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Underwriting

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  • 1. UnderwritingFrom Wikipedia, the free encyclopedia (Redirected from Securities underwriting) Jump to: navigation, search"Underwriting refers to the process that a large financial service provider(bank, insurer, investment house) uses to assess the eligibility of a customer toreceive their products (equity capital, insurance, mortgage, or credit). Thename derives from the Lloyds of London insurance market. Financial bankers,who would accept some of the risk on a given venture (historically a seavoyage with associated risks of shipwreck) in exchange for a premium, wouldliterally write their names under the risk information that was written on aLloyds slip created for this purpose.Securities underwritingSecurities underwriting refers to the process by which investment banks raiseinvestment capital from investors on behalf of corporations and governmentsthat are issuing securities (both equity and debt capital). The services of anunderwriter are typically used during a public offering.This is a way of selling a newly issued security, such as stocks or bonds, toinvestors. A syndicate of banks (the lead managers) underwrites thetransaction, which means they have taken on the risk of distributing thesecurities. Should they not be able to find enough investors, they will have tohold some securities themselves. Underwriters make their income from theprice difference (the "underwriting spread") between the price they pay theissuer and what they collect from investors or from broker-dealers who buyportions of the offering.
  • 2. Risk, exclusivity, and rewardOnce the underwriting agreement is struck, the underwriter bears the risk ofbeing unable to sell the underlying securities, and the cost of holding them onits books until such time in the future that they may be favorably sold.If the instrument is desirable, the underwriter and the securities issuer maychoose to enter into an exclusivity agreement. In exchange for a higher pricepaid upfront to the issuer, or other favorable terms, the issuer may agree tomake the underwriter the exclusive agent for the initial sale of the securitiesinstrument. That is, even though third-party buyers might approach the issuerdirectly to buy, the issuer agrees to sell exclusively through the underwriter.In summary, the securities issuer gets cash up front, access to the contacts andsales channels of the underwriter, and is insulated from the market risk ofbeing unable to sell the securities at a good price. The underwriter gets a niceprofit from the markup, plus possibly an exclusive sales agreement.Also, if the securities are priced significantly below market price (as is often thecustom), the underwriter also curries favor with powerful end customers bygranting them an immediate profit (see flipping), perhaps in a quid pro quo.This practice, which is typically justified as the reward for the underwriter fortaking on the market risk, is occasionally criticized as unethical, such as theallegations that Frank Quattrone acted improperly in doling out hot IPO stockduring the dot com bubble.Bank UnderwritingIn banking, underwriting is the detailed credit analysis preceding the grantingof a loan, based on credit information furnished by the borrower; such
  • 3. underwriting falls into several areas: (a) Consumer loan underwriting includesthe verification of such items as employment history, salary and financialstatements; publicly available information, such as the borrowers credithistory, which is detailed in a credit report; and the lenders evaluation of theborrowers credit needs and ability to pay. Examples include mortgageunderwriting. (b) Commercial (or business) underwriting consists of theevaluation of financial information provided by small businesses includinganalysis of the business balance sheet including tangible net worth, the ratio ofdebt to worth (leverage) and available liquidity (current ratio). Analysis of theincome statement typically includes revenue trends, gross margin, profitability,and debt service coverage (see Debt Service Coverage Ratio). 65.102.7.131(talk) 03:46, 15 January 2013 (UTC)Underwriting can also refer to the purchase of corporate bonds, commercialpaper, government securities, municipal general-obligation bonds by acommercial bank or dealer bank for its own account or for resale to investors.Bank underwriting of corporate securities is carried out through separateholding-company affiliates, called securities affiliates or Section 20 affiliates.Insurance underwritingInsurance underwriters evaluate the risk and exposures of potential clients.They decide how much coverage the client should receive, how much theyshould pay for it, or whether even to accept the risk and insure them.Underwriting involves measuring risk exposure and determining the premiumthat needs to be charged to insure that risk. The function of the underwriter isto protect the companys book of business from risks that they feel will make aloss and issue insurance policies at a premium that is commensurate with theexposure presented by a risk.
  • 4. Each insurance company has its own set of underwriting guidelines to help theunderwriter determine whether or not the company should accept the risk.The information used to evaluate the risk of an applicant for insurance willdepend on the type of coverage involved. For example, in underwritingautomobile coverage, an individuals driving record is critical. As part of theunderwriting process for life or health insurance, medical underwriting may beused to examine the applicants health status (other factors may be consideredas well, such as age & occupation). The factors that insurers use to classify risksshould be objective, clearly related to the likely cost of providing coverage,practical to administer, consistent with applicable law, and designed to protectthe long-term viability of the insurance program.The underwriters may either decline the risk or may provide a quotation inwhich the premiums have been loaded or in which various exclusions havebeen stipulated, which restrict the circumstances under which a claim wouldbe paid. Depending on the type of insurance product (line of business),insurance companies use automated underwriting systems to encode theserules, and reduce the amount of manual work in processing quotations andpolicy issuance. This is especially the case for certain simpler life or personallines (auto, homeowners) insurance. Some insurance companies, however, relyon agents to underwrite for them. This arrangement allows an insurer tooperate in a market closer to its clients without having to establish a physicalpresence. A Lloyds Coverholder is one such example in which a LloydsSyndicate (an insurer who is a member of Lloyds of London) delegates itsunderwriting authority to, hence allowing that syndicate to operate in a regionor country as if it is a local insurer. In Hong Kong, where the largest number ofApproved Lloyds Coverholders are domiciled in Asia Pacific, insurers and their
  • 5. potential clients seek a closer way for the Lloyds market to access theemerging insurance market of Asia Pacific and vice versa.Other forms of underwritingReal estate underwritingIn evaluation of a real estate loan, in addition to assessing the borrower, theproperty itself is scrutinized. Underwriters use the debt service coverage ratioto figure out whether the property is capable of redeeming its own value ornot.Forensic underwritingForensic underwriting is the "after-the-fact" process used by lenders todetermine what went wrong with a mortgage.[4] Forensic underwriting refersto a borrowers ability to work out a modification scenario with their currentlien holder, not to qualify them for a new loan or a refinance. This is typicallydone by an underwriter staffed with a team of people who are experienced inevery aspect of the real estate field.Sponsorship underwritingUnderwriting spotUnderwriting may also refer to financial sponsorship of a venture, and is alsoused as a term within public broadcasting (both public television and radio) todescribe funding given by a company or organization for the operations of theservice, in exchange for a mention of their product or service within thestations programming.
  • 6. Thomson Financial League TablesUnderwriting activity reported in Thomson Financial League Tables[5](numbersin $ billion) (number of issues in parentheses):Global Debt, Equity & Equity-relatedYear Underwriting Activity Source2008 4,715 (13,542) Q4 2008 report2007 7,510 (22,256) Q4 2007 report2006 7,643 (21,818) Q4 2006 report2005 6,511 (20,118) Q4 2005 report2004 5,693 (20,066) Q4 2004 report2003 5,326 (19,706) Q4 2003 report2002 4,257 (14,070) Q4 2002 report2001 4,112 (NA) Q4 2001 report

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