#analyst #fixed #income
Credit Enhancement
Credit enhancement reduces credit risks. Internal credit enhancement considerations include:
- Tranche structure. The senior tranches get paid first, and the subordinated tranches get paid only if there are enough funds left. The subordinated tranches absorb the credit risk, making the senior tranches less risky.
- Overcollateralization. The amount of overcollateralization can be used to absorb losses. If the liability of the structure is $100 million and the collateral's value is $105 million, then the first $5 million loss will not result in a loss to any of the tranches.
- Excess spread. Underlying assets support a higher level of payment than that promised to security holders.
External credit enhancements are financial guarantees from third parties. Examples include surety bonds, bank guarantees, and letters of credit. If the third-party defaults, the external credit enhancement will fail. A cash collateral account can mitigate this concern.
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Subject 2. Bond Indenture unsecured bond is not secured by collateral.
Covered bonds are debts issued by banks that are fully collateralized by residential or commercial mortgage loans or by loans to public sector institutions.
<span>Credit Enhancement
Credit enhancement reduces credit risks. Internal credit enhancement considerations include:
Tranche structure. The senior tranches get paid first, and the subordinated tranches get paid only if there are enough funds left. The subordinated tranches absorb the credit risk, making the senior tranches less risky. Overcollateralization. The amount of overcollateralization can be used to absorb losses. If the liability of the structure is $100 million and the collateral's value is $105 million, then the first $5 million loss will not result in a loss to any of the tranches. Excess spread. Underlying assets support a higher level of payment than that promised to security holders.
External credit enhancements are financial guarantees from third parties. Examples include surety bonds, bank guarantees, and letters of credit. If the third-party defaults, the external credit enhancement will fail. A cash collateral account can mitigate this concern.
Bond Covenants
Affirmative covenants set forth certain actions that borrowers must take, such as:
Paying interest and principal on a timely Summary
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