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class="vector-sitenotice-container"> <div id="siteNotice"></div> </div> <div class="vector-column-start"> <div class="vector-main-menu-container"> <div id="mw-navigation"> <nav id="mw-panel" class="vector-main-menu-landmark" aria-label="Site"> <div id="vector-main-menu-pinned-container" class="vector-pinned-container"> </div> </nav> </div> </div> <div class="vector-sticky-pinned-container"> <nav id="mw-panel-toc" aria-label="Contents" data-event-name="ui.sidebar-toc" class="mw-table-of-contents-container vector-toc-landmark"> <div id="vector-toc-pinned-container" class="vector-pinned-container"> <div id="vector-toc" class="vector-toc vector-pinnable-element"> <div class="vector-pinnable-header vector-toc-pinnable-header vector-pinnable-header-pinned" data-feature-name="toc-pinned" data-pinnable-element-id="vector-toc" > <h2 class="vector-pinnable-header-label">Contents</h2> <button class="vector-pinnable-header-toggle-button vector-pinnable-header-pin-button" data-event-name="pinnable-header.vector-toc.pin">move to sidebar</button> <button class="vector-pinnable-header-toggle-button vector-pinnable-header-unpin-button" data-event-name="pinnable-header.vector-toc.unpin">hide</button> </div> <ul class="vector-toc-contents" id="mw-panel-toc-list"> <li id="toc-mw-content-text" class="vector-toc-list-item vector-toc-level-1"> <a href="#" class="vector-toc-link"> <div class="vector-toc-text">(Top)</div> </a> </li> <li id="toc-Types" class="vector-toc-list-item vector-toc-level-1 vector-toc-list-item-expanded"> <a class="vector-toc-link" href="#Types"> <div class="vector-toc-text"> <span class="vector-toc-numb">1</span> <span>Types</span> </div> </a> <ul id="toc-Types-sublist" class="vector-toc-list"> </ul> </li> <li id="toc-Internal_credit_enhancement" class="vector-toc-list-item vector-toc-level-1 vector-toc-list-item-expanded"> <a class="vector-toc-link" href="#Internal_credit_enhancement"> <div class="vector-toc-text"> <span class="vector-toc-numb">2</span> <span>Internal credit enhancement</span> </div> </a> <button aria-controls="toc-Internal_credit_enhancement-sublist" class="cdx-button cdx-button--weight-quiet cdx-button--icon-only vector-toc-toggle"> <span class="vector-icon mw-ui-icon-wikimedia-expand"></span> <span>Toggle Internal credit enhancement subsection</span> </button> <ul id="toc-Internal_credit_enhancement-sublist" class="vector-toc-list"> <li id="toc-Subordination_or_credit_tranching" class="vector-toc-list-item vector-toc-level-2"> <a class="vector-toc-link" href="#Subordination_or_credit_tranching"> <div class="vector-toc-text"> <span class="vector-toc-numb">2.1</span> <span>Subordination or credit tranching</span> </div> </a> <ul id="toc-Subordination_or_credit_tranching-sublist" class="vector-toc-list"> </ul> </li> <li id="toc-Excess_spread" class="vector-toc-list-item vector-toc-level-2"> <a class="vector-toc-link" href="#Excess_spread"> <div class="vector-toc-text"> <span class="vector-toc-numb">2.2</span> <span>Excess spread</span> </div> </a> <ul id="toc-Excess_spread-sublist" class="vector-toc-list"> </ul> </li> <li id="toc-Overcollateralization" class="vector-toc-list-item vector-toc-level-2"> <a class="vector-toc-link" href="#Overcollateralization"> <div class="vector-toc-text"> <span class="vector-toc-numb">2.3</span> <span>Overcollateralization</span> </div> </a> <ul id="toc-Overcollateralization-sublist" class="vector-toc-list"> </ul> </li> <li id="toc-Reserve_account" class="vector-toc-list-item vector-toc-level-2"> <a class="vector-toc-link" href="#Reserve_account"> <div class="vector-toc-text"> <span class="vector-toc-numb">2.4</span> <span>Reserve account</span> </div> </a> <ul id="toc-Reserve_account-sublist" class="vector-toc-list"> </ul> </li> </ul> </li> <li id="toc-External_credit_enhancement" class="vector-toc-list-item vector-toc-level-1 vector-toc-list-item-expanded"> <a class="vector-toc-link" href="#External_credit_enhancement"> <div class="vector-toc-text"> <span class="vector-toc-numb">3</span> <span>External credit enhancement</span> </div> </a> <button aria-controls="toc-External_credit_enhancement-sublist" class="cdx-button cdx-button--weight-quiet