21+ Sample Underwriting Agreement
What Is an Underwriting Agreement?
An underwriting agreement is a type of contract document that is used between a group of investment bankers known as an underwriting group and the business that is issuing new securities. The underwriting agreement’s objective is to ensure that all parties understand their roles in the process, which in turn gives a chance to avoid any possible dispute. The underwriting group’s pledge to acquire the new securities issue, the agreed-upon price, the first resale price and the settlement date are all outlined in this agreement.
The individuals who assume another individual’s risk for a certain amount of payment and who determine the amount of risk that is present for the lenders are called underwriters. Because of their capacity to assess risk, underwriters have become essential individuals in the mortgage sector, insurance industry, equities markets, and typical kinds of debt security trading. A lead underwriter is also called a book runner.
Important Elements of an Underwriting Agreement
In order to be effective, there are some key elements or provisions that need to be included whenever you draft an underwriting agreement. Here are those elements discussed below:
Representations and Warranties. This section is included towards the start of the underwriting agreement. What is a representation? It refers to a declaration as to the correctness of facts. One party makes representations to the other party in order to persuade them to enter into the contract. What does a warranty mean? A warranty is a guarantee of compensation if the factual claim is proven to be untrue. The representations and warranties parts of the underwriting agreement are often and carefully negotiated by the parties.Agreements to Sell and Purchase. This section means that the company that is involved in the underwriting agreement agrees to sell securities to the underwriters at the price provided in this part, and the underwriters agree to purchase securities from the business at the price indicated in this section.Conditions and Obligations of the Underwriters. This section details the underwriters’ conditions and obligations in the underwriting agreement. Other papers must be delivered as part of these criteria. An example of this is a negative assurance letter. What is it? It refers to a letter from the company’s auditor confirming that certain facts are correct. Another example of a document that needs to be delivered is a letter containing the opinion by the legal firm representing the underwriters. An opinion letter from a law firm attests to the legality of certain legal classifications. These opinion letters help to avoid costly lawsuits in the future.Covenants. A covenant refers to a commitment to undertake out or refrain from carrying out specific activities. Alternatively, a covenant may demand that specific criteria be met. One business covenant that must be fulfilled is that the firm must adhere to all applicable securities and other laws, rules, and regulations in each jurisdiction where the securities are sold.Greenshoe/over-allotment option. This agreement can also contain an over-allotment option, also known as a greenshoe. This provision allows the underwriters to sell more shares to investors than were originally planned. The greenshoe option typically allows investors to purchase up to 15% more shares than the initial number of shares. When demand for the company’s shares is larger than projected, the over-allotment option comes in handy.
What Are the Types of Underwriting Agreements?
Discussed below are the different types of underwriting agreements that exist:
Firm Commitment. In this type of underwriting agreement, the underwriter assures to buy all of the securities offered for sale by the issuer, regardless of whether or not they can sell them to investors. This type of underwriting agreement is the most desirable one since it immediately guarantees all of the issuer’s money. The greater the demand for the offering, the greater the chances are that it will be completed on a firm commitment basis. Also, in this type of underwriting agreement, the underwriter puts its own money at risk if the securities cannot be sold to investors. Underwriting a securities offering on the basis of a solid commitment exposes the underwriter to significant risk.Best Efforts Underwriting Agreement. Underwriters try their hardest to make a sale of all of the securities provided by the issuer in this form of underwriting arrangement. However, the underwriter is not required to acquire the securities for its own account. The lesser the demand for a problem, the more likely it will be solved using best efforts. Any shares or bonds not sold in a best efforts underwriting will be returned to the issuer.Standby Underwriting Agreement. This type of underwriting agreement is usually used alongside a preemptive rights offering. All standby underwriting is done with a strong commitment. The standby underwriter offers to buy any shares not purchased by present stockholders. The securities will subsequently be resold to the public by the standby underwriter.All or None Underwriting Agreement. In this type of underwriting agreement, the issuer specifies that the funds from the sale of all securities must be received. The funds of investors are placed in escrow until such time that all securities are sold. The funds are released to the issuer if all of the securities are sold. If all of the securities are not sold, the issuance is canceled, and the money is refunded to the investors.Mini-Maxi Underwriting Agreement. This type of underwriting agreement is related to the best efforts underwriting agreement. This type of agreement will not become operational until a certain number of securities are sold. Once the minimum has been attained, the underwriter may sell the securities up to its maximum amount stipulated in the offering’s conditions. All investor monies are placed in escrow until the underwriting is finished. If the minimum number of securities required under the offering is not met, the offering is terminated and the investors’ cash is refunded.
What Are the Different Types of Underwriting?
Discussed below are the different types of underwriting that exist:
- Underwriting for Loans – This sort of underwriting is automated and entails evaluating the credit history of the applicant, their financial records, and the value of any collateral given, as well as any other forms of considerations based on the loan’s size and purpose. Mortgages are the most prevalent kind of loan underwriting that includes a human underwriter. This is also the form of loan underwriting that the majority of individuals deal with. The evaluation of loan underwriting can span anything from a few minutes to a few weeks, relying on whether the evaluation involves the involvement of a human individual.
