The exchanges have a great business model. They are financial companies that take limited credit risk, while their data is in demand from investors and the media. Finally, they have limited barriers to entry. Creating a competitor to the New York Stock Exchange is difficult, to say the least.
Intercontinental Exchange (NYSE:ICE) just reported record earnings in the first quarter of 2021, but the surprising feature of the result was that the growth was coming from something that has nothing to do with stock trading.
The New York Stock Exchange and mortgages?
The New York Stock Exchange is not the first thing that leaps to mind when discussing mortgages. However, Intercontinental Exchange made a big acquisition last year that puts the company in the midst of a major technological disruption of a paper and in-person business.
Intercontinental Exchange bought mortgage service provider Ellie Mae, which operates Encompass, a software product that helps mortgage bankers assemble loans. In addition to Ellie Mae, Intercontinental Exchange owns the Mortgage Electronic Registration System (MERS), which tracks title and servicing for almost every mortgage in the U.S.
The mortgage technology segment
The mortgage technology segment consists of five basic business lines: origination technology, network solutions, closing solutions, data and analytics, and registration and other. On the conference call, the company announced that closing and network will be split (they used to be one unit).
Origination technology revolves around the flagship Encompass loan origination system, which assembled about 45% of all mortgage loans originated in the U.S. The network and closing functions handle some of the post-closing secondary functionality, while MERS includes the registration functionality.
Changing the way mortgages are originated
Finally, data and analytics promises to be a major growth pillar going forward. Intercontinental Exchange’s automation, intelligence, and quality (AIQ) offering brings machine learning and artificial intelligence to the whole origination process.
Intercontinental Exchange generated under $100 million in revenue in this space, which it views as a $4 billion total addressable market. Notwithstanding tech-heavy originators like Rocket, most of the mortgage origination business is manual, on paper, and done in-person.
Mortgage technology is where the growth is
Intercontinental Exchange bought Ellie Mae late last year, so the year-over-year comparison is distorted by the partial year. If Intercontinental Exchange had owned Ellie Mae for the whole year, mortgage technology revenue would have grown 61% on a year-over-year basis. Transaction revenue rose 84%, while recurring revenue rose 32%. Intercontinental Exchange guided for second-quarter recurring revenue in mortgage technology to increase 30% on a year-over-year basis.
For the quarter, earnings per share rose to $1.34 per share, up from record earnings in the first quarter of 2020 of $1.25. Revenue rose 15% year over year to $1.8 billion less transaction expenses. The exchanges segment was flat on a year-over-year basis as volumes were unusually high in the first quarter of 2020. Fixed income and data also rose modestly. While these are great businesses, the growth for Intercontinental Exchange going forward will lie in mortgage technology.
Intercontinental Exchange trades at 23 times expected 2021 earnings per share, which is about where peers like Nasdaq (NASDAQ:NDAQ) trade. The company recently increased its quarterly dividend by 10%, and the stock now yields 1.2%. Intercontinental Exchange is also ringing the register in its crypto investments, by selling its 1.4% stake in Coinbase (NASDAQ:COIN) and merging its Bakkt subsidiary with a special purpose acquisition company sponsored by Victory Capital.
The exchanges have a great model, with a large competitive moat. Intercontinental Exchange sees a $10 billion addressable market in its various mortgage technology offerings, which gives the stock a growth story as well as a stable, safe business.
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