Definition
Credit Enhancement
Credit enhancement is a structural feature that improves the credit quality of a securitisation, such as over-collateralisation, cash reserves or subordinated tranches.
Credit enhancement protects senior investors in a securitisation from losses by providing a buffer. Internal forms include over-collateralisation and a subordinated junior tranche that absorbs early losses; external forms include guarantees or cash collateral from the originator.
The level of enhancement determines the credit rating of the senior pass-through certificates. The RBI regulates how much enhancement an originator can provide so that true risk transfer is preserved and the deal is not effectively a disguised loan back to the originator.
Related terms
- Securitisation (Loans)Securitisation is the pooling of loans and issuing of tradable securities backed by their cash flows, letting originators raise funds and transfer risk.
- Minimum Retention Requirement (MRR)MRR is the portion of a securitised loan pool that the originating lender must keep on its own books, ensuring it retains 'skin in the game' after selling the loans.
- Pass-Through Certificate (PTC)A Pass-Through Certificate is a securitised instrument that channels the principal and interest collected from an underlying pool of loans directly through to the investors who hold it.
Plain-English explainer from Investdesk Investors Encyclopedia. General information, not financial advice.