intercontinental Exchange encompasses the entire mortgage production process

Intercontinental Exchange essentially operates three segments. Best known is the stock market segment, which includes the New York Stock Exchange, financial derivatives, commodities, and data and listing services. The exchange segment generates 60% of Intercontinental Exchange’s sales after transaction costs. The second segment is annuity and data services, which provide real-time pricing for millions of fixed income investments, including all types of fixed income indices and data. ICE also handles credit default swaps and provides connectivity solutions for many in the investment community.

The third segment is mortgage technology, which spans the entire mortgage value chain. Last year ICE bought Ellie Mae, who is known for the Encompass lending system. Encompass encapsulates all the important parts of a loan and is really the ecosystem where the loan transitions from a lead to a funded status. In addition to Ellie Mae, ICE owns the Mortgage Electronic Registration System (MERS), which tracks title and maintenance and serves as an industry standard. Finally, ICE owns Simplifile, an electronic connection service that connects lenders, settlement agents and administrative offices in the county.

So Intercontinental Exchange basically covers everything in the credit lifecycle, from the start of a loan to financing. The natural next step for ICE would be secondary, which is to sell a loan after it has been granted. Most mortgage lenders are not banks and simply do not own a mortgage loan. They take care of the lending process, but once a loan is made they sell it on the secondary market.

Secondary is the next area ripe for disruption

For most mortgage lenders, selling loans in the secondary market is a cumbersome business. While there is an exchange for funded loans, including Black KnightAt Resitrader’s Exchange, loans are generally sold by sending spreadsheets to various corresponding lenders who then bid on individual loans. The mortgage bank then grants the loans to the respective top bidders. A large lender could sell hundreds of loans in a day.

Aside from Resitrader and a few other marketplaces, there isn’t a huge, centralized marketplace to sell loans with with a central clearing party. As an exchange with a treasure trove of data, Intercontinental Exchange seems to have a natural chance here.

You’d think a massive exchange with a mortgage interest would work to create a secondary mortgage loan market – and the right move might be to consider a merger with Black Knight. That would give ICE the secondary piece as well as all of the secondary analytics services offered by Black Knights Optimal Blue.

During the results conference call, Intercontinental Exchange spent a lot of time discussing the potential cost savings in the manufacturing process that seems to be at the fore right now. But the mortgage sector is currently going through a phase of merger frenzy, with the recent bid war over CoreLogic. The big names pile up and banks like it Western Alliance make big purchases in origination. Intercontinental Exchange should do all of the lending business (it is essentially an exchange company, after all) and could either build one or buy one. Black Knight’s Resitrader is the most popular platform in this field. Black Knight would be a natural acquisition for Intercontinental Exchange. .

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Brent Nyitray, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Intercontinental Exchange. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.

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