cdx-button--icon-only vector-toc-toggle"> <span class="vector-icon mw-ui-icon-wikimedia-expand"></span> <span>Toggle External credit enhancement subsection</span> </button> <ul id="toc-External_credit_enhancement-sublist" class="vector-toc-list"> <li id="toc-Surety_bonds" class="vector-toc-list-item vector-toc-level-2"> <a class="vector-toc-link" href="#Surety_bonds"> <div class="vector-toc-text"> <span class="vector-toc-numb">3.1</span> <span>Surety bonds</span> </div> </a> <ul id="toc-Surety_bonds-sublist" class="vector-toc-list"> </ul> </li> <li id="toc-Wrapped_securities" class="vector-toc-list-item vector-toc-level-2"> <a class="vector-toc-link" href="#Wrapped_securities"> <div class="vector-toc-text"> <span class="vector-toc-numb">3.2</span> <span>Wrapped securities</span> </div> </a> <ul id="toc-Wrapped_securities-sublist" class="vector-toc-list"> </ul> </li> <li id="toc-Letter_of_credit" class="vector-toc-list-item vector-toc-level-2"> <a class="vector-toc-link" href="#Letter_of_credit"> <div class="vector-toc-text"> <span class="vector-toc-numb">3.3</span> <span>Letter of credit</span> </div> </a> <ul id="toc-Letter_of_credit-sublist" class="vector-toc-list"> </ul> </li> <li id="toc-Cash_collateral_account" class="vector-toc-list-item vector-toc-level-2"> <a class="vector-toc-link" href="#Cash_collateral_account"> <div class="vector-toc-text"> <span class="vector-toc-numb">3.4</span> <span>Cash collateral account</span> </div> </a> <ul id="toc-Cash_collateral_account-sublist" class="vector-toc-list"> </ul> </li> </ul> </li> <li id="toc-See_also" class="vector-toc-list-item vector-toc-level-1 vector-toc-list-item-expanded"> <a class="vector-toc-link" href="#See_also"> <div class="vector-toc-text"> <span class="vector-toc-numb">4</span> <span>See also</span> </div> </a> <ul id="toc-See_also-sublist" class="vector-toc-list"> </ul> </li> <li id="toc-References" class="vector-toc-list-item vector-toc-level-1 vector-toc-list-item-expanded"> <a class="vector-toc-link" href="#References"> <div class="vector-toc-text"> <span class="vector-toc-numb">5</span> <span>References</span> </div> </a> <ul id="toc-References-sublist" class="vector-toc-list"> </ul> </li> </ul> </div> </div> </nav> </div> </div> <div class="mw-content-container"> <main id="content" class="mw-body"> <header class="mw-body-header vector-page-titlebar"> <nav aria-label="Contents" class="vector-toc-landmark"> <div id="vector-page-titlebar-toc" class="vector-dropdown vector-page-titlebar-toc vector-button-flush-left" title="Table of Contents" > <input type="checkbox" id="vector-page-titlebar-toc-checkbox" role="button" aria-haspopup="true" data-event-name="ui.dropdown-vector-page-titlebar-toc" class="vector-dropdown-checkbox 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role="presentation"><tbody><tr><td class="mbox-image"><div class="mbox-image-div"><span typeof="mw:File"><a href="/wiki/File:Question_book-new.svg" class="mw-file-description"><img alt="" src="//upload.wikimedia.org/wikipedia/en/thumb/9/99/Question_book-new.svg/50px-Question_book-new.svg.png" decoding="async" width="50" height="39" class="mw-file-element" srcset="//upload.wikimedia.org/wikipedia/en/thumb/9/99/Question_book-new.svg/75px-Question_book-new.svg.png 1.5x, //upload.wikimedia.org/wikipedia/en/thumb/9/99/Question_book-new.svg/100px-Question_book-new.svg.png 2x" data-file-width="512" data-file-height="399" /></a></span></div></td><td class="mbox-text"><div class="mbox-text-span">This article <b>needs additional citations for <a href="/wiki/Wikipedia:Verifiability" title="Wikipedia:Verifiability">verification</a></b>.<span class="hide-when-compact"> Please help <a href="/wiki/Special:EditPage/Credit_enhancement" title="Special:EditPage/Credit enhancement">improve this article</a> by <a href="/wiki/Help:Referencing_for_beginners" title="Help:Referencing for beginners">adding citations to reliable sources</a>. Unsourced material may be challenged and removed.<br /><small><span class="plainlinks"><i>Find sources:</i> <a rel="nofollow" class="external text" href="https://www.google.com/search?as_eq=wikipedia&q=%22Credit+enhancement%22">"Credit enhancement"</a> – <a rel="nofollow" class="external text" href="https://www.google.com/search?tbm=nws&q=%22Credit+enhancement%22+-wikipedia&tbs=ar:1">news</a> <b>·</b> <a rel="nofollow" class="external text" href="https://www.google.com/search?