Credit Enhancement

A method whereby a company attempts to improve its debt or credit worthiness.

Investopedia Says:
Credit enhancements take many different forms. An example of a credit enhancement would be conversion rights added on to a debt instrument in order to lower the issuing interest rate.

Techniques used to improve the credit rating of an asset-backed security or a municipal bond, generally to get an investment grade rating from a bond rating agency and to improve the marketability of the securities to investors. There are two general classifications of credit enhancements: third-party enhancement, in which a third party pledges its own creditworthiness and guarantees repayment in exchange for a fee; and self-enhancement, which is generally done by the issuer through Overcollateralization i.e., pledging loans with a book value greater than the face value of the bonds offered for sale.

Third party enhancements take the form of a Standby Letter of Credit or Commercial Letter of Credit issued by a bank, a surety bond from an insurance company, or a special reserve fund managed by a Financial Guarantee firm. The type of enhancement used and the amount of credit protection purchased varies according to the characteristics of the portfolio. Holders of the securities issued have recourse against the guarantor to the extent of the guarantee. Lines of credit are sometimes referred to as soft capital because they would not ordinarily be called upon. See also Backup Line.

Any of a series of methods that reduce the risk of extending credit to a specific individual or company.
Example: A credit enhancement can be provided by using credit insurance, a Guaranty Collateral a Letter of Credit or additional borrowers. Each method offers the Lender some recourse in the event of borrower default.