VRC | European Private Market Trends: Q2 2026 Direct Lending & Private Equity Update

Unitranche Loan Credit Spreads, considering Coupon Margin and OID Benefit*

• Traditional Middle Market (≤ ~€75mm EBITDA):
  • Issuance Price: ~97.5 – 98.5; Coupon Margin: ~5.00% – 6.00%
  • Credit Spread: ~5.25% – 6.25%
• Upper Middle Market (˃ ~€75mm EBITDA):
  • Issuance Price: ~97.5 – 98.5; Coupon Margin: ~4.75% – 5.75%
  • Credit Spread: ~5.00% – 6.00%

*Credit spread is inclusive of the OID benefit and the coupon spread/margin.

Direct lending pricing remained broadly unchanged from the fourth quarter of 2025 and first quarter 2026 levels, despite the public market volatility. European direct lenders continue to hold substantial dry powder, while new issuance remains limited and lender demand is high, keeping terms competitive for regular-way credits. As observed during the first quarter of 2026, more storied, lower-quality, or AI-exposed deals will likely carry pricing premiums (estimates of 50 to more than 100 basis points since December), if brought to market at all, reflecting elevated uncertainty and risk that varies by industry and geography.

As a result, deals are bifurcated into competitive processes or those having difficulty accessing the direct lending primary market. Purchase multiples, credit spreads, and underwriting terms are expected to remain aggressive for high-quality companies, reflecting continued competition for available transactions. This dynamic continued through the second quarter and will likely persist until new deal activity increases, helping offset the substantial dry powder held by private equity and direct lending. Cyclical, storied, and AI-exposed companies and industries will continue to require materially higher risk premiums, which may create further dispersion between the haves and have-nots.

European Direct Lending, M&A, and Private Equity Activity Trends

Direct lending deal volumes were negatively impacted by AI concerns and inflationary pressures, with first-half 2026 deal volume decreasing to €15.2 billion from €23.5 billion during the first half of 2025, or approximately 35%, per PitchBook LCD. Ongoing valuation mismatches between buyers and sellers continue to pressure M&A volumes.

European private equity fundraising is also on track to underperform, with €39.1 billion raised during the first half of 2026 compared with €54.2 billion during the first half of 2025, according to PitchBook. The trend continues the fundraising slowdown observed in 2025, when total fundraising declined to €80.8 billion from €146.7 billion in 2024, due in part to a challenging exit environment for historical investments.

Total estimated exit value increased to nearly €175.0 billion in the first half of 2026 from around €112.0 billion in the first half of 2025, although total estimated count increased only approximately 5%, as very large exits drove higher volume figures, but the market struggles to achieve realizations.

In response, private equity firms are exploring alternative liquidity options—such as dividend recapitalizations, net asset value (NAV) financings, minority sales, and continuation funds. Direct lenders are willing to fund these strategies but approach them cautiously due to elevated risks and potential conflicts of interest.

The outlook for M&A and alternative exit routes for PE investments has become more uncertain. Direct lenders report increased caution when performing due diligence, although lenders remain open for business and deal pipelines remain active in the first half of 2026. If tensions in the Middle East ease and oil prices stabilize, several factors suggest positive momentum for M&A and alternative exit routes: private equity firms continue to face pressure to return capital amid extended hold periods, approaching loan maturities, significant available dry powder, and an all-in cost of debt that remains below 2024 levels. These dynamics may support a rebound in M&A and alternative exit activity in 2026 and beyond if market conditions continue to stabilize.

Portfolio Performance, Default Risk, and Direct Lending Credit Trends

Direct lenders expect portfolio performance to remain stable, although AI, higher oil prices, and inflationary pressures remain headwinds. Market participants generally view these challenges as idiosyncratic rather than systemic.

Many direct lenders note that underwriting has considered AI exposure for some time and, as a result, loans have largely been made to companies with low exposure, strong competitive positions, or business models viewed as more resilient to AI-related disruption, including those with significant regulatory or compliance requirements, proprietary data assets, or meaningful customer interaction.

Market interest rate expectations have shifted higher since year-end, due to inflationary pressures, with the European Central Bank increasing its key interest rate by 25 basis points in June 2026. Since December, spot EURIBOR and SONIA rates have widened by approximately 30 and 5 basis points, respectively, and five-year swap rates widened nearly 15 basis points for EURIBOR and around 40 basis points for SONIA. As a result, the all-in cost of debt is likely to remain high, pressuring interest coverage ratios.

