Black Knight Financial Services Inc. is benefiting from new banking regulations that push mortgage lenders to use automation software, sending the company's shares surging since its initial public offering two months ago.
Banks are racing to comply with rules taking effect in October that require borrowers to sign the vast majority of home-loan documents electronically, transforming an industry that previously relied on fax machines and in-person delivery. Black Knight, the largest U.S. mortgage-software firm, is gaining as investors bet that more loans will be forced into the cloud and processed on the company's servers.
Stringent mortgage rules stemming from Dodd-Frank legislation have created a regulatory minefield for banks and loan brokers. This year alone, the Consumer Financial Protection Bureau has handed out more than $260 million in fines for residential-mortgage rule violations. Automated processing of home loans, such as the services offered by Black Knight, gives lenders protection by vetting every action for compliance.
"The fastest-growing spending category for mortgage companies is technology," said Brian Schwartz, a managing director and senior software analyst at Oppenheimer & Co. "Lenders are re-architecting their systems and they're turning to outside vendors."
Black Knight, with a 19% gain in its share price since its May 19 initial public offering through July 17, has outperformed competitors such as CoreLogic Inc. and Ellie Mae Inc., which have risen 4.2% and 17%, respectively, in the same period, while the Standard & Poor's 500 Index has dropped 0.1 percent.
Wells, JPMorgan
About 57% of U.S. mortgages are serviced using Black Knight's MSP system, and it counts the nation's biggest lenders, including Wells Fargo & Co. and JPMorgan Chase & Co., among its customers.
When it comes to processing loan applications, however, Jacksonville, Florida-based Black Knight has only about 20% of the market. Tom Sanzone, the company's president and chief executive officer, said he plans to boost volume by cross-selling to existing customers. Of the top 25 U.S. lenders, 23 already use Black Knight for loan servicing or data analytics, he said.
"We're going after the big players," Sanzone, 54, said in an interview. "We aren't interested in our origination platform going to a client doing 100 loans a month."
More Loans
While new regulations are boosting demand for technology, the U.S. mortgage market is still recovering from a slump that left originations at a 17-year low in 2014. Lending probably will climb 14% this year, according to the Mortgage Bankers Association, which would make it the second-lowest for originations since 2000.
The average cost of initiating a mortgage was $7,195 in the first quarter, 3 percent higher than in the prior three months, according to the Mortgage Bankers Association. About 65% of that was for personnel. In a few years, personnel costs will be down to about 10%, with technology having a bigger share, said Scott Sambucci, vice president at Blend Labs Inc., a San Francisco-based mortgage-software startup.
"Mortgage staffers right now are like travel agents before we found out that technology makes travel cheaper," he said. "New regulations have forced lenders to throw away their fax machines and put larger investments into real technology."
Changing Regulations
Lending rules that rarely changed before the housing crisis are now in constant flux, said Richard Green, sales manager in the mortgage division of Presidential Bank, in Bethesda, Md.
Last month, the Consumer Financial Protection Bureau said it was delaying by two months the Aug. 1 implementation of its TILA-RESPA Integrated Disclosure rule -- what the mortgage industry calls TRID -- that revamps application and closing procedures. The new regulations update housing laws from the 1970s known as the Truth in Lending Act and Real Estate Settlement Procedures Act. The bureau said the delay was due to its own paperwork error.
"People outside of the industry think last year's regulations on qualified mortgages were a sea change for the industry, but they weren't," Green said. "TRID is bigger because it's not just about who gets mortgages, it's about how the mortgages are made and how lenders do business."
The biggest technological demand is for cloud computing, said Ross MacMillan, an analyst at RBC Capital Markets. Lenders pay for access to software maintained on distant servers by companies like Black Knight or its smaller competitors, CoreLogic and Ellie Mae. The model is known as software as a service, or SaaS.
'More Nimble'
"Cloud applications are much more nimble and can be updated with very high frequency," MacMillan said. "You don't need a department to manage the operation."
Black Knight's plan to grab a bigger share of the origination market may be hampered by its "substantial debt," which could get in the way of buying what it needs to expand its offerings, the company said in a regulatory filing before the $507.2 million IPO. Black Knight owed about $2.1 billion at the end of March. The company planned to use some of the funds raised in the IPO to reduce debt to about $1.8 billion, it said in the filing.
In comparison, CoreLogic had $1.28 billion of long-term debt at the end of March, and Ellie Mae had no long-term debt, according to their regulatory filings.
Before the housing crash, mortgage companies wanted their software to be "homegrown," or tailored to their individual brand, said Sanzone, Black Knight's CEO, who started his career as a software programmer for mortgage traders at Salomon Brothers in the 1980s. Now, conformity is the rule, he said.
"People want standardized technology that regulators have seen before and feel comfortable with," Sanzone said. "That's a very big tailwind for us."
