Underwriting
Encyclopedia
Underwriting refers to the process that a large financial service provider (bank, insurer, investment house) uses to assess the eligibility of a customer to receive their products (equity capital, insurance, mortgage
Mortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...

, or credit). The name derives from the Lloyd's of London
Lloyd's of London
Lloyd's, also known as Lloyd's of London, is a British insurance and reinsurance market. It serves as a partially mutualised marketplace where multiple financial backers, underwriters, or members, whether individuals or corporations, come together to pool and spread risk...

 insurance market. Financial bankers, who would accept some of the risk on a given venture (historically a sea voyage with associated risks of shipwreck
Five for One
Five for one is a reference in William Shakespeare's The Tempest to a traveller's insurance practice conducted in medieval England.-Origin:Because merchant-adventurers sailing from the Kingdom of England would usually not return, they could deposit money with an underwriter upon leaving and, upon...

) in exchange for a premium, would literally write their names under the risk information that was written on a Lloyd's slip created for this purpose.

Securities underwriting

Securities
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...

 underwriting refers to the process by which investment banks
Investment banking
An investment bank is a financial institution that assists individuals, corporations and governments in raising capital by underwriting and/or acting as the client's agent in the issuance of securities...

 raise investment capital from investors on behalf of corporations and governments that are issuing securities (both equity
Ownership equity
In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists...

 and debt capital
Debt capital
Debt capital is the capital that a business raises by taking out a loan. It is a loan made to a company that is normally repaid at some future date...

).

This is a way of selling a newly issued security, such as stocks or bonds, to investors. A syndicate
Syndicate
A syndicate is a self-organizing group of individuals, companies or entities formed to transact some specific business, or to promote a common interest or in the case of criminals, to engage in organized crime...

 of banks (the lead managers) underwrite the transaction, which means they have taken on the risk of distributing the securities. Should they not be able to find enough investors, they will have to hold some securities themselves. Underwriters make their income from the price difference (the "underwriting spread
Underwriting spread
The underwriting spread is the difference between the amount paid by the underwriting group in a new issue of securities and the price at which securities are offered for sale to the public. It is the underwriter's gross profit margin, usually expressed in points per unit of sale...

") between the price they pay the issuer and what they collect from investors or from broker-dealers who buy portions of the offering.

Risk, exclusivity, and reward

Once the underwriting agreement is struck, the underwriter bears the risk of being able to sell the underlying securities, and the cost of holding them on its books until such time in the future that they may be favorably sold.

If the instrument is desirable, the underwriter and the securities issuer may choose to enter into an exclusivity agreement. In exchange for a higher price paid upfront to the issuer, or other favorable terms, the issuer may agree to make the underwriter the exclusive agent for the initial sale of the securities instrument. That is, even though third-party buyers might approach the issuer directly to buy, the issuer agrees to sell exclusively through the underwriter.

In summary, the securities issuer gets cash up front, access to the contacts and sales channels of the underwriter, and is insulated from the market risk of being unable to sell the securities at a good price. The underwriter gets a nice profit from the markup, plus possibly an exclusive sales agreement.

Also, if the securities are priced significantly below market price (as is often the custom), the underwriter also curries favor with powerful end customers by granting them an immediate profit (see flipping
Flipping
Flipping is a term used primarily in the United States to describe purchasing a revenue-generating asset and quickly reselling it for profit...

), perhaps in a quid pro quo
Quid pro quo
Quid pro quo most often means a more-or-less equal exchange or substitution of goods or services. English speakers often use the term to mean "a favour for a favour" and the phrases with almost identical meaning include: "give and take", "tit for tat", "this for that", and "you scratch my back,...

. This practice, which is typically justified as the reward for the underwriter for taking on the market risk, is occasionally criticized as unethical, such as the allegations that Frank Quattrone
Frank Quattrone
Frank Quattrone is an American technology-focused investment banker who started technology sector franchises at Morgan Stanley, Deutsche Bank, and Credit Suisse First Boston. He helped bring dozens of technology companies public during the 1990s tech boom, including Netscape, Cisco, and Amazon.com...

 acted improperly in doling out hot IPO
Initial public offering
An initial public offering or stock market launch, is the first sale of stock by a private company to the public. It can be used by either small or large companies to raise expansion capital and become publicly traded enterprises...

 stock during the dot com bubble.

Bank underwriting

In banking, underwriting is the detailed credit
Credit (finance)
Credit is the trust which allows one party to provide resources to another party where that second party does not reimburse the first party immediately , but instead arranges either to repay or return those resources at a later date. The resources provided may be financial Credit is the trust...

 analysis preceding the granting of a loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....

, based on credit information furnished by the borrower, such as employment a history, salary and financial statements
Financial statements
A financial statement is a formal record of the financial activities of a business, person, or other entity. In British English—including United Kingdom company law—a financial statement is often referred to as an account, although the term financial statement is also used, particularly by...

; publicly available information, such as the borrower's credit history, which is detailed in a credit report; and the lender's evaluation of the borrower's credit needs and ability to pay. Examples include mortgage underwriting.

Underwriting can also refer to the purchase of corporate bond
Corporate bond
A corporate bond is a bond issued by a corporation. It is a bond that a corporation issues to raise money in order to expand its business. The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date...

s, commercial paper
Commercial paper
In the global money market, commercial paper is an unsecured promissory note with a fixed maturity of 1 to 270 days. Commercial Paper is a money-market security issued by large banks and corporations to get money to meet short term debt obligations , and is only backed by an issuing bank or...

