VRC | European Private Market Update: Q2 2025

The article in brief:
• The European private market has show resilience in the face of global economic uncertainty, with primary and secondary loan issuance rebounding after a slowdown in April 2025 due to the the U.S. tariff announcements.
• The European market is becoming an increasingly competitive alternative to the U.S. market, with stronger fundraising and a more favorable regulatory environment, driven by lower leverage levels, lower inflation, and active government stimulus.
• Despite the uncertainty, Private Equity and Direct Lenders remain focused on improving underlying businesses and addressing capital structure issues, with most portfolio companies holding up well and capital structure amendment solutions being implemented to manage higher debt costs.

Public Market Backdrop

On April 2, 2025, the U.S. announced sweeping global tariffs. European secondary loan prices decreased sharply after the announcements, with the average bid in the ELLI declining from 97.68 at the end of March 2025 to approximately 96 by the second week of April. However, as the market absorbed the tariff news and the Trump Administration’s policy tone softened, the average bid in the ELLI rose to 97.75 by the end of June 2025, marginally above levels in March.

Given uncertainty from the tariff announcements, April 2025 European primary Broadly Syndicated Loan (BSL) issuance slowed to a halt. However, in May and June 2025, the robust activity seen in 1Q 2025 quickly returned, and issuance levels rebounded to more normal levels. Per LCD, high June volumes were partly driven by elevated repricing activity. European HY bond issuance also rebounded to a record monthly issuance in June.

Overall, BSL primary and secondary spreads quickly normalized after the selloff seen in April 2025 and rebounded to levels near or tighter than Q1 2025 by the end of June 2025.

European vs. U.S. Trends

Central bank policy continues to diverge among the Federal Reserve, BOE, and ECB, with the BOE and ECB cutting their benchmark rates by 50 and 100 basis points, respectively, since December 2024. The Federal Reserve has held rates steady. While historical differences in inflation rates (Inflation Rates: Euro Area 1.9%, UK 3.5% and US 2.4% as of May 2025) and growth rates (GDP: Germany 0.40%, France 0.10%, UK 0.7%, and US -0.50% as of March 2025) contribute to the departure, the main driver lies in expectations for inflation and growth. The ECB, focusing on its singular inflation mandate, is faced with falling inflation and growth concerns. The Federal Reserve, balancing its dual mandate of stable prices and maximum employment, notes strong relative growth expectations (the Atlanta Fed’s GDPNow forecasts 2Q 2025 GDP growth to rebound to ~2.4%) and the potential for higher inflation due to robust demand and potential tariff impacts. These expectations support the Federal Reserve’s decision to hold rates steady in the near term.

The different policy decisions result in differing yields due to differing reference rates, despite only a slight premium in credit spreads of ~25 to 38 bps between the U.S. and European Direct Lending markets. As of June 2025, spot rates were ~1.9% EURIBOR, 4.1% SONIA, and 4.3% 3-month Term SOFR, resulting in implied yields to VRC’s proprietary Unitranche matrix of ~7.7%, 9.9%, and 9.7%, respectively. On a five-year swap basis, the difference decreases as EURIBOR is expected to increase from spot levels (5-year swap 2.2%) and SONIA and SOFR are expected to decline (3.7% and 3.4%, respectively), resulting in implied yields to VRC’s proprietary Unitranche matrix of ~8.0%, 9.4%, and 8.8%, respectively.

The European market is believed to represent an increasingly competitive alternative to the U.S. market, as strong fundraising by U.S.-focused investment funds caused some investors to become overexposed to the US and, therefore, need further diversification. LPs note concerns about tariff-related volatility and the stability of the U.S. market. Positives for the European market include typically lower leverage levels than comparable U.S. companies, lower inflation levels, active government stimulus, and increased infrastructure and defense spending. Therefore, European fundraising for private assets is expected to improve.

While the European narrative is positive, LPs are looking for Europe to prove out some of the hypotheses and show improved growth trends after several years of sluggish growth and tame high inflation rates in certain countries, such as the UK.

