When Averages Deceive
European leveraged loan markets ended 2025 with a reassuring narrative: improved interest coverage at 3.5 times, leverage below 5 times, and CLO issuance exceeding €60 billion. Primary spreads compressed by 30 basis points to post-pandemic lows. If someone read only the headlines, they would conclude that the European credit cycle is in great shape.
The problem lies in the percentiles, not the averages. Currently, 10% of market loans trade below 90 cents on the euro. More than 5% of that segment is rated CCC or lower, up from 3% a year earlier, with default probabilities estimated around 50%. The ratio of downgrades to upgrades rose from 1.9 times to 2.7 times over the same period. Fitch predicts that the European loan default rate could soar to the 2.5-3% range, double the 1.1% recorded in the twelve months leading up to November 2025.
The term circulating among restructuring teams to describe this situation is not "gradual deterioration." It is "credit cockroaches": early signs of irregularities, weakened controls, and covenant erosion that appear on the margins before the problems become visible in consolidated financial statements. The metaphor is not accidental; when a cockroach appears, it rarely comes alone.
The Architecture of the Problem: COVID Debt and Private Credit
The structural origins of this cycle can be precisely dated. Leveraged buyout transactions from the 2020-2022 period were executed with near-zero rates and extremely loose covenant structures. What then seemed like prudent financial engineering—floating-rate debt, broad covenants, high entry multiples—has turned into a tacit bet that rates would not remain high for years.
That bet has failed. The consequence has not been an immediate collapse but something more difficult to manage: companies that are technically solvent but have capital structures consuming operational oxygen. Interest coverage improving from 2.8 to 3.5 times over two years sounds good until compared to businesses that generated 4.5 or 5 times before the cycle of hikes.
What will change in 2026 is the role of private credit. The funds that entered these deals as alternative lenders now face a classic dilemma: extend the maturity schedule once again—having already gone through several cycles of refinancing and repricing in 2024-2025—or accept that the original investment thesis is not going to recover and force an equity restructuring. Amanda Blackhall O'Sullivan, a financial restructuring director at Interpath, describes it without euphemism: 2026 looks set to be a year of contentious but executable restructurings, with an increasing emphasis on operations adjacent to forced execution.
Private credit has a tactical advantage here that syndicated banks lack: in single-lender structures, execution on equity collateral is cleaner, faster, and avoids judicial complexity. Simon Edel from EY Parthenon identifies this mechanism as the preferred tool when the numbers don't add up for a more elaborate court process. In the retail sector—citing Superdry, Poundland, and River Island as examples—restructuring plans focus on both financial liabilities and leasing obligations, adding a layer of negotiation with landlords that complicates timelines.
The Risk that Comes from the U.S. but Is Not the Same
The warning that most unsettles European legal and credit teams right now does not stem from the balance of their own portfolios. It comes from observing what has happened in the U.S. market with so-called aggressive Liability Management Exercises: operations where coordinated groups of lenders negotiated from a preferential position via uptiering or transfer of collateral, leaving the rest of the pool in a de facto subordinate position. The effective default rate in the U.S., including these operations, reached 3.7% compared to a nominal 1.3%.
Europe does not replicate that pattern for structural reasons. European credit documents historically offer more balanced protections among creditors. The available tools—the UK's Restructuring Plans, Germany's StaRUG with its ability to drag in equity holders, the Netherlands' WHOA—provide frameworks that allow for capital reconfigurations without the litigation chaos of Chapter 11. But the warning circulating in the market, noted in Financial Times analysis, is different: the risk is not that Europe replicates U.S. uptiers, but that lenders cooperating in consensual restructurings remain exposed to legal actions from dissenting creditors invoking the U.S. framework as a reference.
Duncan Turner of FTI Consulting adds another vector of macroeconomic uncertainty that the "improved metrics" narrative fails to capture: if inflation ticks up—either due to Federal Reserve monetary policy or fiscal pressures in the UK—gilt yields could rise just as maturities thought resolved come back to the table. The maturity wall of 2025 was predominantly managed through refinancings. A new cycle of rising rates would not find the same room for maneuver.
A third element that Sergio Grasso of iason identifies as a sign of underestimated systemic fragility is that CDS spreads no longer function as reliable indicators of fundamental credit risk. When the most liquid hedging instrument decouples from the credit quality of the underlying asset—as illustrated by the Intrum AB episode or the credit event at Ardagh, where the auction mechanics disconnected from the real risk—the efficiency in capital allocation deteriorates in ways that do not appear in management reports until it is too late.
The Pattern That CLOs Cannot Hide
The €60 billion in new CLO issuance during 2025, plus the €63 billion in resets and adjustments, represents genuine technical support for the market: structural buyers with mandates that do not liquidate at the first signs of volatility. This explains why secondary spreads remained relatively stable around 470 basis points, even as the primary market compressed.
However, the technical support from CLOs does not resolve the operational issues of the underlying companies. A securitization vehicle can keep the price of a loan stable in the secondary market while the company that issued it accumulates pressures from labor costs, energy, or commercial fees that its capital structure cannot absorb. The bifurcation described by the industry—63% of loans at par or above, 10% below 90 cents—precisely depicts a market where technical support is masking the real dispersion of risk.
The selectivity that M&G managers and other institutional investors recommend to capture higher default-adjusted yields above 6% in euros is not a conservative stance. It is an explicit acknowledgment that the index averages no longer accurately describe the outcome distribution within the portfolio. In an environment where the downgrade to upgrade ratio is 2.7 times and the CCC segment is growing, the cost of not differentiating among issuers materializes asymmetrically and with a lag.
The acceleration of restructurings expected in the first half of 2026 does not represent a systemic crisis of European credit. It reflects the natural maturation of positions built on cycle assumptions that expired two years ago, now managed by lenders who have already exhausted the easy extensions and face the hard work of rebuilding capital structures based on actual operational fundamentals.
