CLO Chemical Challenges Reveal Industry Struggles in Europe

The European chemicals sector is currently grappling with significant challenges, causing concern among collateralized loan obligation (CLO) managers. Recent research from Bank of America indicates that over 35% of floating-rate debt from chemical companies backed by CLOs was trading below 90 in January. This decline in loan prices is particularly troubling, as most leveraged loans are performing at par or higher.

CLO Chemical Challenges in Europe

When loans drop significantly in price, it often stems from rating downgrades and a decline in credit quality. Within the chemicals industry, several borrowers are rated B3 by Moody’s, including notable companies like INEOS Quattro Holdings, Caldic, and Archroma. Such price drops make it increasingly difficult for CLO managers to exit these positions without incurring losses.

Moreover, if credit ratings of these companies fall to triple-C, CLO managers may struggle to meet their overcollateralization (OC) tests. This situation could cause cash to be redirected from CLO equity to pay notes. Defaults among chemical companies would negatively impact CLO equity returns, thereby escalating the financial risks associated with these investments.

Broader Implications for European Industry

The struggles of the chemicals sector reflect broader issues affecting the European industrial landscape. European chemicals companies are becoming less appealing to CLOs due to uncompetitive conditions, primarily driven by high energy costs and increased pressure from cheap imports, particularly from China. A report commissioned by the EU last year highlighted that several major industrial sectors, including chemicals, automotive, and basic metals, are under threat, representing approximately 15% of the EU’s GDP.

• High energy prices have surged following geopolitical tensions, particularly since Russia’s invasion of Ukraine.
• The share of chemicals from China in EU imports has doubled from 9% in 2014 to 18% by 2024.

These factors threaten the viability of European industrial companies, further complicating their access to capital. Given the capital-intensive nature of heavy industries, these companies rely on leveraged loans provided by CLOs or other funding sources to finance operations and projects.

Need for Strategic Industrial Policies

European governments must reevaluate their industrial policies to encourage investment in domestic industries. The current competitive landscape has evolved due to shifting geopolitical dynamics, highlighting the urgency for Europe to become more economically self-sufficient. Past assumptions regarding free trade and globalization require reassessment, especially considering changes in relationships with major global powers.

Failing to establish robust industrial strategies may lead to prolonged economic decline and reduced geopolitical significance for Europe. As companies find financing increasingly challenging, strategic investment in key sectors becomes critical for future stability and growth.