Warrior Trading Blog

Underwriter Definition: Day Trading Terminology

Underwriter

An underwriter is a financial intermediary that takes on some of the risk of another financial actor for a commission, fee, interest payment, spread or some other special privilege. Underwriters are prevalent in a wide variety of financial sectors, primarily insurance, equities, mortgages and credit securities.

The Role of the Underwriter

Underwriters are essentially the risk experts of the financial world, though most institutions will focus on one sector of the financial industry to specialize in, such as equity or insurance underwriting. The role of the underwriter is to identify financial agents who would benefit from divesting some degree of risk, price that risk and then create an agreement to cover that risk for the financial agent.

Often the role of the underwriter in taking on some degree of risk for a financial agent or for a specific deal is essential for the operation of that company or deal. For example, in initial public offerings (IPOs) investment banks will underwrite the IPO by guaranteeing to purchase a certain amount of the offered shares at a certain price. This guarantee both enables the offering company to take on the large degree of uncertainty and cost involved in the IPO process and gives a sense of security to potential investors.

On many occasions the risk involved in a transaction is too great for even the largest underwriters, in which case they will form an underwriting syndicate with other underwriters to collectively assume the risk involved. Underwriting syndicates may have primary and secondary underwriters or may form as a collection of equals in all respects.

Mortgage Underwriters

Mortgage loan underwriters are by far the most common form of underwriter in the financial industry. Mortgage loans receive approval as a result of a number of different factors, including the income of the applicant, their credit history, their level of savings and their overall ratio of debt to equity.

Underwriters for mortgage loans make sure that any applicants meet all the necessary requirements, and then deny or approve any loan. The underwriter will also review the appraisal of a property to make sure that it is up-to-date and accurately reflects the loan amount.

The underwriters for mortgage loans have the final approval for any mortgage loan. Mortgage loans that are denied may have access to an appeal process, but underwriting decisions are only overturned when there is substantial support for an error in the original assessment.

Insurance Underwriters

Underwriters for insurance contracts review any applications for coverage plans, and then reject or accept the applicant based on a standard system of risk analysis. Insurance brokers and other relevant insurance entities will submit the applications for insurance coverage for their clients, and then the underwriters review and choose whether or not to offer coverage.

In addition, the underwriter will advise on any relevant risk management issues, determine appropriate levels of coverage for individuals and review current insurance clients for a continuation of coverage.

Equity Underwriters

In the equity market an underwriter will administrate the issuance and distribution of securities from a company. The equity underwriter’s most prominent role is in initial public offerings, or IPOs. An IPO involves the sale of shares for a private company on a public stock exchange.

Underwriters for IPOs are specialists who work with the issuing company to identify the optimal IPO price for the securities, then buys some or all of them from the issuer to sell them on to investors using the distribution network of the underwriter.

Credit Underwriters

Credit underwriters buy credit securities, such as municipal, government and corporate bonds. from the issuing body and then resells them at a profit. The profit from credit underwriting is called the ‘underwriting spread’. A credit underwriter will either resell the credit securities directly to the market or to specialist dealers who will then sell them on to market buyers.

Final Thoughts

Underwriters play a critical intermediary role in the financial markets based on their expertise in the evaluation and pricing of specific forms of financial risk. There are a large range of common financial practices in the contemporary markets that would be extremely difficult and costly, if not outright impossible, without the specialist role that financial underwriters play.