Overcollateralization (OC) Test
Private Credit glossary · Documentation, Covenants & Terms
Definition
A CLO compliance test that requires the ratio of the collateral pool's par value to the par value of each rated tranche to exceed a minimum threshold (e.g., Class A: OC_A = Collateral Par/Class A Par ≥ 120%). When the test fails — typically because defaults reduce collateral par — all cash flow that would have gone to equity and subordinate tranches is diverted to pay down the senior-most tranche until the OC ratio is restored. The primary mechanism by which loan-pool defaults translate into CLO-equity cash-flow impairment.
Overcollateralization (OC) Test in plain English
A CLO is basically a fund that borrows money to buy a big pile of loans, then slices its own IOUs into safer and riskier layers. The OC test is a safety check that asks: 'Is the pile of loans still worth comfortably more than what we owe the senior layers?' — for example, at least $120 of loans backing every $100 of the safest tranche. Think of it like a bank checking that your house is still worth well more than your mortgage. If too many loans in the pile default, the pile shrinks and the test fails; when that happens, cash that would have flowed to the risky equity holders gets rerouted to pay down the safest layer first until the cushion is rebuilt. That rerouting is exactly how loan defaults end up starving the equity slice of its payouts.
Also called: OC
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