CCC Buckets
Definition
Concentration limits in CLO indentures that restrict exposure to CCC-rated (or lower) assets, typically to 7.5% of the collateral pool's par value. Assets exceeding this threshold receive haircuts (often 50-100%) in overcollateralization test calculations, creating strong incentives for managers to trade out of deteriorating credits before they reach CCC.
Why it matters
CCC buckets create a critical tension in CLO management: while managers have discretion to hold distressed assets through credit cycles, exceeding the bucket forces either selling into weak markets or accepting OC test deterioration. This explains why CLO bid prices for CCC loans often trade below fundamentals—managers facing bucket constraints become forced sellers. The buckets also create cliff effects where a single-notch downgrade (B- to CCC+) can trigger significant portfolio impacts if the bucket is already full.
Common misconceptions
- •CCC buckets don't prohibit CCC holdings—they limit them to 7.5% and haircut the excess. Managers can hold 10% CCC exposure; they just accept 50% haircuts on the excess 2.5% in OC calculations.
- •The 7.5% bucket applies to CCC and below (including defaulted assets in some structures). A portfolio with 5% CCC and 3% defaulted loans may be over the bucket even though CCC alone is under 7.5%.
- •Bucket violations don't trigger immediate sales. They create OC pressure that may eventually force deleveraging or diversion, but managers retain trading discretion (within certain limits).
- •Haircut methodologies vary significantly by deal vintage. Some deals haircut excess at 50%, others at 100%. Some apply graduated haircuts (first 1% over gets 25%, next 1% gets 50%, etc.). Verify in the indenture.
Technical details
Standard bucket structure
Most CLOs limit CCC-rated and defaulted assets to 7.5% of total collateral par value. Calculation: (Par value of CCC assets + par value of defaulted assets) ÷ (total collateral par). If result exceeds 7.5%, the excess receives a haircut in OC calculations. Example: $500M CLO with $45M CCC exposure = 9.0% of pool. Bucket allows $37.5M (7.5%). Excess $7.5M gets haircut. At 50% haircut, OC calculation treats this as $3.75M instead of $7.5M, reducing collateral value by $3.75M. This creates immediate OC pressure even though no defaults have occurred.
Haircut methodologies
Haircut treatment of excess CCC varies by deal and vintage. Common approaches: (1) 50% haircut on excess—most common in post-2010 deals. Excess counts at half value in OC. (2) 100% haircut on excess—more conservative deals. Excess counts as zero in OC. (3) Graduated haircuts—tiered penalties. First 1% over bucket at 25% haircut, next 1% at 50%, additional at 75-100%. (4) Time-based haircuts—some deals increase haircuts the longer assets remain CCC (CCC for <6 months: 25%, 6-12 months: 50%, >12 months: 75%). Exact methodology is indenture-specific and critically important for stress modeling.
What counts toward the bucket
Definitions vary, but typically include: (1) Moody's Caa-rated assets (Caa1, Caa2, Caa3). (2) S&P CCC-rated assets (CCC+, CCC, CCC-). (3) Defaulted assets (often counted separately but sometimes included in same bucket). (4) Non-performing loans (60+ days past due in some structures). Assets on negative watch or with split ratings where one agency has them at CCC typically count. Importantly, a loan rated B-/B3 that is downgraded to CCC+/Caa1 immediately counts even if credit fundamentals haven't deteriorated materially—rating is what matters, not manager's view. This creates forced trading pressure ahead of downgrades.
Manager behavior around bucket limits
When approaching bucket limits (6-7% CCC), managers face strategic decisions: (1) Preemptive trading—sell deteriorating B- credits before they hit CCC, often at 85-90 cents to avoid selling at 70-75 post-downgrade. (2) Hold and accept haircut—if manager believes recovery exceeds haircut, may strategically exceed bucket. (3) Trade higher-rated credits—sell performing credits to raise cash for workout opportunities. (4) Stop buying distressed—even if manager sees value, bucket constraints limit ability to add CCC exposure. This creates persistent bid-offer imbalance in CCC loan markets—more natural sellers (bucket-constrained CLOs) than buyers (opportunity funds, hedge funds). Explains why CCC loans often trade 5-10 points below recovery values.
Interaction with OC tests
CCC buckets impact OC tests directly through haircuts. Example OC impact: CLO has 128% AAA OC ratio (threshold 125%). Manager allows CCC exposure to reach 10% ($50M on $500M pool). Excess 2.5% ($12.5M) at 50% haircut reduces collateral by $6.25M. New OC: was $128M collateral / $100M debt = 128%. Now $121.75M / $100M = 121.75%. Test fails by 3.25%. This triggers cash flow diversion even though no defaults occurred. The cliff effect is severe: a company downgraded from B- to CCC+ when bucket is at 7.4% causes only minor impact. Same downgrade when bucket is at 7.5% forces either immediate sale or OC deterioration. This nonlinearity creates incentive to keep buffer below bucket.
Default vs CCC: treatment differences
Defaulted assets and CCC assets are often treated differently despite both counting toward concentration limits. Defaulted assets: Typically haircut to recovery value or zero until workout completes. May have separate bucket (5% defaulted limit) or share CCC bucket. Often trigger additional restrictions (can't buy more loans from same issuer). CCC assets: Haircut only applies to excess over bucket. Otherwise count at full par in OC. Can still pay current interest (unlike defaults). May migrate back to B rating, restoring full value. This distinction matters for portfolio construction—managers can hold more CCC exposure than defaulted exposure because performing CCC loans still generate cash flow and may improve, while defaults are binary write-downs.