Credit Cliff

Credit Cliff

Informal; a situation where a decline in credit availability can make a bad situation for a company even worse. For example, suppose a company has a large amount of debt. It may default on one loan or bond, causing its credit rating to be reduced. This will cause banks and investors to require higher interest rates for further extensions of credit. This increases the company's liabilities and can cause further defaults on loans and bonds. In short, a credit cliff is a compounding of a bad situation caused by credit problems.
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98) If her earned income is sufficient to earn the maximum Earned Income Tax Credit of $5572, her taxable income (other than investment income) is held constant at $19,000, and her investment income varies, then the Earned Income Tax Credit cliff effect creates a range of income past the $3400 cliff effect threshold over which the taxpayer is worse off.
Based on these revised purchase rate assumptions (assuming no change in assumptions related to yield, losses, or payment rate is warranted), in most cases, a one-category downgrade with respect to the rating of the seller/servicer should not result in a credit cliff for outstanding securitized bonds.
This will help identify so-called credit cliff situations, where the creditworthiness and rating could decline precipitously under certain, lower probability but adverse scenarios.
Such hazards include the tendency to hedge exposures with different counterparties while underwriting one's own risk on the basis of the net exposure (assuming performance by both the initial derivative and the hedged derivative), and the existence of credit cliffs inherent in downgrade triggers or material adverse change clauses that may invoke termination rights on the part of performing derivative counterparties, but not on the part of the party that suffered the downgrade or material adverse change.
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