Credit Enhancement refers to the use of the credit of an entity to provide additional security in bond or note financing. This term typically is used in the context of bank letters of credit, bond insurance, and state or federal credit programs, but also may refer more broadly to the use of any form of guaranty, secondary source of payment, rating, or similar additional credit-improving instruments.
Letter of Credit
A commitment, usually issued by a commercial bank, used to guarantee the payment of principal and interest on debt issues. In municipal financings, bank letters of credit are sometimes used as additional sources of security for issues of municipal notes or bonds, with the bank issuing the letter of credit committing to pay principal of and interest on the securities in the event of non-payment or default.
A guarantee by an insurance company to make scheduled payment of interest and principal of a bond issue in the event that the borrower is unable to make those payments on time. The cost of insurance is usually paid by the borrower in case of a new issue of bonds, and the insurance is not purchased unless the cost is far more than offset by the lower interest rate that may result from the use of the insurance.
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