enhancing the credit of a nonagency CMO so that an issuer can obtain any credit rating desired for a tranche in a deal. The same credit enhancement mechanisms are used for ABS structures discussed in the next chapter. Agency CMOs are created from pools of passthrough securities. In the nonagency market, a CMO can be created from either a pool of passthroughs or unsecuritized mortgage loans. It is uncommon for non- conforming mortgage loans to be securitized as passthroughs and then the passthroughs carved up to create a CMO. Instead, in the nonagency mar- ket a CMO is carved out of mortgage loans that have not been securitized as passthroughs. Since a mortgage loan is commonly referred to as a whole loan, nonagency CMOs are also referred to as whole-loan CMOs. The underlying loans for agency securities are those that conform to the underwriting standards of the agency issuing or guaranteeing the issue. That is, only conforming loans are included in pools that are col- lateral for an agency mortgage-backed security. The three main under- writing standards deal with (1) the maximum loan-to-value ratio, (2) the maximum payment-to-income ratio, and (3) the maximum loan amount. A nonconforming mortgage loan is one that does not conform to the underwriting standards established by any of the agencies.   Credit Enhancement Mechanisms Typically a double A or triple A rating is sought for the most senior tranche in a nonagency CMO. The amount of credit enhancement nec- essary depends on rating agency requirements. There are two general types of credit enhancement mechanisms: external and internal. We describe each type below.   External Credit Enhancements External credit enhancements come in the form of third-party guaran- tees that provide for first protection against losses up to a specified level,     for example, 10%. The most common forms of external credit enhance- ment are (1) a corporate guarantee, (2) a letter of credit, (3) pool insur- ance, and (4) bond insurance. Pool insurance policies cover losses resulting from defaults and fore- closures. Policies are typically written for a dollar amount of coverage that continues in force throughout the life of the pool. However, some policies are written so that the dollar amount of coverage declines as the pool sea- sons as long as two conditions are met: (1) the credit performance is better than expected and (2) the rating agencies that rated the issue approve. Since only defaults and foreclosures are covered, additional insurance must be obtained to cover losses resulting from bankruptcy (i.e., court mandated modification of mortgage debt-"cramdown"), fraud arising in