Credit Support

Credit Support

Credit support is a measure taken to reduce the risk of default on a loan or other financial asset. In the context of securitisations, credit support is typically used to increase the credit rating of the securities that are issued to investors. Credit support can be provided in a number of ways, including:

• Reserve fund: A reserve fund is a pool of money that is set aside to cover losses in the event of defaults on the underlying assets.
• Overcollateralisation: Overcollateralisation occurs when the value of the underlying assets exceeds the amount of debt that is issued. This means that even if some of the underlying assets default, there will still be enough money to pay off the debt.
• Senior/subordinated tranches: In a senior/subordinated structure, the senior tranches have a higher priority claim on the cash flows from the underlying assets than the subordinated tranches. This means that if there are any losses, the subordinated tranches will bear the losses first.
• Credit enhancement: Credit enhancement is a general term for any mechanism that is used to reduce the credit risk of a securitisation.

Credit support can be used to improve the credit rating of a securitisation, which can make it more attractive to investors. However, credit support also comes at a cost, as it reduces the amount of money that is available to investors.

Here are some examples of credit support in securitisation:

• A securitisation of mortgages might have a reserve fund of 5% of the face value of the mortgages. This means that if 5% of the mortgages default, the reserve fund will be used to pay off the debt.
• A securitisation of credit cards might be overcollateralised by 10%. This means that the value of the underlying credit cards is 10% greater than the amount of debt that is issued.
• A securitisation of loans might have a senior/subordinated structure, with the senior tranches having a 90% priority claim on the cash flows from the underlying assets. This means that if there are any losses, the subordinated tranches will bear the losses first.