Originally Posted by FLMountainMan
Just to be the Devil's Advocate (because I think it's a bad idea) - couldn't the bank give guidelines for the level of risk they thought was acceptable? Then they would have some indemnification against the underwriting company and would presumably save money by outsourcing that department (huge if, I know). And why the disparity in how it's done amongst credit unions vs. banks? Is it as simple as credit unions are small-time and banks are big-time? Or is there some banking regulation I'm unaware of?
Well, this is a really broad reaching question. Bank lending covers such a large scope and underwriting them is highly diversified. For example:
--Other personal lending
--Commercial Real Estate
--Government and Institutions
--Specialized Industries (O&G reserve lending, auto dealership floorplan and consumer, etc.)
--Capital Markets debt lending (both investment grade and high-yield)
--Middle Market cash flow
--Asset based lending
I'm sure there are more. Each of these areas is a completely different underwriting model and big banks that are involved in some or all of these have highly specialized underwriting groups and line credit officers that focus pretty much on a single area and become specialized in that.
To my knowledge, the only area where the underwriting got outsourced was consumer mortgage lending and I'm no expert in that area, but I believe that it had to do with the fact that the government guaranteed a lot of those loans, so the underwriting standards were, at least ostensibly, pretty cut and dry. We see how well that worked out.
In other areas of underwriting this isn't the case. I do underwriting for large commercial loans and it's more akin to making a custom suit than to buying off the rack. We have a structuring group that tries to do some upfront analysis and puts out a term-sheet to outline the transaction, but often in the course of the due diligence, we find issues that require us (or permit us) to make changes to the transaction. While it is theoretically possible that an outside service could manage this process, only someone within the bank's operational and/or credit chain is going to be able to make the final decision on the risk/reward offsets of a particular transaction.
All that said, there are parts of our due diligence that we do outsource. My specific experience is with middle market lending with deal sizes between, say $25MM and $2B or so. We used to have internal appraisers. That department got downsized and we were left with one guy who managed hiring appraisers and reviewed their reports. Now he's gone and my group hires the appraiser and reviews their reports. We have an internal field examination group that does detailed collateral due diligence on both new transactions and monitoring of portfolio transactions. In order to manage headcount in that group we often outsource that function, but we maintain group managers that supervise and review their work and are responsible for the final product. So there are some aspects of the underwriting, that we do outsource. However, these are only service functions to the ultimate underwriting.
I think that generally, underwriting and managing of risk is something that most banks consider a core competency that they want to maintain in house.