Support feature intended to reduce credit risk to certain mortgage-backed security investors.
Credit enhancement is a support feature intended to reduce credit risk to certain mortgage-backed security investors.
Credit enhancement matters because not every MBS relies on the same support structure. Agency MBS often rely on agency or government-related support, while non-agency MBS may use deal-level credit support to absorb losses before they reach certain investor classes.
For borrowers, the term is indirect but useful. It explains why non-agency securities can have layered structures, different investor classes, and pricing that reflects collateral and credit-risk support.
Borrowers usually encounter credit-enhancement concepts only indirectly, when learning why some mortgage types fit agency execution and others move through non-agency channels.
The term becomes practical when comparing Agency MBS with Non-Agency MBS or trying to understand why jumbo and nonstandard loans may be funded differently.
| Support idea | What it tries to do |
|---|---|
| Senior-Subordinate Structure | Allocates losses to subordinate classes before senior classes |
| Excess Spread | Uses extra interest cash flow as a cushion |
| Overcollateralization | Uses collateral value greater than issued securities in some structures |
| Reserve account | Sets aside funds for certain transaction needs |
A non-agency MBS contains several investor classes. A subordinate class absorbs certain losses before the senior class, making the senior class less exposed to initial credit losses.
Credit enhancement differs from Agency Guarantee because an agency guarantee is a specific support framework in agency securities, while credit enhancement is a broader support concept.
It differs from Senior-Subordinate Structure because senior-subordinate structure is one method of credit enhancement.
It also differs from Tranche because a tranche is an investor class, while credit enhancement describes support intended to protect certain classes.