Credit Enhancement

Credit enhancement is an essential part of a securitization transaction and is usually determined by rating agencies in order to determine the rating of an asset-backed security . There are different types of credit enhancements. A general distinction is made between structure-related credit enhancement and external credit enhancement.

Structural credit enhancement

Excess spread

The excess spread is the difference between the interest payments received on the underlying collateral and the coupon of the asset-backed securities issued . The excess spread is usually a first-loss tranche.

Overcollateralization

Overcollateralization is a type of overcollateralisation (civil law) and a common form of credit enhancement. Overcollateralization means that the security ( mortgage , mortgage , deposit , security assignment , etc.) and their cash flows are higher than the securities issued (and possibly their coupon payments and other transaction costs).

Reserve account

A reserve account (or spread account), i.e. the protection against losses up to a certain amount, is usually also used as overcollateralization. The protection amount of the reserve account can only be paid in during the transaction, but it can also be reduced proportionally to the redemption of the securities.

External credit enhancement

Wrapped Securities

Wrapped securities are asset-backed securities that are additionally protected against credit risk by an insurance company (monoline insurer).

Cash collateral account

Credit enhancement can also be achieved with a Cash Collateral Account (CCA). The guarantor can borrow a certain amount from a bank and invest it in short-term money market instruments with the highest available credit rating.