Credit enhancement

Cash flows generated by assets are allocated with different priorities to classes of varying seniorities.

If an asset in the pool defaults, the losses thus incurred are allocated from the bottom up (from the most junior to the most senior tranche).

The excess spread is the difference between the interest rate received on the underlying collateral and the coupon on the issued security.

[1] By law, surety companies cannot provide a bond as a form of a credit enhancement guarantee.

A third party or, in some cases, the parent company of the ABS issuer may provide a promise to reimburse the trust for losses up to a specified amount.

Deals can also include agreements to advance principal and interest or to buy back any defaulted loans.

The third-party guarantees are typically provided by AAA-rated financial guarantors or monoline insurance companies.