Meaning and definition of underwriting
Underwriting can be explained as a process through which the investment bankers raise investment capital from investors on the behalf of governments and corporations which are issuing securities (debt as well as equity). However, underwriting is also referred as the process of issuing insurance polices.
As explained by Investopedia, the word “underwriter” is believed to have obtained from the practice of having each risk taker write down his/her name under the total risk amount acceptable at a specified premium. In a way, this is still true today, for the fresh issues are generally brought to the market by an underwriting syndicate wherein every firm takes the responsibility of selling out its specified allotment.
Forms of underwriting
The main forms of underwriting include:
- Real estate underwriting
In valuation of real estate loan, other than assessing the borrower, the property itself is scrutinized. The underwriters use the debt service coverage ratio to find out whether the property is capable of redeeming its own value or not.
- Forensic underwriting
Forensic underwriting refers to an “after-the-fact” process used by the lenders for determining what went wrong with a mortgage. Besides, forensic underwriting also describes a borrower’s ability of working out modification scenario with their existing lien holder, not qualifying them for a fresh loan or a refinance. This is generally done through an underwriter staffed with a team of people who have experience in every facet of the real estate field.
- Sponsorship underwriting
Another form of underwriting is the financial sponsorship of a venture. This term is also used to delineate funding provided by an organization or company for the operations of the service, in lieu of a mention of the product or service.
Risk, exclusivity and reward
After the underwriting agreement is struck, the underwriter faces the risk of being capable of selling the underlying securities, as well as the cost of holding them on the books till the time in future when they might be sold favorably. If, in any case, the instrument is desirable, the underwriter and the security issuer might opt for entering into an exclusivity agreement wherein the underwriter is chosen as the exclusive agent for the initial sale of securities.