While idiosyncratic issues persist, default rates remain modest. According to PitchBook LCD in May 2026, S&P Global Ratings projected the European speculative-grade default rate to increase to 3.75% by March 2027 from 3.3% and 2.6% in March and June 2026, respectively. This is a shift from December 2025 when S&P expected the default rate to fall to 3.25% by September 2026 due to higher energy prices, the weaker economic outlook, and trade uncertainties. Fitch Ratings issued similar guidance of 4.0-4.5% expected defaults for European Leveraged Loans.

Direct lending workouts are especially focused on 2021-2022 post-COVID vintages that carry higher debt loads than supported by today’s interest rate environment. Sponsors and direct lenders are proactively managing these situations through common capital structure solutions, including payment-in-kind (PIK) toggle adjustments, maturity extensions, sponsor equity infusions, enhanced liquidity monitoring, and covenant amendments.

These measures help mitigate elevated debt costs by reducing leverage and cash interest burdens. In return, direct lenders typically receive additional economics—such as PIK premiums, amendment fees, and principal repayments—alongside enhanced control features like sale milestones, increased reporting, and tighter covenants. This constructive approach has helped limit payment defaults across portfolios, though some cases result in debt-for-equity swaps or liability management exercises.

Outlook for European Private Markets and Direct Lending

European private markets remained competitive during the second quarter of 2026, with high-quality companies continuing to attract strong valuations and aggressive financing terms. Consistent with trends observed in the first quarter, European direct lending market participants remain focused on the potential negative impacts of higher oil prices, inflation pressures, and evolving AI-related disruption. As a result, financing terms and investor appetite have become increasingly bifurcated across sectors, business models, and credit profiles.

Portfolio risks remain concentrated among pre-2022 vintages characterized by elevated leverage, constrained interest coverage, and approaching maturities. Increased uncertainty may further stress these companies and limit available exit opportunities. In some situations, sponsors and lenders may need to pursue restructuring initiatives or other capital structure solutions to address refinancing and liquidity challenges, which could weigh negatively on valuations.

For valuation purposes, current market conditions continue to support a company-specific approach that emphasizes operating performance, debt sustainability, liquidity, and sector-specific risk considerations. While many businesses continue to perform in line with expectations, performance across portfolios remains uneven, reinforcing the importance of careful analysis of individual facts and circumstances.

VRC’s European Direct Lending Credit Spread Matrix

• During the second quarter of 2026, VRC maintained credit spread assumptions within its European middle-market matrix at first quarter 2026 levels. Given continued conflict in the Middle East, European loan issuance slowed during the first half of 2026. However, substantial dry powder among European private lenders continued to support competitive lending terms despite market volatility earlier this year.

Euro Area and UK Economic Growth and GDP Trends

• Euro area real GDP growth stalled during the first quarter of 2026, with the European Commission forecasting full-year growth of 0.9% in 2026 and 1.2% in 2027 in real terms. While the United Kingdom and Germany outperformed the broader euro area, weaker economic activity and France, particularly within construction, weighted on regional growth.
• Despite trade-related disruptions in 2025 and renewed geopolitical uncertainty in 2026, the euro area economy has remained relatively resilient. According to the ECB, growth is expected to improve modestly in 2027 as economic conditions stabilize.

European Inflation Trends and Central Bank Policy

• Inflation in the United Kingdom decreased to 2.6% in June, from 3.3% in March, although it remains elevated due to volatility in energy prices, with transport being the largest contributor to the downward trend in June, while hotels and restaurants increased the most year-over-year.
• Inflation for the euro area increased in June to 2.8%, from 2.6% in March, although it represents an improvement from May.
• In June 2026, the ECB increased policy rates for the first time in almost three years, raising the main deposit facility to 2.25% because of higher inflation and related uncertainty caused by conflict in the Middle East.
• The Bank of England (BoE) held its Bank Rate at 3.75% in June 2026, although there is potential for the BoE to raise rates later in 2026, as higher energy prices filter through the economy given the re-escalation of the Middle East conflict.
• In the U.S., the Fed held rates in the 3.50%-3.75% target range in its June meeting. Market participants currently expect the possibility of one to two 25 basis point rate increases by the end of 2026, according to CME FedWatch. Market expectations for the Fed Funds rate in September 2027 generally fall within a range of 3.75% – 4.75%, although rate projections have been volatile.

EURIBOR, SONIA, and Interest Rate Outlook

• 3M EURIBOR increased to 2.32% in June, from 2.07% in March, and 3M SONIA increased to 3.75% in June, from 3.74% in March.
• Market expectations currently imply a 25 basis point ECB rate increase in September. According to Chatham Financial forecasts, EURIBOR rates are expected to rise modestly in late 2026, while SONIA is projected to move toward the 4.0% range in the near term and approximately 4.50% – 4.75% over longer horizons.
• After an easing of rates in 2025, the outlook has shifted in 2026 to potentially rising rates in late 2026 as central banks are increasingly cautious around energy prices and elevated inflation.

