One of the first company briefings I published in Net Interest, back in August 2020, was on The Intercontinental Exchange, otherwise known as ICE. It’s a fascinating company. Launched as an energy trading platform in 2000, it expanded into other segments across the trading value chain to become one of the largest commodity exchanges globally. Not content with just trading energy, its founder and CEO, Jeff Sprecher, pushed into other areas. He bought the New York Stock Exchange to gain exposure to equities, he acquired numerous data companies, he even tried to buy eBay.

More recently, he’s had his eye on the mortgage industry. At the time of my first briefing, Sprecher had just announced the acquisition of Ellie Mae, a residential mortgage software provider. This week, he doubled down on mortgage, announcing his largest acquisition to date, of Black Knight Inc. 

As we highlighted in the earlier piece, it’s not obvious why an exchange should enter the mortgage market. Squint a bit though, and you can see some overlap. Exchanges provide a forum for hedging risk, and US mortgages – as we discussed in Financing the American Home – involve the reallocation of a lot of interest rate risk. “As an early entrepreneur, I studied the exchange space,” said Sprecher on a call announcing the Black Knight deal. “And I discovered that the largest exchanges all have one asset class in common: interest rates.” In the US, a lot of that activity can be traced back to the mortgage market. 

By getting closer to the market, Sprecher argues that ICE is able to design new hedging solutions that make mortgage lending more efficient. Such vertical integration is unusual – equity exchanges don’t own fund accounting platforms – but there’s another parallel: analog-to-digital transformation.

Sprecher was early to see the upside available from shifting trading from a manual process to an electronic process. He calls it the analog-to-digital transformation and having navigated it in energy markets, he sees the same shift developing elsewhere, including in mortgage markets. “Since our founding, ICE has operated with a strategy to build tools and markets for institutions and consumers which operate in the white space of the inefficiencies of legacy markets.”

There are few markets as inefficient as the mortgage market. “It is the most analog space and asset class that we’ve seen, as we’ve been on our journey of taking businesses from analog to digital,” chimed in Sprecher’s number two, Ben Jackson, on the call. The manual nature of loan origination means that the cost to originate a US home mortgage is currently close to $9,000. By imposing a more digital infrastructure, ICE reckons it can shave ~$2,600 off this amount. 

ICE’s first foray into the mortgage market was back in 2016 through the acquisition of a business called MERS (Mortgage Electronic Registry Service). MERS is a database where ~85% of mortgages in the US reside. Sprecher analogises it to the Depository Trust & Clearing Corporation (DTCC) in equities. Then, in 2019, he acquired a business called Simplifile, which runs a network that connects mortgage settlement agents to the local counties where mortgages need to be registered, so that documents can be shared electronically. The big move came in 2020, with the acquisition of Ellie Mae, which offers loan origination software for mortgage lenders. 

Through the combination of these companies, ICE created a new operating business – ICE Mortgage Technology – which last year generated $1.4 billion of revenue, 20% of the group total. The bulk of that revenue comes from Ellie Mae’s origination technology, used by around 3,000 clients involved in the origination of mortgages. Long term, the company projects a doubling of revenues over 10 years, for an average annual growth rate of 8-10%.

The problem is that short-term, the origination market is very cyclical. It’s an issue we discussed in Mortgage Mayhem, when we looked more closely at the US mortgage origination market. Higher interest rates means fewer new mortgages, and fewer new mortgages means less money for software providers. The Mortgage Bankers Association projects that US mortgage originations will fall 36% this year. Blend, a fintech startup which ranks as the number two point-of-sale system among third-party providers behind Ellie Mae, went public ten months ago – its stock is down 80% since. 

In the front-line mortgage industry, the classic hedge is to be active in mortgage servicing as well as origination. Once a mortgage loan has been originated, its ongoing management is handed over to a mortgage servicer. Servicers are responsible for overseeing loan maintenance, payment collection and application process, escrow management, investor management, tax and insurance payments, and more. There are around 65 million active first and second lien mortgage loans and lines of credit in the US and unlike annual mortgage origination flows, that number is pretty static. To service these loans properly, a good software platform is required. The biggest such platform? Black Knight.

Black Knight

Just like ICE, Black Knight is the product of a deal-hungry founder. Unusually, though, Black Knight’s was as keen on selling assets as he was on buying. Across the entire financial services industry, it is difficult to find a capital allocator as active as William P. Foley II. 

Foley started out as a lawyer in the 1970s. One of his clients was a local savings and loan company in Arizona. Foley developed a keen relationship with the bankers there and soon quit the law to go and join them.

One of his first jobs at the savings and loan was to advise on the acquisition of a small title insurer, Fidelity National Financial (FNF). Most real estate transactions in the US require the use of title insurance before a bank will lend and the transaction can be completed. For a small fee, specialist insurers like FNF provide protection against any defect affecting the priority of the mortgage. Through its ownership of FNF, the savings and loan company’s strategy was to cross-sell banking services to title insurance customers. 