- Underwriting for Insurances – In this type of underwriting, the prospective policyholder is given focus. A prospective policyholder is also referred to as the person who is looking for or applying for health insurance. It wasn’t always like this in the past, since underwriting for health insurance was previously used to assess how much to charge an applicant depending on their health and even whether to give coverage at all, frequently based on the applicant’s pre-existing diseases. In life insurance underwriting, the underwriter attempts to identify the risk of insuring a prospective policyholder based on their age, health, lifestyle, employment, and other characteristics. Underwriting for life insurance can result in acceptance (along with a variety of coverage quantities, costs, exclusions, and restrictions) or outright rejection.
- Underwriting for Securities – This type of underwriting is undertaken on behalf of a potential investor, typically an investment bank, to assess risk and the proper price of certain securities. Individual stocks and debt instruments, such as governmental, corporate, or municipal bonds, might be included in this sort of underwriting. Underwriters or their employers acquire these securities with the intent of reselling them for a profit to investors or distributors, who in turn redistribute them or resell them to other buyers.
- Underwriting for Real Estate – In this type of underwriting, a borrower’s past, as well as the real estate property for which they wish to obtain a loan, are both considered. The underwriting procedure will assess if the property’s value can be recovered if the borrower is unable to repay the loan.
Steps of Underwriting
For an underwriting process to be effective, it needs to follow a number of steps. In this particular section of the article, we will discuss mortgage underwriting.
1. Start Your Mortgage Application
In this step, choose the type of mortgage loan that you want to apply for. It can be a conventional mortgage, jumbo mortgage, fixed-rate mortgage, adjustable-rate mortgage. or government mortgage. After you’ve decided on the mortgage of your choice, proceed on filling out a mortgage application form, which can be done online, or in-person with the presence of the lender. Additional information may be required, depending on the type of mortgage loan that you are applying for.
2. Obtain a Loan Estimate
This step happens after filling out a mortgage application. In this step, your lender will immediately give you a loan estimate for you to review. The amount in the loan estimate may also depend on the type of mortgage that you applied. The loan estimate document also explains how much you’ll pay in monthly mortgage payments, total cost, and principle in the first five years—as well as the percentage you’ll pay in interest throughout the life of the loan.
3. Processing of the Loan Application
Once you’ve received your loan estimate and done a thorough review of the document, and you still want to proceed with the loan application, then this step will follow suit. What happens in this part of the application process? The lender or loan processor will seek proof for the personal and financial information from your mortgage application at this step. When all of the required material is obtained, the underwriter then begins to scrutinize it for any inconsistencies, potential gaps, or potential risks.
4. Wait for the Application Results
After submitting all the other necessary requirements or documents, this is now the step in the mortgage underwriting process in which you wait. In this step, the mortgage loan application might be approved, suspended, or denied by the underwriter. The underwriter usually accepts the mortgage loan application, but with terms or contingencies. That indicates you still have work to complete or information to supply, such as further documents or an appraisal.
5. Sort Out Any Contingencies
Once the application gets approved by your lender, this step will follow suit. This is the stage at which you’ll collaborate with your lender to ensure that any contingencies discovered in the previous phase have been resolved. In addition, your lender will lock in your interest rate. Once all of the requirements have been completed, you will get a “clear to close” letter from your lender. That implies your mortgage loan is complete and ready for closing on the scheduled day.
6. Closing Process
This serves as the final part of the process. In this stage, you will usually receive a closing disclosure document at least three days prior to your closing out date. It is sent in advance to give you enough time to go through the basics of your loan, such as your monthly mortgage payment and the money you’ll need to bring to closing. To summarize, the most essential thing you can do to keep the underwriting process flowing as smoothly as possible is to answer your lender’s requests for information as quickly as possible, especially if you hit some snags along the road.
What is the Main Purpose of Underwriting?
The main purpose of underwriting is to reassess the risk level of a proposed transaction or agreement. The underwriter must assess the risk of a client filing a claim that needs to be paid out before the said policy becomes profitable for an insurer. The risk for a lender in the underwriting process is default or nonpayment. Similarly, investment banks use securities underwriting to calculate the risk-adjusted value of freshly issued shares and bonds.
What is an Underwriting Spread?
An underwriting spread refers to a difference between the price per share paid by an underwriter or underwriting group to an issuing corporation and the public offering price offered by the underwriter to the public. In general, the underwriting spread should indicate the net proceeds that the underwriter will be able to acquire from the investment. The underwriting spread might be large depending on the size of the securities issuance and the price that the shares can demand on the open market.
Do I Need to Obtain a Certain College Degree to be an Underwriter?
No, it typically is not required. To get started in the underwriting business as an underwriter, you typically do not need a specialized bachelor’s degree, although having a degree in courses that involve mathematics, business, economics, and finance is helpful. If a certain college degree is not needed, what makes a good underwriter? Well, a good underwriter should be detail-oriented and has strong math, communication, problem-solving, and decision-making abilities. Once employed, you will normally get on-the-job training while being overseen by experienced underwriters. As a trainee, you will learn about typical risk variables and fundamental underwriting applications. As you gain experience, you will be able to work independently and take on greater responsibility.
As stated earlier, underwriting has a critical role in the world of finance as it serves to establish fair rates on loans, helps investors arrive at proper decisions concerning their various investments, ensures accurate assessment and coverage, and so on. With recent developments in today’s technology, the process of writing an underwriting agreement, and underwriting as a whole has been cut by a significant amount of time. What usually takes a number of weeks or months will now require a number of days or hours, hereby making the entire process easier. In this article, you can acquire examples of underwriting agreements for personal use.