, government securities, municipal general-obligation bonds by a commercial bank
Commercial bank
After the implementation of the Glass–Steagall Act, the U.S. Congress required that banks engage only in banking activities, whereas investment banks were limited to capital market activities. As the two no longer have to be under separate ownership under U.S...

 or dealer bank for its own account
Deposit account
A deposit account is a current account, savings account, or other type of bank account, at a banking institution that allows money to be deposited and withdrawn by the account holder. These transactions are recorded on the bank's books, and the resulting balance is recorded as a liability for the...

 or for resale to investors. Bank underwriting of corporate securities is carried out through separate holding-company affiliates, called securities affiliates or Section 20 affiliates.

Insurance underwriting

Insurance
Insurance
In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...

 underwriters evaluate the risk and exposures of potential clients. They decide how much coverage the client should receive, how much they should pay for it, or whether even to accept the risk and insure them. Underwriting involves measuring risk exposure and determining the premium that needs to be charged to insure that risk. The function of the underwriter is to protect the company's book of business from risks that they feel will make a loss and issue insurance policies
Insurance contract
In insurance, the insurance policy is a contract between the insurer and the insured, known as the policyholder, which determines the claims which the insurer is legally required to pay. In exchange for payment, known as the premium, the insurer pays for damages to the insured which are caused by...

 at a premium that is commensurate with the exposure presented by a risk.

Each insurance company has its own set of underwriting guidelines to help the underwriter determine whether or not the company should accept the risk. The information used to evaluate the risk of an applicant for insurance will depend on the type of coverage involved. For example, in underwriting automobile coverage, an individual's driving record is critical. As part of the underwriting process for life
Life insurance
Life insurance is a contract between an insurance policy holder and an insurer, where the insurer promises to pay a designated beneficiary a sum of money upon the death of the insured person. Depending on the contract, other events such as terminal illness or critical illness may also trigger...

 or health insurance
Health insurance
Health insurance is insurance against the risk of incurring medical expenses among individuals. By estimating the overall risk of health care expenses among a targeted group, an insurer can develop a routine finance structure, such as a monthly premium or payroll tax, to ensure that money is...

, medical underwriting
Medical Underwriting
Medical underwriting is an insurance term referring to the use of medical or health status information in the evaluation of an applicant for coverage . As part of the underwriting process, health information may be used in making two related decisions: whether to offer or deny coverage; and what...

 may be used to examine the applicant's health status (other factors may be considered as well, such as age & occupation). The factors that insurers use to classify risks should be objective, clearly related to the likely cost of providing coverage, practical to administer, consistent with applicable law, and designed to protect the long-term viability of the insurance program.

The underwriters may either decline the risk or may provide a quotation in which the premiums have been loaded or in which various exclusions have been stipulated, which restrict the circumstances under which a claim would be paid. Depending on the type of insurance product (line of business), insurance companies use automated underwriting systems to encode these rules, and reduce the amount of manual work in processing quotations and policy issuance. This is especially the case for certain simpler life or personal lines (auto, homeowners) insurance.

Real estate underwriting

In evaluation of a real estate loan, in addition to assessing the borrower, the property itself is scrutinized. Underwriters use the debt service coverage ratio
Debt service coverage ratio
The debt service coverage ratio , also known as "debt coverage ratio," is the ratio of cash available for debt servicing to interest, principal and lease payments. It is a popular benchmark used in the measurement of an entity's ability to produce enough cash to cover its debt payments...

 to figure out whether the property is capable of redeeming its own value or not.

Forensic underwriting

Forensic underwriting is the "after-the-fact" process used by lenders to determine what went wrong with a mortgage. Forensic underwriting refers to a borrower's ability to work out a modification scenario with their current lien holder, not to qualify them for a new loan or a refinance. This is typically done by an underwriter staffed with a team of people who are experienced in every aspect of the real estate field.

Sponsorship underwriting

Underwriting may also refer to financial sponsorship of a venture, and is also used as a term within public broadcasting
Public broadcasting
Public broadcasting includes radio, television and other electronic media outlets whose primary mission is public service. Public broadcasters receive funding from diverse sources including license fees, individual contributions, public financing and commercial financing.Public broadcasting may be...

 (both public television and radio) to describe funding given by a company or organization for the operations of the service, in exchange for a mention of their product or service within the station's programming.

Thomson Financial League Tables

Underwriting activity reported in Thomson Financial League Tables(numbers in $ billion) (number of issues in parentheses):

Global Debt, Equity & Equity-related
Year Underwriting Activity Source
2008 4,715 (13,542) Q4 2008 report
2007 7,510 (22,256) Q4 2007 report
2006 7,643 (21,818) Q4 2006 report
2005 6,511 (20,118) Q4 2005 report
2004 5,693 (20,066) Q4 2004 report
2003 5,326 (19,706) Q4 2003 report
2002 4,257 (14,070) Q4 2002 report
2001 4,112 (NA) Q4 2001 report

See also

  • Investment bank
  • Predictive analytics
    Predictive analytics
    Predictive analytics encompasses a variety of statistical techniques from modeling, machine learning, data mining and game theory that analyze current and historical facts to make predictions about future events....

  • Thomson Financial League Tables
  • Medical Underwriting
    Medical Underwriting
    Medical underwriting is an insurance term referring to the use of medical or health status information in the evaluation of an applicant for coverage . As part of the underwriting process, health information may be used in making two related decisions: whether to offer or deny coverage; and what...

  • Underwriting contract
    Underwriting contract
    In investment banking, an underwriting contract is a contract between an underwriter and an issuer of securities.The following types of underwriting contracts are most common:...


External links

The source of this article is wikipedia, the free encyclopedia.  The text of this article is licensed under the GFDL.
 
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