Why is a cash collateral account an external credit enhancement?

CFA Level I
#1

To me sounds more like an internal credit enhancement, just like a reserve account is. Can someone help?
Thanks guys.

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#2

Greetings friend! Internal credit enhancements are internal/structural. Typically you’re talking about tranche structure, over collateralization (putting more assets into the ABS) or yield spread (with excess spread being set aside in a reserve account in case of future shortfalls).

External credit enhancements refer to things that improve the ABS credit rating either with third party support or external funding. A cash collateral account comprises money borrowed from a bank and invested in 1-month commercial paper (money borrowed from a bank = help from external funding). If the ABS issuer lacks money to make future payments, it will use the money from the maturing commercial paper, that it purchased with the borrowed bank funds, to make the payments to ABS investors. Does this help?

Cheers - good luck - you got this :+1:

#3

Hello Greybeard,

I was confused because i couldn’t understand why a cash reserve account would be an internal credit enhancement and a cash collateral account would be an external one. With your explanation, i now get that the “money borrowed from a bank” nature of a cash collateral account, makes it necessarly an external credit enhancement. Thanks a lot for your help sir.

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