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Culture Documents
country. The presentation gives potential buyers the chance to ask questions from the
management team. If the buyers like the offering, they make a non-binding commitment to
purchase, called a subscription. Because there may not be a firm offering price at the time,
purchasers usually subscribe for a certain number of shares. This process lets the underwriter
gauge the demand for the offering (called indications of interest) and determine whether the
contemplated price is fair.
Determining the final offering price is one of the underwriter's most important
responsibilities. First, the price determines the size of the capital proceeds. Second, an
accurate price estimate makes it easier for the underwriter to sell the securities. Thus, the
issuer and the underwriter work closely together to determine the price. Once an agreement is
reached on price and the SEC has made the registration statement effective, the underwriter
calls the subscribers to confirm their orders. If the demand is particularly high, the
underwriter and issuer might raise the price and reconfirm this with all the subscribers.
Once the underwriter is sure it will sell all of the shares in the offering, it closes the offering.
Then it purchases all the shares from the company (if the offering is a guaranteed offering),
and the issuer receives the proceeds minus the underwriting fees. The underwriters then sell
the shares to the subscribers at the offering price. If any subscribers have withdrawn their
bids, then the underwriters simply sell the shares to someone else or own the shares
themselves. It is important to note that the underwriters credit the shares into all subscriber
accounts (and withdraw the cash) simultaneously so that no subscriber gets a head start.
Although the underwriter influences the initial price of the securities, once the subscribers
begin selling, the free-market forces of supply and demand dictate the price. Underwriters
usually maintain a secondary market in the securities they issue, which means they agree to
purchase or sell securities out of their own inventories in order to keep the price of the
securities from swinging wildly.
Why it Matters:
Underwriters bring a company's securities to market. In so doing, investors become more
aware about the company. Issuers compensate underwriters by paying a spread, which is the
difference between what the issuer receives per share and what the underwriter sells the
shares for. For example, if Company XYZ shares had a public offering price of $10 per share,
XYZ Company might only receive $9 per share if the underwriter takes a $1 per share fee.
The $1 spread compensates the underwriter and syndicate for three things: negotiating and
managing the offering, assuming the risk of buying the securities if nobody else will, and
managing the sale of the shares. Making a market in the securities also generates commission
revenue for underwriters.
As mentioned earlier, underwriters take on considerable risk. Not only must they advise a
client about matters large and small throughout the process, they relieve the issuer of the risk
of trying to sell all the shares at the offer price. Underwriters often mitigate this risk by
forming a syndicate whose members each share a portion of the shares in return for a portion
of the fee.
Underwriters work hard to determine the "right" price for an offering, but sometimes they
leave money on the table. For example, if Company XYZ prices its 10 million share IPO at
$15 per share but the shares trade at $30 two days after the IPO, this suggests that the
underwriter probably underestimated the demand for the issue. As a result, Company XYZ
received $150 million (less underwriting fees) when it could have possibly fetched $300
million. Thus, the issuing company must also follow a robust due diligence process on their
end in order to optimize their capital raising efforts.
Public vs Private
Every for-profit corporation has stockholders, since every firm is owned by someone. There
is, however, a critical difference between a public and private corporation. A public firm is
one whose stocks you can buy in an open exchange, such as the New York Stock Exchange.
There is an openly displayed price at which the stock has just changed hands, and the stock's
issuer must make financial data freely available. Shares of private firms, however, are held by
far fewer individuals, and such companies aren't obligated to publish financial data. If you
wish to buy shares of such firms, you must get in touch with one of the shareholders, who
may or may not be willing to sell.
Going Public
Companies almost always start their lives as private firms and "go public" after they grow.
The process of going public, also known as the IPO, involves selling shares to a far larger
audience than before and publishing financial as well as other strategic information for the
world to see. A public firm must conform to many more regulations than a private company
and must actively market its shares to a large number new investors, who may never have
heard of the firm before. To help with this process, firms hire an underwriter.
IPO Underwriter
The underwriter is usually an investment bank that employs IPO specialists. These bankers
ensure that the firm satisfies all regulatory requirements, such as filing with the appropriate
bodies and depositing all fees, and makes all mandatory financial data available to the public.
Next, and perhaps most importantly, the underwriter contacts large prospective buyers of
stock, such as mutual funds and insurance companies who have large sums of money to
invest. The underwriter takes the pulse of prospective buyers and then recommends an IPO
price to the firm. This is the price at which the shares will be sold. An excessive price may
leave the firm with unsold stock, while a price that is too low will mean forgone revenue
from the stock sale.
Underwriter Guarantee
The underwriter usually provides a guarantee to the firm to sell a specific
quantity of stock during the IPO process. Should the underwriter fail to
convince prospective investors to buy this many shares, it must buy the
surplus itself. money to a failed IPO, the underwriter must therefore work
especially hard to sell all available shares. Should the underwriter end up
with a great quantity of stock, which it was forced to buy from the issuing
firm, it will sell these shares in the open market. Such sales must proceed
with caution, because suddenly dumping a lot of shares can drag the price
down, hurting both the issuer as well as the underwriter.
An underwriter is critical to the mortgage process, as he is the one who will approve
or deny the loan. He prepares a careful, detailed analysis of the loan package to
determine if a potential borrower presents an appropriate level of risk. He has total
knowledge of the lender's policies and procedures, allowing him to make sound
judgments on every application he reviews.
Loan Analysis
An underwriter must fully understand his institution's policy for approving loans, the two
most notable elements of which are acceptable loan-to-value (LTV) and debt-to-income
(DTI) ratios. Using the information in the application and supporting documents, the
underwriter calculates these ratios. If the application meets these guidelines, the underwriter
approves the loan. The underwriter must also specify closing conditions so that the file is
complete and all applicable regulations are met. For example, if his flood search reveals that
the property is in a flood hazard zone, he must require flood insurance as a condition of
closing.
Compensating Factors
While the numbers on the application are typically an accurate representation of a borrower's
ability to pay, an underwriter must know when to look at factors beyond the numbers. For
example, if the bank allows a 40 percent DTI ratio and a borrower comes in at 42 percent,
policy says that loan will be denied. However, the underwriter may see that the applicant has
long-time, stable employment, highly liquid assets and a very low LTV. The underwriter can
then approve the loan as an exception, citing the compensating factors.