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Here’s how confident Jeff Sprecher is that he’s on the cusp of transforming the lengthy, paper-heavy slog of getting a home loan into a fully digitized snap. Sprecher, founder and CEO of trading colossus Intercontinental Exchange (ICE), is making the biggest takeover bet in its history that he can transform what’s arguably the most despised, unreformed relic in financial services. To up the revolution, he’s paying private equity firm Thoma Bravo a staggering $11 billion to purchase Ellie Mae, a small but sprinting provider of software that automates the origination process for banks and brokers.
Ellie Mae, reckons Sprecher, adds the big missing piece he needs to make navigating the entire trip electronic, from getting quotes from lenders to recording the note with the county clerk. Once that link is in place, says Sprecher, the process that now takes two months or more, costs around $8,000, and ferries stacks of documents in a slow-motion loop among lenders, lawyers, and notaries will all happen online in an “e-closing room,” take a couple of weeks tops, and cost $2,600 less.
It’s hardly surprising that Sprecher—who is married to Kelly Loeffler, currently the junior U.S. senator from Georgia—is heading the crusade to modernize mortgages. He’s the leading figure in remaking old-line exchanges dominated by traders shouting bids from “open outcry pits” into electronic platforms. Twenty years ago, he created the forerunner to ICE by buying a failing oil and gas exchange in Atlanta for $1,000. Sprecher built on its success to computerize energy markets through ICE’s acquisition of the International Petroleum Exchange, agricultural commodities via the New York Board of Trade, and equities through its 2013 purchase of the New York Stock Exchange.
Instead, what’s remarkable is the size of the deal, amounting to 18% of ICE’s $57 billion market cap, and that he’s paying multiples of what he thought Ellie Mae was worth less than two years ago. In effect, Sprecher is making a gigantic wager that, first, Americans will soon be getting most of their home loans online in one of the biggest fintech upheavals ever, and second, that ICE will be both the first mover and the leading provider, garnering rich gains from what looks like a superexpensive acquisition.
Never waste a crisis
When COVID-19 struck, ICE Mortgage Services was already collaborating with Ellie Mae to furnish the digital pieces ICE was missing. But their joint campaign for getting banks, lawyers, or title insurers to switch from people and paper to clicks was progressing slowly. Then overnight, the confluence of two potent forces shrank what looked like a long timetable. First, the pandemic changed going digital for major parts of the process from a choice parties could put off to a must-have. Lockdowns prevented customers from visiting banks, law offices, and mortgage brokers, so borrowers shopped online and signed their mortgage notes at virtual closings. Taking those first steps led participants to do more and more online.
Second, record-low interest rates ignited a historic boom in refinancing. That put pressure on banks and attorneys to move faster so that the big backlog didn’t grow even larger, extending what already were long delays. Once again, the solution was going electronic. The sudden shift in momentum convinced Sprecher that the transition was now accelerating, so that the growth in customers joining a fully automated ecosystem over the next few years would be enormous. Suddenly, what Ellie Mae offered––the bridge to creating that end-to-end, all-electronic platform––was a lot more valuable. “All at once, COVID hits, and we see everyone from lenders to lawyers to title insurers flocking to go to our digital platforms,” Sprecher tells Fortune. “In part, it was that sea change that gave us the confidence to buy Ellie Mae.”
Sprecher has long viewed taking the $3 trillion a year market for new home loans the way of energy and equities as the biggest untapped opportunity in financial services. For the past three years, he’s been assembling pieces. That task requires ensuring that the two main parts of the process, origination and closing, are fully electronic and that they are linked seamlessly so that participants can do everything online, from customers shopping for loans to lenders recording mortgage trust notes with the counties.
Origination is often called the “front end” of the journey, encompassing all the steps up to the “closing.” It includes what’s long been the slowest, most people-intensive area. That’s “underwriting,” the part where lenders review the borrower’s file to judge if he or she qualifies, and the client’s lawyer rereviews the bank-approved documents to correct any mistakes. Closing, referred to as the “back end,” happens after underwriting and covers registering the legal documents with government agencies and industry databases. Ellie Mae’s sweet spot is originations; ICE is the leading force in streamlining the back end. As we’ll see, their union targets automating the elaborate dance between lenders and lawyers that turns what’s now a long journey into a digital jaunt.
The murky world of getting a mortgage
The mortgage process consists of six steps, the first four constituting origination, and the final two forming closing, or the back end. The first step is “prequalification.” It’s where the customer contacts lenders to review the rates and other terms they’re offering. Second comes the “application”; the borrower chooses the product that fits his or her needs and sends an application to the broker or commercial or investment bank to request the loan. The third step is “processing.” It has two parts. The customer provides the lender all the information for income and asset verification and also marshals the services the lender requires, from securing an appraisal to getting a mortgage as well as flood and title insurance.
Those three stages are relatively easy to automate. Customers routinely canvass lenders online at sites such as Rocketmortgage.com or Ellie Mae’s Encompass site. Lenders have long offered platforms for customers to upload their financial data online. Where the process turns to molasses generally comes in Step 4, “underwriting.” It covers the review of all documents first by the lender, then separately by the borrower’s “settlement agent,” a fancy term for his or her lawyer.
