It stands for credit-enhancing interest only strip; an I/O strip (interest only strip) that serves as a credit enhancer (credit enhancement). A credit-enhancing interest-only strip (I/O) is an on-balance sheet asset that meets two key conditions: it represents a valuation of cash flows related to future margin income, and is subordinated to other items. A credit enhancement is a contractual arrangement in which a bank or other entity retains or assumes a securitization exposure and, in substance, provides a certain degree of additional protection (credit enhancement) to other parties to the transaction.

Furthermore, and in form or in substance, it represents a contractual right to receive part or all of the interest and no more than a minimal amount of principal falling due on the underlying exposures of a securitization; and it exposes the holder to credit risk directly or indirectly in relation to the underlying exposures that is above a pro rata share of the holder’s claim on the underlying exposures, whether by means of subordination provisions or other credit-enhancement tools.

The strip provides the first line of defense against credit losses on the receivables (e.g., credit card receivables) underlying securitized certificates, and, as a result, are typically the most subordinated residual interests in a securitization, constituting the highest level of risk and volatility. Furthermore, the value assigned to the strip is a major driver of the gain arising on sale for the initial and periodic transfer of the receivables. Their value, therefore, impact earnings, asset quality, and capital levels.