techniques used to improve the credit rating of an asset-backed security or a municipal bond, generally to get an investment grade rating from a bond rating agency and to improve the marketability of the securities to investors. There are two general classifications of credit enhancements: third-party enhancement, in which a third party pledges its own creditworthiness and guarantees repayment in exchange for a fee; and self-enhancement, which is generally done by the issuer through over collateralization i.e., pledging loans with a book value greater than the face value of the bonds offered for sale.
Third party enhancements take the form of a standby letter of credit or commercial letter of creditissued by a bank, a surety bond from an insurance company, or a special reserve fund managed by a financial guarantee firm. The type of enhancement used and the amount of credit protection purchased varies according to the characteristics of the portfolio. Holders of the securities issued have recourse against the guarantor to the extent of the guarantee. Lines of credit are sometimes referred to as soft capital because they would not ordinarily be called upon.
techniques used by debt issuers to raise the credit rating of their offering and thereby lower their interest costs. A municipality may have its bonds insured by one of the large insurance companies such as Municipal Bond Investor's Assurance (MBIA) or American Municipal Bond Assurance Corporation (AMBAC), thereby raising the bond's credit rating.
techniques used by debt issuers to raise the credit rating of their offering, and thereby lower their interest costs. A municipality may have their bond insured by one of the large insurance companies such as Municipal Bond Investor's Assurance (MBIA) or American Municipal Bond Assurance Corporation (AMBAC), thereby raising the bond's credit rating to AAA. A corporate bond issuer may arrange for a bank letter of credit to back its issue, raising its rating to AAA. While investors in such credit-enhanced issuers feel safer because an insurance company or bank stands ready to step in if there is a default by the underlying issuer, the yield received by the investor is lower than if the bond were uninsured.
any of a series of methods that reduce the risk of extending credit to a specific individual or company.
Example: A credit enhancement can be provided by using credit insurance, a guaranty, collateral, a letter of credit, or additional borrowers. Each method offers the lendersome recourse in the event of borrower default.