The banks typically print out all the loan, appraisal, title, and other documents and review them for errors, and to verify that the loans comply with guidelines from federal and state agencies, and purchasers such as Fannie Mae that bundle and sell them as mortgage-backed securities. “The mortgage regulations enacted in the wake of the financial crisis forced the banks to check carefully for mistakes, and they usually do it manually, by ‘stare and compare,’” says Sprecher.
Today, because of the backlog, the bank’s sign-off typically arrives more than two months after the process begins.
Next comes the second, client-protection part of the underwriting. The lender sends the same package, amounting to thousands of pages, to the borrower’s lawyer, whose staff combs through the documents that lender just reviewed, also to fix mistakes. The lawyer sends their corrections back to the lender, and when the latter agrees that the changes are on point, underwriting is completed, and the loan is ready to close. The lawyer’s review usually takes two additional weeks or more, so that loans that in most periods go from shopping to closing in two months, now stay in the pipeline for 90 days.
Step 5 is closing. When the customer is buying a house, the purchase and mortgage closings usually happen at the same time. Most Americans have attended the ceremony, often on multiple occasions. You go to your attorney’s office, sign reams of documents, including the mortgage note witnessed by a notary who’s usually on the lawyer’s staff. Meanwhile, reps from the lender and title insurer pop in to handle last-minute issues from their side. When the mortgage is funded, the paper records get boxed, stamped with a bar code, and go into the lender’s warehouse. If the loan goes to foreclosure, the bank dispatches someone to find the right box and dig out the relevant files.
Step 6 is the part of closing often known as “post closing.” The lender officially enters the loan into MERS or the Mortgage Electronic Registration Systems (as we’ll see, now part of ICE) using an ID number assigned during underwriting. MERS is a giant database that catalogs the owners and servicers for 85% of all the home loans in America and tracks changes when the mortgages, mortgage-backed securities (MBS), or servicing rights are sold. The beauty of MERS is that when one member buys the loan or servicing rights from another, the transaction is documented electronically, waiving the need for transferring paper deeds or rerecording paperwork with the local county. Subscribing to MERS gives all of those parties immediate digital access to the profiles of loans they have originated, are servicing, or are pondering buying.
Besides dragging on for two months or more even when applications are modest, the process is extremely expensive. In the past decade, the average cost to customers has doubled from $4,000 to $8,000. “Two-thirds of that increase comes from adding the people needed to do all the checking mandated by the regulations,” says Sprecher. For Sprecher, the best way to start his campaign for shaving thousands in fees and achieving the, say, 10-day originations was targeting the old-fashioned back end. “At ICE, we’ve specialized in building the closing and post-closing part first, as we did in energy and as we’re doing now in fixed income,” says Sprecher. “Establishing the back-end logistics is more valuable than building the front end, matching buyers and sellers. When you’ve built the back end, people will come on the front end, they’ll come through the door.”
In 2016, ICE made its initial move by purchasing a key building block for its new back-end project, MERS. Since then, it’s succeeded in multiplying the lenders and servicers who subscribe by connecting them electronically to the MERS network. Fee-paying members register new mortgages with the click of a mouse; save by nixing paperwork when loans are sold; and track industrywide sales of loans and servicing rights that provide valuable data for identifying trends.
In May of 2019, ICE added the second big segment to its infrastructure by paying $335 million for Simplifile, a service that electronically records mortgages with the local counties, crucial to ensuring that the lender can fully enforce the loan’s terms. “That was a big step towards automation,” says Sprecher. “Before Simplifile, the lawyer had to walk into a county clerk’s office with the paper mortgage note, or send it in by FedEx. It could sit on someone’s desk for days before going into the public record.” Simplifile now digitally connects 23,000 attorneys’ offices with 2,000 county registries.
Prior to buying Simplifile, ICE formed a partnership with Ellie Mae. The software provider offers the equivalent of an App Store for home loans. Its Encompass software connects mortgage-shoppers with lenders, appraisers, title insurers, and the like, and speeds the early steps of the process by enabling customers to upload financial information and service providers to make offers, all online. At the time, Ellie Mae was making slow but steady progress attracting users. But the once the client chose a lender and loan, and the bank issued a commitment and guaranteed rate, the digital highway stopped, and the players trudged over the dirt road of underwriting.
The partners’ goal was making underwriting, the poky part in the middle, fully electronic. When that happened, they could offer an all-in-one solution since Ellie Mae was the leader in the first stages of the front end and ICE dominated the back end. In 2018, Sprecher pondered buying Ellie Mae. “They were clearly the best guys in the digital mortgage business,” says Sprecher. But he also believed that to transform the process fast and create a mass-market product on the scale of a Salesforce or a LinkedIn, Ellie Mae would need to move to a cloud-based platform that could handle giant volumes of data. “They were working on a cloud-based platform,” he recalls. “But we weren’t sure they could get there. Our thinking at the time was ‘What do we do with a legacy software business?’” Adds ICE President Ben Jackson, “There was a question mark on whether they could get customers to a cloud-based version of their app. We thought it would take longer than it did.” A second factor, says Jackson, was that ICE hadn’t added Simplifile yet, and hence didn’t have the closing architecture completed, crucial to taking the entire workflow electronic.
