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

A CLO manager is reviewing the deal's overcollateralization (OC) test, defined as the par value of performing collateral divided by the par value of the senior notes. Senior notes are USD 400 million, the OC trigger is 125%, and collateral par is USD 520 million, of which USD 30 million is now defaulted and counted at zero. What is the OC ratio and the test outcome?

The OC ratio is 122.5% and the test fails. Performing collateral is USD 490 million after removing USD 30 million of defaulted assets, divided by USD 400 million of senior notes, which is below the 125% trigger, so cash flow is typically diverted to repay senior notes.

  1. A130% and the test is passed
  2. B122.5% and the test is failedCorrect
  3. C125% and the test is failed
  4. D122.5% and the test is passed

Explanation

Performing collateral = 520 - 30 = USD 490 million. OC ratio = 490/400 = 122.5%, below the 125% trigger, so the test fails and cash flows are typically diverted to pay down senior notes. 130% wrongly includes the defaulted assets at par (520/400).

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