CREDIT ENHANCEMENT MECHANISMS

The mechanisms for credit enhancement can be classified into three categories: (1) originator-provided, (2) structural, and (3) third-party provided. Originator-provided credit enhancement refers to credit support where a part of the credit risk of the asset pool is assumed by the originator/seller. Structural credit enhancement refers to the redistribution of credit risks among the bond classes comprising the structure, so that one bond class provides credit enhancement to the other bond classes. Third-party credit enhancement refers to the assumption of credit risk by parties other than the originator and the other bond classes in the structure. We discuss each type of credit enhancement in the rest of this section.

Originator-Provided Credit Enhancements

Originator-provided credit enhancement essentially involves the originator/seller injecting an equity contribution into the transaction. This can come in the form of cash, assets in excess of the liabilities, or retained profits. In addition, typically the originator/seller will invest in the subordinated bond class. The form of equity contributed does have implications for the securitizer.

Excess Spread or Profit

Excess spread is the most natural form of enhancement and the one that is least burdensome to the originator/seller. The idea of excess spread is simple: Whatever is available from the income of the transaction (after meeting senior expenses) to meet losses on the assets is credit-enhancing ...

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