European Credit Market Spread and Yield Trends

• Spread-to-maturity (STM) for the ELLI Index decreased to E+454 in June, from E+504 in March. Meanwhile, the ELLI Index yield-to-maturity (YTM) decreased to 6.92% in June, from 7.30% in March.
• The European B-rated loan STM declined to E+425 in June, from E+479 in March. YTM for B-rated loans moved lower to 6.60% in June, from 7.01% in March.
• Volatile market conditions in the broadly syndicated loan markets coupled with relatively stable private debt spreads imply the illiquidity premium between the two markets has compressed in the first two quarters of 2026.

European Leveraged Loan and High-Yield Issuance Trends

• Senior loan issuance remained strong in 2025, with nearly €03 billion issued, surpassing 2024 totals and increasing 17.7% year-over-year. Through June 2026, approximately €56.38 billion of senior loans have been issued, tracking approximately 11.2% below full-year 2025 issuance levels.
• 2026 began with strong issuance and active markets, but conflict in the Middle East, elevated inflation, and negative sentiment surrounding private markets contributed to issuance slowing materially late in the first quarter and into the second quarter.

European Leveraged Loan Market Fundamentals

Broadly Syndicated Credit Statistics

• In 2025, average leverage ratios for the syndicated lending market increased above 5.0x for the first time since the first quarter of 2024.
• In 2026, leverage ratios have remained near 5.0x. Meanwhile, average interest coverage decreased to 2.71x in the second quarter and remains below the 4.0x historical average pre-2022.

European Default Rate Trends and Credit Risk Outlook

• According to S&P, European speculative-grade corporate defaults will increase to 3.75% by March 2027 in their most recent base-case forecast. S&P’s forecast is broadly consistent with expected U.S. speculative-grade default rates of approximately 3.8% for March 2027.
• Overall, these levels are still relatively low compared to other higher stressed periods (i.e., The Great Recession, COVID, etc.) and are unlikely to lead to material portfolio losses for managers and investors.
• S&P noted its base case forecast could increase further by the first quarter of 2027 as a result of disrupted energy flows, rising interest-rate expectations, and lingering trade uncertainty. If the situation in the Middle East escalates further, the default rate could approach 5.0%.
• Fitch has increased its 2026 European leveraged loan default forecast to 4.0% – 4.5%, reflecting an expected increase in credit quality deterioration among leveraged loan issuers. Fitch left their European high-yield and U.S. leveraged loan forecasts unchanged, indicating they do not expect a broader deterioration across the market.

European Private Equity Deal Activity and M&A Trends

• According to PitchBook, 2025 was a strong year for European private equity deal activity, with approximately €643.4 billion of deal value, representing a 17.9% increase relative to 2024 (€545.69 billion). Activity accelerated during the second half of 2025, when approximately €363.82 billion in transaction volume was completed. Through June 2026, deal activity totaled approximately €302.4 billion, representing an 8.2% increase relative to the first half of 2025.
• Through June 2026, European leveraged buyout volumes as a percentage of total deal volumes have increased, currently accounting for 53.8%, slightly higher than 53.3% in 2025.

European Private Equity Fundraising Trends

• 2025 proved to be a difficult year for private equity fundraising in Europe. According to PitchBook, European private equity funds raised approximately €82.0 billion in 2025, a nearly 44.6% decline compared to 2024’s record figure of €148.0 billion.
• To date in 2026, only €39.1 billion has been raised, an approximate 27.9% decrease compared to the same period last year. The fundraising environment remains constrained and may continue to do so until exit activity improves.

Private Equity and Private Credit Dry Powder Trends

• According to data from S&P Capital IQ Pro, sponsors globally held approximately $2.5 trillion of private equity dry powder as of June 2026, while private debt managers held approximately $474 billion.
• These capital reserves continue to provide capacity for future transaction activity and support ongoing demand for private credit financing. Assuming leverage levels of 40% to 50%, private equity dry powder could imply substantial future financing demand associated with leveraged buyout activity of an additional nearly $1 to $1.25 trillion.
• In 2026, private debt dry powder has increased year-over-year, although private equity dry powder has largely remained stagnant.

European Private Equity Valuation Multiples

• European median private equity buyout EV/EBITDA multiples decreased from 12.6x in 2025 to 10.8x as of June 2026 (13.1x TTM).
• Compared to full-year 2025 totals, exit activity by count is expected to decline by approximately 30% (nearly 15% by volume) in 2026, per PitchBook.