Case 039Structured finance and securitisationHard

Nandavan CLO I holds Rs 500 crore of loans against class A notes of Rs 330 crore and class B of Rs 55 crore, with an A/B overcollateralisation trigger of 125%. After a default and a CCC haircut, does the test fail, and how much cash is diverted from the equity to cure it?

NomuraNew York · 2026

The situation

Nandavan CLO I holds Rs 500 crore par of leveraged loans yielding 10%. It has issued class A notes of Rs 330 crore at 8.5%, class B of Rs 55 crore at 10%, and Rs 115 crore of equity. Senior fees are 0.5% a year on the pool. The class A/B overcollateralisation test requires adjusted collateral par to be at least 125% of the A and B notes.

This quarter Rs 20 crore of loans defaults, with an expected recovery of 40%. Downgrades also push Rs 40 crore of loans above the CCC bucket limit of 7.5% of the pool, and the indenture carries that excess at its market value of 70.

Your task

Recompute the test, say whether it fails, work out the principal paydown needed to cure it, and trace this quarter's interest waterfall.

Quick check

Where does the cash to cure a failed OC test come from?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

The test fails: adjusted par of Rs 476 crore over Rs 385 crore of notes is 123.6%, below 125%. Curing it needs Rs 4.2 crore of class A paydown. This quarter only about Rs 2.99 crore is left after fees and note interest, so all of it is diverted and the equity gets nothing. The test is still short at 124.6%, so next quarter's equity cash is diverted too.

Step 1Why does a CLO have coverage tests at all?

Think of a joint family where the eldest are fed first and the youngest eat whatever is left; if the harvest shrinks, the rule is that the youngest give up their share to rebuild the grain store. Coverage tests protect the senior notes by starving the equity: when collateral falls too far relative to the notes, cash that would reach the equity is redirected to repay the top of the structure. The rules sit in the indentureThe legal contract governing the CLO: eligibility of loans, the tests, and the order in which every rupee of interest and principal is paid.'s priority of payments.

Step 2Does the test fail?

Before the losses the ratio is 500 over 385, 129.9%. Two adjustments follow the indenture. The defaulted Rs 20 crore counts at its Rs 8 crore recovery, and the Rs 40 crore of CCC excess counts at Rs 28 crore, cutting adjusted par to Rs 476 crore and the ratio to 123.6%. Notice that half the damage comes from loans that are still paying: the CCC haircut exists because a pool drifting down the rating scale is weaker than its par suggests.

Two haircuts of 12 take the A/B test from 129.9% to 123.6%500Collateral par-12Default at 40-12CCC excess at 70476Adjusted parRs crore. Axis starts at 300.A/B OC testBefore129.9%After123.6%Trigger125.0%Cure: pay A down 4.2476 / 380.8 = 125%
Carrying the defaulted loan at 40 and the CCC excess at 70 takes Rs 24 crore off collateral par, cutting the A/B test from 129.9% to 123.6% against a 125% trigger; paying class A down by Rs 4.2 crore restores it.
The relationship
476385−X≥1.25  ⇒  X≥385−4761.25=4.2\frac{476}{385 - X} \ge 1.25 \;\Rightarrow\; X \ge 385 - \frac{476}{1.25} = 4.2
476adjusted collateral par, Rs crore
385class A plus class B notes
Xclass A principal repaid from diverted interest
What it says in wordsRepay senior notes until the adjusted collateral is again 125% of what is owed to A and B.
Step 3Where does the cure come from this quarter?

Interest is earned on the Rs 480 crore still paying, Rs 12.00 crore for the quarter. Fees take Rs 0.62 crore, class A interest Rs 7.01 crore and class B Rs 1.38 crore. The Rs 2.99 crore left would normally be the equity's distribution; with the test failing, all of it repays class A, and the equity receives nothing. Cash collected from interest is not collateral, so paying down notes with it improves the ratio without reducing the numerator.

The failed test sends the equity's cash to class A principalInterest collected12.001. Senior fees0.622. Class A interest7.013. Class B interest1.384. A/B OC test fails: pay down class A2.995. Equity distribution0.00, was 3.49 before the lossesRs crore for one quarter
Of Rs 12.00 crore of interest this quarter, fees, class A and class B interest take Rs 9.01 crore, and the remaining Rs 2.99 crore is diverted to repay class A, so the equity receives nothing instead of about Rs 3.49 crore.

After the diversion class A is Rs 327.01 crore and the ratio is 124.6%, still short, so about Rs 1.2 crore more comes out of next quarter's equity cash. For an equity investor the damage is timing as much as loss: two quarters of zero distributions on a position that expected about Rs 3.5 crore each. The manager's levers are to trade CCC loans for higher rated ones, or buy loans below par to rebuild the numerator, each with its own cost.

Where candidates lose it

The usual slip is testing on raw par: 480 over 385 is 124.7%, which fails for the wrong reason, or 500 over 385 which passes. The indenture's haircuts for defaults and CCC excess decide the answer.

The second is saying the class A holders lose money. They are the ones being protected: the cure pays them early. The equity bears the cost, which is the whole design of the waterfall.

What the interviewer asks next

  • Why do the indenture's CCC haircuts use market value rather than par?
  • How would the manager use reinvestment to cure the test without diverting cash?
  • What is the interest coverage test, and could it fail here too?
  • How does a failed test affect the class B notes?

Asked at Nomura, Structured Products, New York, 2026 (Wall Street Oasis): What section of the indenture deals with payment waterfalls?

Company names and figures are illustrative.