Interest Coverage (IC) Test
Private Credit glossary · Underwriting & Credit Analysis
Definition
A CLO compliance test that requires the ratio of interest income collected from the collateral pool to the interest due on each rated tranche to exceed a minimum (typically 105%–110%). If defaults reduce interest collections below the threshold, cash flow is diverted from the CLO equity tranche to pay down senior tranches — the same mechanism as the OC test, but triggered by interest shortfalls rather than par shortfalls. Together, OC and IC tests are why CLO equity is called 'leveraged credit beta.'
Interest Coverage (IC) Test in plain English
This is the OC test's twin, but it watches income instead of asset value. It checks whether the interest the loan pile collects each period is comfortably bigger than the interest the CLO owes its senior layers — usually a cushion of about 105% to 110%. Picture checking that the rent coming in still covers your building's mortgage payments with a little to spare. If borrowers default and stop paying interest, collections drop; once they fall through the threshold, cash is pulled away from the risky equity slice and used to pay down the senior tranches instead. Between OC (asset value) and IC (income), the equity holders get squeezed the moment defaults rise — which is why CLO equity behaves like a highly amplified bet on how the loans perform.
Also called: IC
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