Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Underwriting Fees

What it is:

In the securities industry, underwriting fees are the fees earned by an investment bank to help bring a company public or to conduct some other offering.

In the mortgage business, an underwriting fee is often a fee charged by a mortgage lender for preparing the loan and associated paperwork. They are typically a percentage of the loan amount and are paid at closing.

How it works (Example):

When a company decides it wants to issue stock, bonds or other publicly traded securities, it hires an underwriter. After determining the offering structure, the underwriter usually assembles a group of other investment banks and brokerage firms that commit to sell a certain percentage of the offering.

The issuer and the underwriter work closely together to determine the price of the offering. 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, which are typically 3% to 7% of the amount of capital being raised.

The underwriters then sell the shares to the subscribers at the offering price.
 

Why it Matters:

Underwriting fees are important because they pay the people who grease the skids for bringing securities to market. The fees compensate 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.

Underwriters work hard to determine the "right" price for an offering, but sometimes they "leave money on the table." For example, if XYZ Company 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, XYZ Company received $150 million (less underwriting fees) when it could have possibly fetched $300 million. In turn, the underwriting fees are lower than they could have been. The knowledge of this consequence is what encourages underwriters to seek the highest price possible for an offering, which also benefits the client's shareholders.