&q=%22Credit+enhancement%22&tbs=bkt:s&tbm=bks">newspapers</a> <b>·</b> <a rel="nofollow" class="external text" href="https://www.google.com/search?tbs=bks:1&q=%22Credit+enhancement%22+-wikipedia">books</a> <b>·</b> <a rel="nofollow" class="external text" href="https://scholar.google.com/scholar?q=%22Credit+enhancement%22">scholar</a> <b>·</b> <a rel="nofollow" class="external text" href="https://www.jstor.org/action/doBasicSearch?Query=%22Credit+enhancement%22&acc=on&wc=on">JSTOR</a></span></small></span> <span class="date-container"><i>(<span class="date">September 2011</span>)</i></span><span class="hide-when-compact"><i> (<small><a href="/wiki/Help:Maintenance_template_removal" title="Help:Maintenance template removal">Learn how and when to remove this message</a></small>)</i></span></div></td></tr></tbody></table> <style data-mw-deduplicate="TemplateStyles:r1129693374">.mw-parser-output .hlist dl,.mw-parser-output .hlist ol,.mw-parser-output .hlist ul{margin:0;padding:0}.mw-parser-output .hlist dd,.mw-parser-output .hlist dt,.mw-parser-output .hlist li{margin:0;display:inline}.mw-parser-output .hlist.inline,.mw-parser-output .hlist.inline dl,.mw-parser-output .hlist.inline ol,.mw-parser-output .hlist.inline ul,.mw-parser-output .hlist dl dl,.mw-parser-output .hlist dl ol,.mw-parser-output .hlist dl ul,.mw-parser-output .hlist ol dl,.mw-parser-output .hlist ol ol,.mw-parser-output .hlist ol ul,.mw-parser-output .hlist ul dl,.mw-parser-output .hlist ul ol,.mw-parser-output .hlist ul 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.sidebar:not(.notheme) .sidebar-title-with-pretitle{background:transparent!important}html.skin-theme-clientpref-os .mw-parser-output .sidebar:not(.notheme) .sidebar-title-with-pretitle a{color:var(--color-progressive)!important}}@media print{body.ns-0 .mw-parser-output .sidebar{display:none!important}}</style><table class="sidebar sidebar-collapse nomobile nowraplinks plainlist" style="width: 18em;"><tbody><tr><th class="sidebar-title"><a href="/wiki/Security_(finance)" title="Security (finance)">Securities</a></th></tr><tr><td class="sidebar-image"><span typeof="mw:File"><a href="/wiki/File:Vereinigte_Ostindische_Compagnie_bond_-_Middelburg_-_Amsterdam_-_1622.jpg" class="mw-file-description"><img src="//upload.wikimedia.org/wikipedia/commons/thumb/1/1e/Vereinigte_Ostindische_Compagnie_bond_-_Middelburg_-_Amsterdam_-_1622.jpg/250px-Vereinigte_Ostindische_Compagnie_bond_-_Middelburg_-_Amsterdam_-_1622.jpg" decoding="async" width="250" height="206" class="mw-file-element" srcset="//upload.wikimedia.org/wikipedia/commons/thumb/1/1e/Vereinigte_Ostindische_Compagnie_bond_-_Middelburg_-_Amsterdam_-_1622.jpg/375px-Vereinigte_Ostindische_Compagnie_bond_-_Middelburg_-_Amsterdam_-_1622.jpg 1.5x, //upload.wikimedia.org/wikipedia/commons/thumb/1/1e/Vereinigte_Ostindische_Compagnie_bond_-_Middelburg_-_Amsterdam_-_1622.jpg/500px-Vereinigte_Ostindische_Compagnie_bond_-_Middelburg_-_Amsterdam_-_1622.jpg 2x" data-file-width="640" data-file-height="528" /></a></span></td></tr><tr><td class="sidebar-content"> <div class="sidebar-list mw-collapsible mw-collapsed"><div class="sidebar-list-title" style="color: var(--color-base)"><a href="/wiki/Security_(finance)" title="Security (finance)">Securities</a></div><div class="sidebar-list-content mw-collapsible-content"> <ul><li><a href="/wiki/Banknote" title="Banknote">Banknote</a></li> <li><a href="/wiki/Bond_(finance)" title="Bond (finance)">Bond</a></li> <li><a href="/wiki/Debenture" title="Debenture">Debenture</a></li> <li><a href="/wiki/Derivative_(finance)" title="Derivative (finance)">Derivative</a></li> <li><a href="/wiki/Stock" title="Stock">Stock</a></li></ul></div></div></td> </tr><tr><td class="sidebar-content"> <div class="sidebar-list mw-collapsible mw-collapsed"><div class="sidebar-list-title" style="color: var(--color-base)"><a href="/wiki/Financial_market" title="Financial market">Markets</a></div><div class="sidebar-list-content mw-collapsible-content"> <ul><li><a href="/wiki/Stock_market" title="Stock market">Stock