Underwriting, the term is related to financial markets for a long time now. Underwriting is predominantly done in investment banking, insurance, commercial banking, NBFCs etc... The term underwriting means, the willingness to cover a potential contingent risk.
Over here I shall be only dealing with the NBFC aspect of credit underwriting in asset based finance. In this context, underwriting is the assessment / judgement of the borrower's credibility and agreeing to fund loans. The risk over here is that the borrower would default in the loan & thus would fail to repay the loan. The underwriting fee is the interest charged at regular time intervals till the time balance is due on the loan contract.
There are different aspects in underwriting process :--
1. Measurement/analysis of any potential risk
2. Market feedback
3. Credit Bureau report
1. Measurement/analysis of any potential risk- There can be an array of risk in funding to customers based on asset. The cash flow generation can be from the deployment & utilization of the asset. Over here market risk plays a key role. The underwriter gauges the current market scenario and takes the decision accordingly. Any favorable market would result in aggressive funding while negative market would result in defensive funding. Other cash flow generation can be from other sources of business activity, whereby credit risk and interest risk plays a role. If party is having a a lot of debt already in the market then its a sign of high credit risk and similarly any rising interest rate environment would eat away a share of the profitability thus decline its Debt Service Coverage Ratio (DSCR).
2. Market feedback- Feedback about the customer from the market is very important. This gives us knowledge about the customer's business activities, relation with stakeholders, past business encounters & details. It is to know the customer and check that the finance is not for money laundering / illegal purposes. Often underwriters visit locations for PD & also for delinquency control to enhance their own knowledge about the customer and locality and potential business activity in future
3. Credit Bureau report- There a few credit bureau which captures the database and details of loans taken by the customer in past. This helps to understand the customer repayment behavior, no. of loans taken, Overdue amount and other details.
For large customers and loans taken financial statements are checked and seen their credibility. Ratio analysis and balance sheet figures help in this analysis.
It is an art that is gained by years and hours of practice and experience. There are many other aspects in portfolio management which is not included in this extract. I shall discuss about the portfolio management in due course of time.
Over here I shall be only dealing with the NBFC aspect of credit underwriting in asset based finance. In this context, underwriting is the assessment / judgement of the borrower's credibility and agreeing to fund loans. The risk over here is that the borrower would default in the loan & thus would fail to repay the loan. The underwriting fee is the interest charged at regular time intervals till the time balance is due on the loan contract.
There are different aspects in underwriting process :--
1. Measurement/analysis of any potential risk
2. Market feedback
3. Credit Bureau report
1. Measurement/analysis of any potential risk- There can be an array of risk in funding to customers based on asset. The cash flow generation can be from the deployment & utilization of the asset. Over here market risk plays a key role. The underwriter gauges the current market scenario and takes the decision accordingly. Any favorable market would result in aggressive funding while negative market would result in defensive funding. Other cash flow generation can be from other sources of business activity, whereby credit risk and interest risk plays a role. If party is having a a lot of debt already in the market then its a sign of high credit risk and similarly any rising interest rate environment would eat away a share of the profitability thus decline its Debt Service Coverage Ratio (DSCR).
2. Market feedback- Feedback about the customer from the market is very important. This gives us knowledge about the customer's business activities, relation with stakeholders, past business encounters & details. It is to know the customer and check that the finance is not for money laundering / illegal purposes. Often underwriters visit locations for PD & also for delinquency control to enhance their own knowledge about the customer and locality and potential business activity in future
3. Credit Bureau report- There a few credit bureau which captures the database and details of loans taken by the customer in past. This helps to understand the customer repayment behavior, no. of loans taken, Overdue amount and other details.
For large customers and loans taken financial statements are checked and seen their credibility. Ratio analysis and balance sheet figures help in this analysis.
It is an art that is gained by years and hours of practice and experience. There are many other aspects in portfolio management which is not included in this extract. I shall discuss about the portfolio management in due course of time.
