Interest coverage test (IC test)

In a cashflow CDO, a measure to protect senior note holders in the event of a reduction in the cashflows produced by the portfolio collateral. If a deal starts to fail its IC test, cashflows are diverted from more junior classes of notes to pay down the liabilities in order of seniority until the deal is back in compliance with the test. The IC test is passed if the interest coverage ratio exceeds a predefined level. The IC ratio is calculated as the proceeds from interest payments on the collateral over a given period divided by the interest payments due on the deal's notes over the same period. Therefore, paying down the most senior notes should increase the IC ratio by reducing the amount of the deal's liabilities and the interest payments due to the noteholders.