market</a></li> <li><a href="/wiki/Commodity_market" title="Commodity market">Commodity market</a></li> <li><a href="/wiki/Foreign_exchange_market" title="Foreign exchange market">Foreign exchange market</a></li> <li><a href="/wiki/Futures_exchange" title="Futures exchange">Futures exchange</a></li> <li><a href="/wiki/Over-the-counter_(finance)" title="Over-the-counter (finance)">Over-the-counter market (OTC)</a></li> <li><a href="/wiki/Spot_market" title="Spot market">Spot market</a></li></ul></div></div></td> </tr><tr><td class="sidebar-content"> <div class="sidebar-list mw-collapsible mw-collapsed"><div class="sidebar-list-title" style="color: var(--color-base)">Bonds by coupon</div><div class="sidebar-list-content mw-collapsible-content"> <ul><li><a href="/wiki/Fixed_rate_bond" class="mw-redirect" title="Fixed rate bond">Fixed rate bond</a></li> <li><a href="/wiki/Floating_rate_note" title="Floating rate note">Floating rate note</a></li> <li><a href="/wiki/Inflation-indexed_bond" title="Inflation-indexed bond">Inflation-indexed bond</a></li> <li><a href="/wiki/Perpetual_bond" title="Perpetual bond">Perpetual bond</a></li> <li><a href="/wiki/Zero-coupon_bond" title="Zero-coupon bond">Zero-coupon bond</a></li> <li><a href="/wiki/Commercial_paper" title="Commercial paper">Commercial paper</a></li></ul></div></div></td> </tr><tr><td class="sidebar-content"> <div class="sidebar-list mw-collapsible mw-collapsed"><div class="sidebar-list-title" style="color: var(--color-base)">Bonds by issuer</div><div class="sidebar-list-content mw-collapsible-content"> <ul><li><a href="/wiki/Corporate_bond" title="Corporate bond">Corporate bond</a></li> <li><a href="/wiki/Government_bond" title="Government bond">Government bond</a></li> <li><a href="/wiki/Municipal_bond" title="Municipal bond">Municipal bond</a></li> <li><a href="/wiki/Pfandbrief" title="Pfandbrief">Pfandbrief</a></li></ul></div></div></td> </tr><tr><td class="sidebar-content"> <div class="sidebar-list mw-collapsible mw-collapsed"><div class="sidebar-list-title" style="color: var(--color-base)"><a href="/wiki/Equity_(finance)" title="Equity (finance)">Equities (stocks)</a></div><div class="sidebar-list-content mw-collapsible-content"> <ul><li><a href="/wiki/Stock" title="Stock">Stock</a></li> <li><a href="/wiki/Share_(finance)" title="Share (finance)">Share</a></li> <li><a href="/wiki/Initial_public_offering" title="Initial public offering">Initial public offering (IPO)</a></li> <li><a href="/wiki/Short_(finance)" title="Short (finance)">Short selling</a></li></ul></div></div></td> </tr><tr><td class="sidebar-content"> <div class="sidebar-list mw-collapsible mw-collapsed"><div class="sidebar-list-title" style="color: var(--color-base)"><a href="/wiki/Investment_fund" title="Investment fund">Investment funds</a></div><div class="sidebar-list-content mw-collapsible-content"> <ul><li><a href="/wiki/Mutual_fund" title="Mutual fund">Mutual fund</a></li> <li><a href="/wiki/Closed-end_fund" title="Closed-end fund">Closed-end fund</a></li> <li><a href="/wiki/Exchange-traded_fund" title="Exchange-traded fund">Exchange-traded fund (ETF)</a></li> <li><a href="/wiki/Hedge_fund" title="Hedge fund">Hedge fund</a></li> <li><a href="/wiki/Index_fund" title="Index fund">Index fund</a></li> <li><a href="/wiki/Segregated_fund" title="Segregated fund">Segregated fund</a></li></ul></div></div></td> </tr><tr><td class="sidebar-content"> <div class="sidebar-list mw-collapsible mw-collapsed"><div class="sidebar-list-title" style="color: var(--color-base)"><a href="/wiki/Structured_finance" title="Structured finance">Structured finance</a></div><div class="sidebar-list-content mw-collapsible-content"> <ul><li><a href="/wiki/Securitization" title="Securitization">Securitization</a></li> <li><a href="/wiki/Agency_security" title="Agency security">Agency security</a></li> <li><a href="/wiki/Asset-backed_security" title="Asset-backed security">Asset-backed security</a></li> <li><a href="/wiki/Mortgage-backed_security" title="Mortgage-backed security">Mortgage-backed security</a></li> <li><a href="/wiki/Commercial_mortgage-backed_security" title="Commercial mortgage-backed security">Commercial mortgage-backed security</a></li> <li><a