Interest diversion test

A par value test present in many cashflow CLOs. Like an overcollateralisation (OC) test, the interest diversion test is triggered if the ratio of the CLO's collateral - measured in par terms (adjusted to reflect defaulted and distressed obligations) over the notional of the CLO's liabilities falls below a predefined threshold. However, this trigger point is generally set at a higher level than for any of the OC tests. In other words, the interest diversion test will trigger earlier than the most junior OC test.

When the interest diversion test is triggered, interest payments to junior tranches are suspended (in full or in part) until the test is cured. In most cases following the breach of the interest diversion test, interest proceeds that would have gone to pay equity notes are used to buy additional collateral. In some cases some or all of the diverted proceeds are used pay down rated tranches - typically in descending order of priority.