In determining the amount of liquidity, it is important to recognize that in some structures there may be internally generated liquidity. For example, in some structures there may be an accumulation payment period to retire a bullet liability. During that period, liquidity is available.

In terms of the economics of the transaction, the securitizer must realize that liquidity creation has an implicit or explicit cost. For example, if liquidity is provided by internal sources such as a cash reserve, the cost is the opportunity cost associated with reinvestment of the cash. Consequently, the structurer will seek to establish just the required amount of liquidity.

Typically, there are three sources of liquidity enhancements: bank facilities, cash reserves, and servicer advances. A servicer typically agrees to provide periodic advances to the structure so as to maintain a regular flow of payments due to the bond classes. These amounts, referred to as servicer advances, are typically for the amount of the delinquencies for the period. The advances are limited to amounts that the servicer expects can be collected in the future. In evaluating the liquidity enhancement provided by the servicer, rating agencies examine the servicer’s financial condition.

Cash reserve is normally created either at the inception of the transaction by retaining a part of the funding raised, or by trapping the excess profit. As in the case of credit enhancements, the size of the cash reserve is also typically reset to a higher level if the transaction starts witnessing any predefined adverse material change or hits triggers, in which case the excess spread otherwise flowing through the transaction is arrested to increase the size of the cash reserve. As may be clear, cash reserve serves both as a credit and liquidity enhancer.