href="/wiki/Residential_mortgage-backed_security" title="Residential mortgage-backed security">Residential mortgage-backed security</a></li> <li><a href="/wiki/Tranche" title="Tranche">Tranche</a></li> <li><a href="/wiki/Collateralized_debt_obligation" title="Collateralized debt obligation">Collateralized debt obligation</a></li> <li><a href="/wiki/Collateralized_fund_obligation" title="Collateralized fund obligation">Collateralized fund obligation</a></li> <li><a href="/wiki/Collateralized_mortgage_obligation" title="Collateralized mortgage obligation">Collateralized mortgage obligation</a></li> <li><a href="/wiki/Credit-linked_note" title="Credit-linked note">Credit-linked note</a></li> <li><a href="/wiki/Unsecured_debt" title="Unsecured debt">Unsecured debt</a></li></ul></div></div></td> </tr><tr><td class="sidebar-content"> <div class="sidebar-list mw-collapsible mw-collapsed"><div class="sidebar-list-title" style="color: var(--color-base)"><a href="/wiki/Derivative_(finance)" title="Derivative (finance)">Derivatives</a></div><div class="sidebar-list-content mw-collapsible-content"> <ul><li><a href="/wiki/Forward_contract" title="Forward contract">Forward</a></li> <li><a href="/wiki/Futures_contract" title="Futures contract">Futures</a></li> <li><a href="/wiki/Option_(finance)" title="Option (finance)">Option</a></li> <li><a href="/wiki/Swap_(finance)" title="Swap (finance)">Swap</a></li> <li><a href="/wiki/Warrant_(finance)" title="Warrant (finance)">Warrant</a></li> <li><a href="/wiki/Credit_derivative" title="Credit derivative">Credit derivative</a></li> <li><a href="/wiki/Hybrid_security" title="Hybrid security">Hybrid security</a></li></ul></div></div></td> </tr><tr><td class="sidebar-navbar"><link rel="mw-deduplicated-inline-style" href="mw-data:TemplateStyles:r1129693374"><style data-mw-deduplicate="TemplateStyles:r1239400231">.mw-parser-output .navbar{display:inline;font-size:88%;font-weight:normal}.mw-parser-output .navbar-collapse{float:left;text-align:left}.mw-parser-output .navbar-boxtext{word-spacing:0}.mw-parser-output .navbar ul{display:inline-block;white-space:nowrap;line-height:inherit}.mw-parser-output .navbar-brackets::before{margin-right:-0.125em;content:"[ "}.mw-parser-output .navbar-brackets::after{margin-left:-0.125em;content:" ]"}.mw-parser-output .navbar li{word-spacing:-0.125em}.mw-parser-output .navbar a>span,.mw-parser-output .navbar a>abbr{text-decoration:inherit}.mw-parser-output .navbar-mini abbr{font-variant:small-caps;border-bottom:none;text-decoration:none;cursor:inherit}.mw-parser-output .navbar-ct-full{font-size:114%;margin:0 7em}.mw-parser-output .navbar-ct-mini{font-size:114%;margin:0 4em}html.skin-theme-clientpref-night .mw-parser-output .navbar li a abbr{color:var(--color-base)!important}@media(prefers-color-scheme:dark){html.skin-theme-clientpref-os .mw-parser-output .navbar li a abbr{color:var(--color-base)!important}}@media print{.mw-parser-output .navbar{display:none!important}}</style><div class="navbar plainlinks hlist navbar-mini"><ul><li class="nv-view"><a href="/wiki/Template:Securities" title="Template:Securities"><abbr title="View this template">v</abbr></a></li><li class="nv-talk"><a href="/wiki/Template_talk:Securities" title="Template talk:Securities"><abbr title="Discuss this template">t</abbr></a></li><li class="nv-edit"><a href="/wiki/Special:EditPage/Template:Securities" title="Special:EditPage/Template:Securities"><abbr title="Edit this template">e</abbr></a></li></ul></div></td></tr></tbody></table> <figure class="mw-default-size" typeof="mw:File/Thumb"><a href="/wiki/File:Borrowing_Under_a_Securitization_Structure.png" class="mw-file-description"><img src="//upload.wikimedia.org/wikipedia/commons/thumb/b/bc/Borrowing_Under_a_Securitization_Structure.png/220px-Borrowing_Under_a_Securitization_Structure.png" decoding="async" width="220" height="191" class="mw-file-element" srcset="//upload.wikimedia.org/wikipedia/commons/thumb/b/bc/Borrowing_Under_a_Securitization_Structure.png/330px-Borrowing_Under_a_Securitization_Structure.png 1.5x, //upload.wikimedia.org/wikipedia/commons/thumb/b/bc/Borrowing_Under_a_Securitization_Structure.png/440px-Borrowing_Under_a_Securitization_Structure.png 