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FRM Part II · FRM Exam Part II · Structured Credit Risk

A CLO has a EUR 400 million collateral pool. The notes comprise EUR 300 million senior, EUR 60 million mezzanine and EUR 40 million equity. The senior overcollateralization (OC) test is defined as collateral par divided by senior notes. After defaults, the par value of performing collateral falls to EUR 345 million. What is the senior OC ratio, and what does it imply if the trigger is 120%?

The senior OC ratio is 115% (EUR 345 million divided by EUR 300 million), below the 120% trigger. The test therefore fails, and cash flows are normally diverted away from equity and junior tranches to pay down senior notes until the ratio is restored.

  1. A115%, the test is failed and cash flows are typically diverted to pay down senior notesCorrect
  2. B115%, the test is passed and equity continues to receive distributions
  3. C133%, the test is passed
  4. D86%, the test is failed because the ratio is below 100%

Explanation

OC ratio = 345 / 300 = 115%, below the 120% trigger, so the test fails. Failure typically diverts interest cash flow from junior and equity holders to repay senior notes, restoring the cushion. 133% would be the pre-default ratio (400/300).

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