Pricing Trends

VRC’s proprietary research indicates that credit spreads for 1st lien, 2nd lien, and Unitranche loans in the Traditional Middle Market (EBITDA of ~€75mm or less) and Upper Middle Market (EBITDA greater than ~€75mm) of:

Unitranche Loan Credit Spreads, considering Coupon Spread and OID Benefit

• Traditional Middle Market:
…• Issuance Price of ~97.5 – 98.5 and Coupon Spread of ~5.00% – 6.00%
…• Credit spread of ~5.25% – 6.25%
• Upper Middle Market:
…• Issuance Price of ~97.5 – 98.5 and Coupon Spread of ~4.75% – 5.75%
…• Credit spread of ~5.00% – 6.00%

In 2Q 2025, Direct Lending pricing remained unchanged from 1Q 2025 levels, despite the BSL volatility, due to several factors: European Direct Lenders have put dry powder to work, new issuance remains lackluster, and demand for issuers with limited tariff exposure remains high. Furthermore, the historically high level of capital-raising activity in Europe in 2024 left most lenders with significant amounts of dry powder, while the pipeline of high-quality deals remained limited. As a result, terms remain competitive for regular-way credits. However, deals with high-potential tariff impacts would likely carry a premium if brought to market at all, reflecting the greater uncertainty and risk, varying by industry and geographic exposure.

Absent any major shocks, market participants expect purchase multiples to remain high, credit spreads to remain tight, and underwriting standards to be aggressive for high-quality companies. This dynamic will likely persist until new deal activity increases, offsetting Private Equity and Direct Lending’s high amounts of dry powder. Cyclical or tariff-impacted companies will continue to require more material risk premiums.

Deal Volume Trends

M&A volumes remain sluggish due to the continued valuation mismatch between buyers and sellers, increased uncertainty from tariffs and the economic outlook, and the high cost of debt. Market participants note elevated diligence activity, but also that some processes have fallen through. Heavily tariff-impacted companies are generally not brought to market. As a result, market participants have delayed their timing estimates for a material rebound to later 2025 or early 2026.

Refinancings and existing portfolio companies continue to provide significant investment opportunities for Direct Lenders through buy-and-build strategies and other accretive investments. Overall, 2Q 2025 saw improved deal volumes in the Middle Market quarter-over-quarter (per KBRA DLD, Middle Market loan volume increased to €23.0 billion versus €12.3 billion in 1Q 2025).

Portfolio Company Performance

Private Equity is focused on improving underlying businesses and addressing capital structure issues to avoid failed sale processes or facing more restrictive or onerous debt capital terms. Sponsors and Direct Lenders report that portfolio companies’ issues are proactively managed, and portfolios are holding up well, with most problem areas already known and have been or are in the process of receiving amendments.

Common capital structure amendment solutions include PIK toggle adjustments, sponsor equity contributions, enhanced liquidity monitoring, and covenant-level amendments. These adjustments help companies manage higher debt costs from elevated reference rates by reducing leverage and cash interest burdens. Direct Lenders typically receive additional economics such as PIK premiums, amendment fees, and principal repayments, along with control and monitoring features like sale milestones, additional reporting, and covenants. This constructive approach by Private Equity and Direct Lenders has helped prevent high levels of defaults and losses in Private Equity and Direct Lender portfolios.

For existing portfolio investments, Direct Lenders expect performance to hold up with potential relief from high cash interest expenses. The interest burden on European companies versus those in the United Kingdom will likely be less, given the divergence in the rate-cutting cycle between the BOE and ECB, resulting in lower all-in yields for EURIBOR-based loans. While idiosyncratic issues continue, overall default rate expectations remain modest. Per Pitchbook LCD, Deutsche Bank, in June 2025, projected the European speculative-grade default rate to increase to 2.3% December 2025 versus 2.1% currently.

Conclusion

Private markets remain competitive, with high-quality companies receiving high valuations and aggressive financing terms. However, the increased uncertainty in the market from potential tariff impacts and geopolitical risks, such as Ukraine and the Middle East, is driving less favorable terms for lower-quality companies. Relative to the U.S., the lower EURIBOR-based cost of debt may lead to an earlier pick-up in Private Equity M&A activity and, thus, new loan demand. However, Europe’s lower growth expectations may prove a challenge to a meaningful increase.

Positively, most European Middle Market companies are in non-cyclical industries and/or are all European domestic businesses. Therefore, direct impacts from U.S.-imposed tariffs on client portfolio companies should be minimal, and we do not expect material movements in European middle market valuations. Portfolio companies may still be impacted by tertiary effects and general contagion.

These factors should continue to support positive valuation adjustments for most debt and equity securities. However, valuation analyses need to consider case-by-case situations focusing on fundamental performance, outlook, affordability of debt, and available liquidity. Therefore, some debt and equity investments will continue to fare better than others.