Credit Enhancement

Structural mechanisms that improve the credit quality of notes issued by an SPV, protecting noteholders from losses. Can be internal (OC, excess spread, subordination, reserve accounts) or external (letters of credit, guarantees, insurance wraps).

OC Test (Over-Collateralisation Test)

Formula: OC Ratio = Performing Asset Par / Outstanding Note Balance. Failure redirects excess interest proceeds to repay senior notes (turbo). CLO Class A/B OC test minimum typically 121–128%.

Subordination

The structural seniority ordering of tranches: losses are absorbed by junior notes before reaching senior notes. Also expressed as 'credit enhancement level' for the senior tranche.

Excess Spread

The difference between interest received on the asset pool and interest paid on issued notes plus fees. The first line of defence absorbing losses; captured in the spread account before OC tests apply.