medium · Debt Capital Markets bond-instruments-structures
In a Collateralized Loan Obligation (CLO) structure, what is the primary function of the Interest Coverage (IC) and Over-Collateralization (OC) tests?
- CLOs are cash-flow securitizations rather than market-value funds, so these tests police the deal's payment waterfall.
- A breach of these tests redirects cash away from the equity tranche, cutting its payouts rather than its yield.
- To automatically divert cash flows from junior tranches to pay down senior debt if the collateral pool deteriorates.
- It restricts the collateral manager to purchasing only senior secured first-lien loans rated single-A or higher by the agencies.
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