Higher oil prices sparked by the Iran war threaten to introduce a range of pressure points for the European leveraged finance market, as the threat of inflation undermines the benign interest-rate environment that has broadly supported credit for the last two years.
Against that difficult backdrop, the broadly syndicated loan (BSL), direct lending and high-yield bond markets are all at risk of wider credit spreads and higher default rates when elevated oil prices erode consumer spending power and raise input costs — particularly if supply chain disruption persists.
This scenario would challenge the more favorable rate outlook that’s been in place since the European Central Bank began cutting rates in June 2024, with markets now pricing in rate hikes this year for the eurozone.
Key points:
- The BSL market faces a two-pronged stress threat — refinancing risk for Covid-era deals meeting a higher interest-rate environment, and broadening default risk if inflationary pressure persists across sectors. Structural support from CLO capital flows is a genuine mitigant, but it cannot compensate indefinitely for deteriorating underlying credit quality.
- The direct lending asset class — with higher average leverage, limited transparency around defaults, and the potential for US LP sentiment to spill into European allocations — is exposed to a compounding set of risks that are harder to monitor. The services-heavy portfolio composition of the European market offers partial shelter from direct energy costs, but inflation’s broader reach means that insulation is only partial.
- High-yield bonds face a distinct but serious set of pressures. Fixed-rate exposure here makes the market more sensitive to inflation expectations than the floating-rate loan markets, while a €60 billion refinancing wall between 2026 and 2028 is a near-term risk.
Connective tissue
Refinancing risk is the thread running through all three markets. In the BSL space, the most acute exposure sits with deals structured during the Covid and post-Covid era of near-zero rates, which are now confronting a materially higher borrowing cost environment.
While borrowers made good headway in addressing near-term obligations with their 2024 and 2025 refinancing efforts, this activity has slowed substantially. The near-term concern of the 2028 and 2027 maturity wall has eased from €79 billion a year ago, though a €66 billion hurdle remains.
When new loan issuance picks up again following an effective hiatus since the outbreak of war in the Middle East, funding costs look set to rise substantially. After tightening through most of 2025, the average yield to maturity of loans tracked by the Morningstar European Leveraged Loan Index (ELLI) jumped back above 7% in March — the first time it had exceeded this threshold since January 2025.
Reputation management
In direct lending, similar refinancing pressures apply. These are compounded by a reputational dimension, as BDC redemption activity in the US has put the asset class under scrutiny. While Europe has fewer retail investors and is therefore somewhat insulated from such activity, the overhang from US dynamics is not entirely absent.
Number crunching
Meanwhile, the high yield market faces the starkest numbers. As a predominantly fixed-rate market, it is more directly sensitive to inflation expectations than the floating-rate loan product.
European high yield issuers have roughly €60 billion of maturities falling due between 2026 and 2028. This set-up echoes the dynamic seen after the 2022 rate shock — when volatile market conditions raised concerns around a concentration of near-term maturities, but higher-rated borrowers with staggered maturity profiles were routinely able to extend debt close to maturity. Nevertheless, the refinancing risk is real, and the window for complacency is narrowing.
Technical picture
As for the technical picture, this diverges across the asset classes. The BSL market, for example, continues to benefit from the structural discipline of CLO capital flows, providing a degree of resilience in deal flow that is relatively independent of broader market sentiment. This remains a key differentiator in volatile conditions.
Europe’s direct lenders face a more complex dynamic. This asset class has yet to be tested through a full credit cycle, and its standing among institutional investors is still evolving. US LP behaviour — shaped in part by BDC-related concerns — could influence European capital allocation on a delayed basis, even if the two markets are not structurally identical. Europe’s greater reliance on institutional investors provides some insulation, but the market remains opaque, and the impact of recent software-sector weakness on fundraising is not yet clear.
Sector exposure
Direct lending deal flow, as tracked by LCD, is concentrated in the Software & Data Integration, and Business Services sectors. This composition profile offers some insulation from direct energy cost exposure, though inflation remains pervasive regardless.
Over in Europe’s high-yield market, the Energy sector was the only positive performer in terms of Q1 sector returns with a gain of 1.5%, while Technology & Electronics was the worst-performing segment with a 4.3% loss. Here, a sustained energy shock would weigh most heavily on the Automotive, Transportation and Basic Industry groupings (with the latter including Chemicals).
In the BSL market, the Interactive Media & Services, Pharmaceuticals, and Life Sciences Tools & Services were the three strongest-performing sectors over the first quarter, while IT Services led the fallers with a chunky 7.7% loss, and Software lost roughly 4%.
Clearly, renewable energy companies across all three markets would be relative beneficiaries in a higher oil price environment.
More broadly, the impact of the Iran war is also being felt through supply chain disruption — which is expected to persist even if shipping begins to resume through the Strait of Hormuz, given the time required for tankers to reach their destinations from the Persian Gulf.
As Barclays analysts noted in a macro wrap published on April 13, “a ceasefire is not a refund; there will be a bill for the past six weeks.” Transportation businesses including airlines, and chemicals remain among the sectors most exposed to this disruption.
Structural sensitivity
For direct lenders, meanwhile, the concern is less about sector and more about structure, as services businesses carrying highly leveraged deal structures are acutely sensitive to any cost pressure that erodes top-line growth.
As for new deal flow, valuation gaps in sponsor-to-sponsor transactions remain wide, and continue to constrain M&A activity. Inflation and uncertainty only add to the challenge, while pressure on GPs to return capital pushes in the opposite direction. That said, the European loan pipeline stands at roughly €7.8 billion, with several large M&A-linked underwrites expected to come to market across loans and bonds, supported by continued CLO demand.
The high yield market has been more directly disrupted, with the onset of conflict in the Middle East having a tangible impact on deal flow, and issuance costs rising roughly 100 bps.
High yield issuers, which are typically higher-rated than loan borrowers, have the option to delay refinancings without triggering alarm among investors or rating agencies — thereby giving them a degree of flexibility that provides some breathing space, even if it defers rather than resolves the underlying pressures.
What’s more, fund outflows from the European high yield market have accelerated since the start of the Iran conflict, adding a technical headwind to the fundamental pressures the asset class already faces.
Featured image by G0d4ather/Getty Images/iStockphoto
Learn about our editorial standards.