2x" data-file-width="606" data-file-height="526" /></a><figcaption>Borrowing under a <a href="/wiki/Securitization" title="Securitization">securitization</a> structure</figcaption></figure> <p><b>Credit enhancement</b> is the improvement of the credit profile of a structured financial transaction or the methods used to improve the credit profiles of such products or transactions. It is a key part of the <a href="/wiki/Securitization_transaction" class="mw-redirect" title="Securitization transaction">securitization transaction</a> in <a href="/wiki/Structured_finance" title="Structured finance">structured finance</a>, and is important for <a href="/wiki/Credit_rating_agency" title="Credit rating agency">credit rating agencies</a> when rating a <a href="/wiki/Securitization" title="Securitization">securitization</a>. </p> <meta property="mw:PageProp/toc" /> <div class="mw-heading mw-heading2"><h2 id="Types">Types</h2><span class="mw-editsection"><span class="mw-editsection-bracket">[</span><a href="/w/index.php?title=Credit_enhancement&action=edit&section=1" title="Edit section: Types"><span>edit</span></a><span class="mw-editsection-bracket">]</span></span></div> <p>There are two primary types of credit enhancement: internal and external. </p> <div class="mw-heading mw-heading2"><h2 id="Internal_credit_enhancement">Internal credit enhancement</h2><span class="mw-editsection"><span class="mw-editsection-bracket">[</span><a href="/w/index.php?title=Credit_enhancement&action=edit&section=2" title="Edit section: Internal credit enhancement"><span>edit</span></a><span class="mw-editsection-bracket">]</span></span></div> <div class="mw-heading mw-heading3"><h3 id="Subordination_or_credit_tranching">Subordination or credit tranching</h3><span class="mw-editsection"><span class="mw-editsection-bracket">[</span><a href="/w/index.php?title=Credit_enhancement&action=edit&section=3" title="Edit section: Subordination or credit tranching"><span>edit</span></a><span class="mw-editsection-bracket">]</span></span></div> <p>Establishing a senior/subordinated structure is one of the most popular techniques to create internal credit enhancement. Cash flows generated by assets are allocated with different priorities to classes of varying seniorities. The senior/subordinated structure thus consists of several tranches, from the most senior to the most subordinated (or junior). The subordinated tranches function as protective layers of the more senior tranches. The tranche with the highest seniority has the first right on cash flow. </p><p>Such protection comes under a waterfall structure. Priority for cash flow comes from the top, while distribution of losses rises from the bottom. If an asset in the pool defaults, the losses thus incurred are allocated from the bottom up (from the most junior to the most senior tranche). The senior tranche (often rated AAA) is unaffected, unless the amount of the losses exceeds the amount in the subordinated tranches. </p> <div class="mw-heading mw-heading3"><h3 id="Excess_spread">Excess spread</h3><span class="mw-editsection"><span class="mw-editsection-bracket">[</span><a href="/w/index.php?title=Credit_enhancement&action=edit&section=4" title="Edit section: Excess spread"><span>edit</span></a><span class="mw-editsection-bracket">]</span></span></div> <p>The excess spread is the difference between the interest rate received on the underlying collateral and the coupon on the issued security. It is typically one of the first defenses against loss. Even if some of the underlying loan payments are late or default, the coupon payment can still be made. In the process of "turboing", excess spread is applied to outstanding classes as principal.<sup id="cite_ref-Dwight_1-0" class="reference"><a href="#cite_note-Dwight-1"><span class="cite-bracket">[</span>1<span class="cite-bracket">]</span></a></sup> </p> <div class="mw-heading mw-heading3"><h3 id="Overcollateralization">Overcollateralization</h3><span class="mw-editsection"><span class="mw-editsection-bracket">[</span><a href="/w/index.php?title=Credit_enhancement&action=edit&section=5" title="Edit section: Overcollateralization"><span>edit</span></a><span class="mw-editsection-bracket">]</span></span></div> <p>Overcollateralization (OC) is a commonly used form of credit enhancement. With this support structure, the face value of the underlying loan portfolio is larger than the security it backs, thus the issued security is overcollateralized. In this manner, even if some of the payments from the underlying loans are late or default, principal and interest payments on the ABS (<a href="/wiki/Asset-backed_security" title="Asset-backed security">asset-backed security</a>) can still be made.