Obscure Banking Question

Because the last thing a bank wants is shitty loans on their books. And if they are securitizing, being known for bad loans isn't exactly a reputation-maker.

The correct answer is: just because.

I figured that underwriters get a commission for every loan that goes through. If a 3rd party did it they would just approve as many loans as they could just for the payday.

If the bank's employees did it their bosses would say "WTF are you stupid or something "how could this person who makes $35k afford a $500k loan?" At least in theory anyway.

I don't see what the rationale is for a bank to underwrite bad loans. High default rates destroy a bank's operations and can sink the entire enterprise (I've seen it happen at my own clients). It has less to do with "getting away with it" and more to do with not wanting shitty loans on your books. There was a lesson learned in the last few years, which is that it is still important to know your customer and that ramping up origination volume beyond your means will eventually bite you in the ass.


Welcome to the mortgage crisis.

Well, this is a really broad reaching question. Bank lending covers such a large scope and underwriting them is highly diversified. For example:

Consumer lending:
--Mortgages
--Credit Cards
--Other personal lending
Business/Enterprise 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.

They do, it's called loan syndication. I guess every bank that take a piece of a syndicated deal can do their own diligence etc. but all the structuring pricing etc. gets done by the arranger(s).

True, but every syndicated deal I've ever worked on was at least reviewed by an in-house underwriter at each participant bank who prepared an approval memo for his credit authorities the same way he would if they were leading the deal. Also, the participants sometimes have input on structuring issues. Well...in my experience, they always give input. Whether or not the agent accepts their input is another matter. But, if the agent gets too far out of market it won't get syndicated.

At least this is true in my little corner of the world.

Not sure how it is in other parts, but where I work, we take owership of the deals we write and approve. Knowing the client, their reputation, the industry, and the market is all local knowledge that should be known to the guy directly handling the loan before a penny goes out the door.

Why did MS get banned?