Credit Enhancement

• Author: Michael Curley
• Pages: 47-59

47

Chapter 7—Credit

Enhancement

The words “credit enhancement” don’t usua lly apply to individual

people. Oh, when you are young and your parents sign your rst

mortgage, they a re gua rantying payment to your mortgage lender.

e same is true if they sign on your auto loan. ese g uaranties, a lthough

casual, are a form of credit enhancement. Parents and rich uncles and aunts

are the usual form of personal credit enhancement. But sometimes when you

are making a commercial purchase and paying for it over time, the vendor

will want you to get a letter of credit (LoC) from your bank to guaranty your

payment. Again, t his is credit enhancement at the personal level. No one,

however, calls these personal guaranties “credit enhancement.” ose words

apply to institutions and institutional debt.

From time to time, governments, businesses, and institutions have trouble

paying their bills. When they default or are delinquent with debt payments,

their credit ratings suer. Sometimes the problems a re transient and can

be readily solved. In the late 1970s, the city of New York went bankrupt.

Recently, the city of Detroit did the same. Both, however, pulled themselves

out of nancial trouble.

So, what is “credit enhancement”? E ssentially, “credit enhancement” is a

euphemism for reducing the risk of non-payment on debt. In general, credit

enhancement is used on (non-federal) government debt as well as some major

corporate and institutional debt.

If lenders or investors believe there is a high risk of loss, they will demand

high interest rates to compensate for the risk. ey will also oer only short

terms to minimize the time in which something can go wrong. Reducing the

risk of default on public debt results in longer terms and lower interest rates.

Longer terms and lower rates mean lower annual payments. Lower annual

payments mean that more projects get done, and the ones that are done have

a greater chance of success.

Take the case of a bus rapid tra nsport (BRT) project in a major interna-

tional city. (BRT projects are considered climate change projects because

they can signicantly reduce the pollution caused by automobile trac.) e

money to repay debt issued to nance the project can only c ome from two