<sup id="cite_ref-Dwight_1-1" class="reference"><a href="#cite_note-Dwight-1"><span class="cite-bracket">[</span>1<span class="cite-bracket">]</span></a></sup> </p> <div class="mw-heading mw-heading3"><h3 id="Reserve_account">Reserve account</h3><span class="mw-editsection"><span class="mw-editsection-bracket">[</span><a href="/w/index.php?title=Credit_enhancement&action=edit&section=6" title="Edit section: Reserve account"><span>edit</span></a><span class="mw-editsection-bracket">]</span></span></div> <p>A reserve account is created to reimburse the issuing trust for losses up to the amount allocated for the reserve. To increase credit support, the reserve account will often be non-declining throughout the life of the security, meaning that the account will increase proportionally up to some specified level as the outstanding debt is paid off.<sup id="cite_ref-Dwight_1-2" class="reference"><a href="#cite_note-Dwight-1"><span class="cite-bracket">[</span>1<span class="cite-bracket">]</span></a></sup> </p> <div class="mw-heading mw-heading2"><h2 id="External_credit_enhancement">External credit enhancement</h2><span class="mw-editsection"><span class="mw-editsection-bracket">[</span><a href="/w/index.php?title=Credit_enhancement&action=edit&section=7" title="Edit section: External credit enhancement"><span>edit</span></a><span class="mw-editsection-bracket">]</span></span></div> <div class="mw-heading mw-heading3"><h3 id="Surety_bonds">Surety bonds</h3><span class="mw-editsection"><span class="mw-editsection-bracket">[</span><a href="/w/index.php?title=Credit_enhancement&action=edit&section=8" title="Edit section: Surety bonds"><span>edit</span></a><span class="mw-editsection-bracket">]</span></span></div> <style data-mw-deduplicate="TemplateStyles:r1236090951">.mw-parser-output .hatnote{font-style:italic}.mw-parser-output div.hatnote{padding-left:1.6em;margin-bottom:0.5em}.mw-parser-output .hatnote i{font-style:normal}.mw-parser-output .hatnote+link+.hatnote{margin-top:-0.5em}@media print{body.ns-0 .mw-parser-output .hatnote{display:none!important}}</style><div role="note" class="hatnote navigation-not-searchable">Main article: <a href="/wiki/Surety_bond" class="mw-redirect" title="Surety bond">Surety bond</a></div> <p><a href="/wiki/Surety_bond" class="mw-redirect" title="Surety bond">Surety bonds</a> are insurance policies that reimburse the ABS for any losses. They are external forms of credit enhancement. ABS paired with surety bonds have ratings that are the same as that of the surety bond’s issuer.<sup id="cite_ref-Dwight_1-3" class="reference"><a href="#cite_note-Dwight-1"><span class="cite-bracket">[</span>1<span class="cite-bracket">]</span></a></sup> By law, surety companies cannot provide a bond as a form of a credit enhancement guarantee. </p> <div class="mw-heading mw-heading3"><h3 id="Wrapped_securities">Wrapped securities</h3><span class="mw-editsection"><span class="mw-editsection-bracket">[</span><a href="/w/index.php?title=Credit_enhancement&action=edit&section=9" title="Edit section: Wrapped securities"><span>edit</span></a><span class="mw-editsection-bracket">]</span></span></div> <p>A wrapped security is insured or guaranteed by a third party. A third party or, in some cases, the parent company of the ABS issuer may provide a promise to reimburse the trust for losses up to a specified amount. Deals can also include agreements to advance principal and interest or to buy back any defaulted loans. The third-party guarantees are typically provided by AAA-rated financial guarantors or <a href="/wiki/Monoline_insurance" class="mw-redirect" title="Monoline insurance">monoline insurance</a> companies.