The European chemicals industry is facing significant challenges that are causing anxiety among collateralized loan obligation (CLO) managers. For several months, leveraged loans for chemical companies have seen a steady decline in their values, leading to heightened risk perceptions.
In January, research from Bank of America revealed that over 35% of floating-rate debt related to chemical companies held by CLOs was trading below 90. Typically, when most leveraged loans are traded at par or above, any loans falling below the threshold of 98 raise red flags for CLO managers. A decline in loan prices is not a random occurrence; it often signals rating downgrades and deteriorating credit quality. Currently, several companies in the chemicals sector, such as INEOS Quattro Holdings and Caldic, are rated B3 by Moody’s, which adds to the concern.
CLO managers may find themselves constrained when attempting to divest from declining chemicals loans, as they would incur losses. Retaining these credits poses additional threats if the credit ratings dip into triple-C territory, potentially breaching overcollateralization tests and diverting cash flow away from CLO equity to pre-pay notes. Moreover, defaults from within the chemicals sector could dampen equity returns for CLOs.
The distress in the chemicals sector reflects broader issues plaguing European industries. European chemicals companies are struggling to maintain profitability due to high energy costs, increased competition from cheap imports, and tariffs imposed by the United States. A report commissioned by the EU last year highlighted similar struggles across various sectors, including automotive and basic metals, which collectively account for 15% of the EU’s GDP and show alarming signs of economic decline.
The rising energy prices, particularly exacerbated by the geopolitical tensions following Russia’s invasion of Ukraine, have further strained European industry. As countries have sought to reduce their dependence on Russian hydrocarbons, industrial energy prices have soared. This has heightened operational costs for European firms compared to their international counterparts, especially as imports from countries like China continued to grow.
The capital-intensive nature of the chemicals and broader industrial sectors demands ongoing access to financial resources, whether through leveraged loans, corporate bonds, or equity investments. Major projects, like the €3.5 billion financing for INEOS’s ethane cracker plant earlier this year, exemplify the necessity for substantial capital inflow.
Looking ahead, the need for European industries to become more self-sufficient is increasingly apparent. The shift in the global political landscape underscores the importance of developing robust industrial strategies that will encourage capital markets to invest in domestic industries. A failure to adapt to these changing dynamics could further entrench economic stagnation and diminish Europe’s geopolitical significance.
Despite the current difficulties, there is hope that by pivoting towards strategies that enhance economic resilience and self-sufficiency, European industries can regain competitiveness and attract much-needed investment. This effort will require concerted action from both governments and the EU to foster an environment conducive to sustainable industrial growth and stability.