medium · Asset-Backed Securities clos
In a CLO (Collateralized Loan Obligation), if an Overcollateralization (OC) test fails, what is the mandatory structural remedy?
- The equity holders are contractually required to make a 'cash call' capital contribution to the trust to replenish the collateral pool balance.
- The senior-most tranche is automatically downgraded by the applicable rating agency to reflect the resulting lack of adequate collateral coverage support.
- Interest cash flows that would have gone to the equity and junior tranches are diverted to pay down the principal of the senior-most bonds.
- The collateral manager must immediately sell all remaining 'CCC' rated assets in the pool and replace them with higher-rated 'B' loans.
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