<sup id="cite_ref-Dwight_1-4" class="reference"><a href="#cite_note-Dwight-1"><span class="cite-bracket">[</span>1<span class="cite-bracket">]</span></a></sup> </p> <div class="mw-heading mw-heading3"><h3 id="Letter_of_credit">Letter of credit</h3><span class="mw-editsection"><span class="mw-editsection-bracket">[</span><a href="/w/index.php?title=Credit_enhancement&action=edit&section=10" title="Edit section: Letter of credit"><span>edit</span></a><span class="mw-editsection-bracket">]</span></span></div> <link rel="mw-deduplicated-inline-style" href="mw-data:TemplateStyles:r1236090951"><div role="note" class="hatnote navigation-not-searchable">Main article: <a href="/wiki/Letter_of_credit" title="Letter of credit">Letter of credit</a></div> <p>With a <a href="/wiki/Letter_of_credit" title="Letter of credit">letter of credit</a> (LOC), a financial institution — usually a bank — is paid a fee to provide a specified cash amount to reimburse the ABS-issuing trust for any cash shortfalls from the collateral, up to the required credit support amount. Letters of credit are becoming less common forms of credit enhancement, as much of their appeal was lost when the rating agencies downgraded the long-term debt of several LOC-provider banks in the early 1990s. Because securities enhanced with LOCs from these lenders faced possible downgrades as well, issuers began to utilize cash collateral accounts instead of LOCs in cases where external credit support was needed.<sup id="cite_ref-Dwight_1-5" class="reference"><a href="#cite_note-Dwight-1"><span class="cite-bracket">[</span>1<span class="cite-bracket">]</span></a></sup> </p> <div class="mw-heading mw-heading3"><h3 id="Cash_collateral_account">Cash collateral account</h3><span class="mw-editsection"><span class="mw-editsection-bracket">[</span><a href="/w/index.php?title=Credit_enhancement&action=edit&section=11" title="Edit section: Cash collateral account"><span>edit</span></a><span class="mw-editsection-bracket">]</span></span></div> <p>With a cash collateral account (CCA), credit enhancement is achieved when the issuer borrows the required credit support amount from a commercial bank and then deposits this cash in short-term commercial paper that has the highest available credit quality. Because a CCA is an actual deposit of cash, a downgrade of the CCA provider would not result in a similar downgrade of the security.<sup id="cite_ref-Dwight_1-6" class="reference"><a href="#cite_note-Dwight-1"><span class="cite-bracket">[</span>1<span class="cite-bracket">]</span></a></sup> </p> <div class="mw-heading mw-heading2"><h2 id="See_also">See also</h2><span class="mw-editsection"><span class="mw-editsection-bracket">[</span><a href="/w/index.php?title=Credit_enhancement&action=edit&section=12" title="Edit section: See also"><span>edit</span></a><span class="mw-editsection-bracket">]</span></span></div> <ul><li><a href="/wiki/Pooled_investment" class="mw-redirect" title="Pooled investment">Pooled investment</a></li> <li><a href="/wiki/Senior_stretch_loan" title="Senior stretch loan">Senior stretch loan</a></li></ul> <div class="mw-heading mw-heading2"><h2 id="References">References</h2><span class="mw-editsection"><span class="mw-editsection-bracket">[</span><a href="/w/index.php?title=Credit_enhancement&action=edit&section=13" title="Edit section: References"><span>edit</span></a><span class="mw-editsection-bracket">]</span></span></div> <div class="mw-references-wrap"><ol class="references"> <li id="cite_note-Dwight-1"><span class="mw-cite-backlink">^ <a href="#cite_ref-Dwight_1-0"><sup><i><b>a</b></i></sup></a> <a href="#cite_ref-Dwight_1-1"><sup><i><b>b</b></i></sup></a> <a href="#cite_ref-Dwight_1-2"><sup><i><b>c</b></i></sup></a> <a href="#cite_ref-Dwight_1-3"><sup><i><b>d</b></i></sup></a> <a href="#cite_ref-Dwight_1-4"><sup><i><b>e</b></i></sup></a> <a href="#cite_ref-Dwight_1-5"><sup><i><b>f</b></i></sup></a> <a href="#cite_ref-Dwight_1-6"><sup><i><b>g</b></i></sup></a></span> <span class="reference-text">Fixed Income Sectors: Asset-Backed Securities A primer on asset-backed securities, Dwight Asset Management Company 2005</span> </li> </ol></div> <div class="navbox-styles"><link rel="mw-deduplicated-inline-style" 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