In February of 2019, Sprecher and Jackson got a shock. Thoma Bravo announced that it was purchasing publicly traded Ellie Mae for $3.7 billion, $1.2 billion over its value prior to the deal. “We thought Thoma Bravo really paid up,” says Sprecher. “We were wrong.” Thoma Bravo is expert in making the investments needed to put the software enterprises it buys on a superfast track. The firm allowed Ellie Mae to hire lots of new people to hasten its move to the cloud. “It’s hard to do that in a public company,” says Sprecher. “Thoma Bravo takes a similar view to us in finding companies going from analog to digital and making it happen fast.”
Following the acquisition, ICE and Ellie Mae continued working together on a fully digital platform. Sprecher and Jackson were astounded by their partner’s rise under Thoma Bravo. While many companies lose revenues during a shift to the cloud, Ellie Mae’s sales took off. By the time COVID-19 hit, Ellie Mae had a cloud-based platform fully in place and was attracting fee-paying borrowers, banks, brokers, real estate agents, and sundry service providers at a rapid rate. Then, the pandemic turbocharged Encompass. “Suddenly, everyone’s working remotely, and for the first time, we see mass adoption of digital tools for mortgages,” says Sprecher. Over two years, Ellie went from providing software handling 38% of the early origination steps for all new home loans to almost half. Since the start of 2019, its revenues have doubled to an annualized run rate of $900 million.
That explosion prompted Sprecher and Jackson to radically reassess Ellie Mae’s worth. “Ellie wasn’t for sale,” says Jackson. “Thoma knew they had a P/E winner. We knew that convincing them to sell would take persuasion, so during the lockdown, Jeff and I got on planes and met with Ellie’s leaders and the Thoma folks in the Bay Area.” Sprecher says he would be reluctant to make an acquisition involving lots of restructuring in the COVID work-at-home world, but was comfortable buying Ellie Mae because it didn’t need fixing. “In this environment, we couldn’t have done a deal like the NYSE that required refocusing the business,” he says. “But with Ellie, we took a calculated risk. The company is so well run that even if the integration takes two or three years, far longer than in normal periods, the deal will work.”
On Aug. 6, ICE unveiled that it was purchasing Ellie for $11 billion, $7.3 billion more than Thoma Bravo had agreed to pay 18 months before. Despite the gigantic sticker, investors welcomed the news, sending ICE shares up 3% the next day, and 5% since the announcement. The combination should greatly benefit from the recent surge in home sales, and, especially, the leap in refinancing. “On almost 90% of all home loans, people are paying between 0.5% and 0.7% more than what they would on a new mortgage, many of which are being offered at around 3%,” says Jackson. “Refinancing a typical loan can bring $200 a month or more in savings.”
The ‘e-closing room’
As Ellie Mae’s numbers show, the convergence of the lockdown and bargain home loans is luring customers to traverse far more of the passage online. Still, the extra business so far is coming mostly in the early steps of the process offered by Ellie and in the all-electronic registry provided by ICE. The big question is whether the mass migration will extend to the slow walk in the middle, underwriting. The signs are positive, as evidenced by the growing popularity of the solution ICE and Ellie have long been working on, the “e-closing room.”
The goal is getting all participants to tie in to a single site. That’s the e-closing room. Lenders post all the documents required for closing on the site, and service providers upload appraisals and title and flood insurance contracts. The customer’s attorney reviews all the documents in the e-closing room, eliminating the need for banks to send huge paper-stuffed packages to law offices. The banks make changes, and attorneys check for mistakes, all at the same time. In fact, Ellie Mae has already added technology that greatly reduces errors. Thoma Bravo purchased A.I. software for Ellie that flags mistakes, identifying, for example, if a field that’s supposed to have nine digits shows eight. “You have no mailing, no calls, a completely digital forum,” says Jackson.
The e-closing rooms are also designed to host the final closings. Taking that meeting online used to be more difficult, in part because most states required that a notary, usually someone in the lawyer’s office, witness the customer’s signing of the mortgage note in person. The pandemic has moved all but half a dozen states to allow remote, digital notarization, lifting a barrier to making the process all-electronic. In an e-closing, no paper is generated. The mortgage note is replaced by an electronic “e-note.” All the closing documents go into a digital vault that attorneys and lenders can access online.
Clearly, getting the parties into the e-closing room is the holy grail for revolutionizing just about the most arduous process in our financial lives. And these virtual confabs where everyone can talk to everyone are taking off. Late last year, less than 1% of the mortgages Ellie Mae handled used an e-closing room. That number has tripled to 3%, and it’s rising fast. “We’re getting near the tipping point you see in all markets that go from analog to digital,” says Sprecher. “Once you reach it, the entire business converts fast. In the future, most lenders will be outsourcing the whole process to ICE Mortgage Services.” It’s a big ambition. But it’s a target made-to-order for Jeff Sprecher.
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