Understanding Credit-Enhancing Interest-Only Strip: A Comprehensive Guide
Definition & Meaning
A credit-enhancing interest-only strip is a type of asset that banks hold on their balance sheets. It gives the bank the right to receive some or all of the interest payments from assets that have been transferred to another party. This asset also exposes the bank to credit risk that goes beyond its proportional claim on the transferred assets. This risk can arise from various factors, including subordination provisions or other credit enhancement methods.
Legal Use & context
This term is commonly used in banking and finance law, particularly in contexts involving asset-backed securities and structured finance. Credit-enhancing interest-only strips are relevant in transactions where banks transfer assets but retain some rights to the income generated from those assets. Users may encounter forms related to these transactions, which can be managed using US Legal Forms templates designed by qualified attorneys.
Real-world examples
Here are a couple of examples of abatement:
Example 1: A bank transfers a pool of mortgages to a trust but retains the right to receive interest payments on a portion of those mortgages. The bank's interest-only strip allows it to benefit from the interest while taking on additional credit risk associated with the mortgages.
Example 2: A financial institution issues a credit-enhancing interest-only strip as part of a structured finance deal, where it retains a subordinate position in the cash flow from the underlying assets (hypothetical example).