What is Credit Enhancement?
Credit enhancement (or credit support) is a risk-reduction technique that provides protection, in the form of financial support, to cover losses under stressed scenarios.
Think of credit enhancement as a kind of financial cushion that allows securities backed by a pool of collateral (such as mortgages or credit card receivables) to absorb losses from defaults on the underlying loans. Thus, it's not the case that through securitization, poor credit assets somehow "transform" into solid investments; instead, credit enhancement helps to offset potential losses.
Credit enhancement is used in project financings, public-private partnership transactions, and structured finance to help mitigate risk for the investors, and has been an accepted practice in bond financing for more than two decades.