At the time, the title insurance market was highly fragmented and Foley saw an opportunity to roll it up. Through acquisition, he grew FNF’s revenue base to $40 million from $6 million over three years. Seeing the potential for upside from the title business alone, he led a management buyout of FNF in 1984 at a $21 million valuation. 

Thus marked the beginning of Bill Foley’s deal making history. In 1987, he took FNF public. Using all the tools available to him through capital markets – equity raises, debt, buybacks, spinoffs, co-investors – he subsequently bought and sold multiple companies. He continued to roll up title insurers, growing FNF into the market leader, with around a third of the market. But he also sought to diversify – into real estate information services, payroll processing, even fast food.

According to one analysis, at the end of 2021, “If you had invested a dollar in FNF’s IPO and done nothing since then, you’d have ~$350 today. Your primary holdings would be FNF (~50% of the total), Fidelity National Information Systems (~20%), Black Knight (~20%), and Cannae (~7%).”

Black Knight was formed in 2014, when FNF bought a company called Lender Processing Services (LPS). LPS’s Technology, Data and Analytics segment was combined with Commerce Velocity, an indirect subsidiary of FNF, to become Black Knight. Foley chose the name in homage to his alma mater, West Point. As part of the recombination, a 35% stake in Black Knight was sold to Thomas H Lee Partners, a long-term Foley co-investor. Later in 2014, another FNF business, Property Insight, was injected into the company. ¹

In May 2015, new shares were sold to the public in a partial IPO that put 12% of Black Knight in public hands. Two years later, in May 2017, Thomas H Lee sold part of its stake in a secondary transaction and in October 2017, FNF exited its stake completely via a spin-off to its own shareholders. As part of this spin-off, the company officially changed its name (and ticker symbol) from Black Knight Financial Services (BKFS) to Black Knight Inc (BKI).

Black Knight’s central product is a technology platform for the mortgage servicing industry, called MSP. The product has a dominant position in the market for servicing technology, supporting 56% of all US mortgage loans. Like ICE in clearing, Black Knight benefitted from the tailwind of regulation in financial services. Starting with the Dodd Frank Act in 2010 (2,300 pages) through the TILA-RESPA Integrated Disclosure Rule (2,000 pages) and into the revised Home Mortgage Disclosure Act from 2018, the volume of rules around mortgages has increased materially. Keeping on top of it all required an underlying technology system that a scale provider was better able to handle. And once locked in to Black Knight, the switching costs from changing platforms are high. At the time of its IPO Black Knight said that the average length of relationship with its top 10 servicer clients was over 25 years. Contracts are typically 5-7 years long, and are normally renewed. 

As well as its core servicing product (57% of revenue) Black Knight offers a loan origination software system called Empower (28% of revenue), which competes with Ellie Mae. The origination business had been growing rapidly, partly due to the cyclical factors that led to record mortgage origination activity and partly due to a push to win market share.

While Ellie Mae’s focus was historically smaller loan originators, Black Knight focused on larger banking clients, where it already had servicing relationships. At one of its last investor days as an independent public company, Ellie Mae disclosed that three quarters of its customers have less than 100 users of its software per firm. In contrast, Black Knight’s have thousands of users. Yet over time, the two firms increasingly bumped up against each other in their respective market segments. “We have seen Black Knight historically,” said the CEO of Ellie Mae on an earnings call. “We’re going to compete with them…and we are going to win a lot of the business.” 

Across the overall loan origination software space, Ellie Mae has a market share of 50-55% and Black Knight a market share of 10-15% based on loan volumes. Combining the two would give ICE a 60-70% share, which is a market position antitrust authorities will no doubt examine. The company anticipates a long timeline for approval (12 months); it is possible that at the end of it, the company may be required to divest part of its origination software business.

Regardless, the overall rationale of the acquisition makes sense. It is interesting that it takes a third-party from outside the industry to bring these two businesses together. By filling in the gaps both companies had, the combined group is able to offer a software solution that spans the mortgage value chain. ICE had previously pegged its addressable market at $10 billion per year; the inclusion of a servicing solution and more data and analytics expands that to $14 billion. 

In addition, ICE secures a more recurring revenue stream. Currently, 50% of its mortgage revenues are subscription-based; that will increase to around 70%. And Sprecher has long been a fan of recurring revenues as a way to fund a growing dividend.

Whether Black Knight, and mortgage overall, remains the endgame for ICE remains to be seen. Answering the question as to why he is in mortgages at all, Jeff Sprecher analogizes the business to the New York Stock Exchange. “The reality is…it’s a network with a database in the middle of 1,400 people that are pointed at that database. And what is the New York Stock Exchange? It’s a network with a database and a lot more than 1,400 people pointed at that same database.” There are lots of businesses like this (including eBay!) so Sprecher may not be done yet.