The Federal Reserve's policy of tightening monetary policy to bring inflation under control has wreaked havoc on the housing market. Housing starts are down on a year-over-year basis, new home sales declined by a lot, and mortgage origination volume is down so much that some companies are filing for bankruptcy and exiting the business.
While mortgages aren't the first thing people think of when Intercontinental Exchange (ICE -0.87%) is mentioned, this decline in the mortgage market is affecting the company's earnings as well. Let's take a look at what's happening and how it might affect Intercontinental's investors.
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Intercontinental Exchange: Exchanges and mortgages
Intercontinental Exchange is the parent company of the New York Stock Exchange, as well as several fixed income and derivatives exchanges. It also has a large presence in the mortgage technology segment, including the Mortgage Electronic Registration Service (MERS), and Ellie Mae, the owner of one of the major loan origination systems, which helps mortgage bankers in the process of assembling loans.
The mortgage business has entered a deep freeze
After a record 2021, mortgage origination volume has collapsed in 2022 as interest rates have risen. In the early days of the COVID-19 pandemic back in 2020, the Federal Reserve took actions that benefited the mortgage market. It drove the federal funds rate to zero and began a program of buying mortgage-backed securities and Treasuries (this program is called quantitative easing). The net result was that millions of homeowners took advantage of low rates and refinanced their mortgages. This allowed them to lower their monthly payments, which was the intent of the program.
With the emergence of outsized inflation, the Fed is reversing these moves, hiking interest rates and letting its portfolio of mortgage-backed securities run off. This has caused mortgage rates to rise rapidly, which takes away the advantage for homeowners to refinance their mortgages. In addition, rising home prices paired with these elevated interest rates have reduced affordability, particularly for first-time homebuyers.
Enter the housing recession
This confluence of events has caused what many commentators call a "housing recession." Mortgage origination volume is expected to fall 46% overall this year. The drop in originations has caused massive layoffs in the mortgage banking business, bankruptcies, and some company shutdowns. Home sales have declined 20% on a year-over-year basis. Since Intercontinental Exchange has exposure to the mortgage industry, this decline will affect the company's earnings.
Mortgage technology is not a major part of Intercontinental Exchange's business; however, it has been driving a lot of the company's growth recently. In the second quarter, Intercontinental's mortgage technology revenue fell 13% year over year. This is due to lower transactions, which lowers MERS fees, and lower mortgage volume, which affects Ellie Mae. Mortgage technology revenue should decline more during the third quarter.
The long-term mortgage thesis remains intact
Intercontinental Exchange's thesis is that the mortgage origination process is antiquated and ripe for disruption. It believes that by using technology to lower the cost of origination it can become a one-stop shop for mortgage originators. The company is probably correct that there is a lot of potential to grab share through technology, but the "housing recession" will likely make this a longer-term story. One bright spot in the situation is that increasing market share could at least offset some of the declines in mortgage volume.
In the near term, Intercontinental Exchange will be driven primarily by its exchange business. Bear markets are never good for exchange volumes, especially the longer they drag on. Analysts still see Intercontinental Exchange reporting an increase in earnings compared to 2021, but they predict declines in the third and fourth quarters.
The stock is trading at 17.5 times expected 2022 earnings per share, which is at the low end of its historical range. While declining mortgage technology earnings will negatively affect earnings, the depressed multiple makes the stock attractive on a long-term basis. That makes this stock worthy of a closer look by long-term investors.
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