The combination of Black Knight and Intercontinental Exchange could unravel. This is why.

Back in May, Intercontinental exchange (ICE 0.34%) and Financial Black Knight (BKI 1.02%) announced a deal whereby Intercontinental Exchange would buy Black Knight for $85 in cash and stock. The deal, valued at approximately $13 billion, would bring together two of the largest companies in the mortgage technology industry.

Since then, the mortgage lending market has collapsed and the government is raising antitrust issues over the transaction. Is the deal doomed?

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Both companies are major players in mortgage technology

Black Knight and Intercontinental Exchange are both major players in mortgage technology. Intercontinental Exchange is best known for owning the New York Stock Exchange, but it has also built a presence in mortgage technology. Intercontinental Exchange owns Ellie Mae, which includes the Encompass loan-making system. It also owns the Electronic Registration System for Mortgages and Simplifile. These companies do not provide mortgages per se, but they help mortgage lenders assemble mortgages for sale to investors.

Black Knight is a mortgage technology company best known for its proprietary lending system, Empower. Black Knight also owns Optimal Blue, a platform that allows originators to price and sell their loans. If Intercontinental Exchange and Black Knight merge, the combined company would have exposure to the entire mortgage manufacturing value chain.

Washington is concerned about the effect of the deal on consumers

The House Financial Services Committee recently sent a letter to the Federal Trade Commission expressing concern about the deal, saying the combined company could exercise “significant market power over consumer loan pricing, access to and sale of consumer data and the pricing of mortgage software.” There are fears that the combined company will face little competition and raise prices, which will be passed on to borrowers. In situations like this, the government could require Intercontinental Exchange to divest one of its lending systems to a competitor.

When the deal was announced, the mortgage industry was experiencing a record year thanks to the Federal Reserve slashing interest rates to rock bottom to stimulate the economy during the height of the pandemic. Mortgage lenders feast on easy refinancing volumes, which disappeared when the Fed began raising rates this year to combat rising inflation. Mortgage formation is a very cyclical, party or famine thing and times are exceptionally tough right now.

Several notable promoters have filed for bankruptcy and industry employment has plummeted. The financial logic of the deal may no longer make sense given the current environment, and an antitrust lawsuit may be Intercontinental Exchange’s excuse for terminating the deal.

The downside for Black Knight is probably limited

If the deal falls apart, Black Knight stock could be sold. However, the stock is trading well below the announced deal value of $85 per share for about $59, and there wasn’t much takeover premium to begin with. This is an acknowledgment of the antitrust risk of the deal and the likelihood of the deal collapsing. Mortgage companies are already under heavy selling pressure — Rocket ship and UWM Holdingsare currently among the most short-positioned stocks in the market.

If the deal unravels, both companies would continue as before. Black Knight is still the market leader in maintenance software and Optimal Blue is very popular with mortgage lenders. Mortgage technology continues to be overshadowed by the exchanges for Intercontinental Exchange, so the impact there should be minimal. If the deal falls through, Black Knight is likely to take a dent in the near term and Intercontinental Exchange should do better as its exchange business continues to thrive.