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Loic Prevot, head of European leveraged credit at Polus Capital Management discusses the outlook for European leveraged finance and CLOs heading into 2026 including strength of the pipeline, CLO equity performance, and the challenges posed by limited supply, elevated cash balances and tightening arbitrage.
1. What are you seeing so far from the leveraged finance pipeline looking ahead to 2026?
The pipeline is noticeably stronger than last year. That said, we’ve been expecting a good pipeline for some time. Everyone is anticipating a pick-up in M&A this year, resulting in more supply coming through the pipeline, but it remains uncertain at this point and could be somewhat sporadic.
We’ve already seen a couple of new-money deals hitting the market, but there’s still a mix of recycled paper, extensions, repricings, and so on. The fact that we’re seeing so many repricings is telling – borrowers are being opportunistic, but it also suggests there isn’t a strong pipeline of net new supply right here, right now.
2. Have recent political or geopolitical developments had any impact on European credit market pricing?
If we think about the latest headlines, whether it’s Venezuela or Iran, we’re talking about geographies that are not directly linked to Europe. From where we sit, in the European leveraged loan and high yield market, there’s limited direct impact. It feels more like a continuation of last year’s themes, driven by a lot of headlines, and while there was occasional short-term volatility, with the exception of the US administration’s trade wars there wasn’t generally much immediate impact on market pricing or fundamental credit performance. I think people have also realised that when volatility does occur, it can be very temporary, so there seems to be a bit of a wait-and-see attitude, and more limited immediate repercussions.
Having said that, the European credit market pricing still feels very much driven by supply and demand rather than by macro headlines. And on that front, there hasn’t been much change so far — there’s still a lot of demand for paper, supply remains limited, and we’re seeing tight pricing in the primary market, particularly for higher-quality credit. Conversely, we’re also seeing the same phenomenon of dispersion and idiosyncratic volatility that we saw through most of the second half of last year in secondary market trading levels.
3. Following your first close in 2025, how has the CLO captive equity strategy and asset class performed over the past year?
If we look at CLO equity performance over the last few years, 2024 and 2025 stand out for having been very strong in terms of distributions, particularly in Europe. Distributions in the US were lower last year, but in Europe, distributions have been in the high teens on average, which is among the best we’ve seen in years. That’s been positive and supportive of fundraising, especially in an environment where overall credit spreads have been compressing.
The investor universe has also widened. More people are familiar with the product, and the product itself has matured, which is attracting new investors. All of this has been positive for fundraising.
In terms of performance, captive CLO equity strategies may differ. In the case of our strategy, in addition to the returns from CLO equity we also have exposure to warehouse returns and allow for opportunistic investments in loans, bonds, and CLO tranches. Speaking just for ourselves, warehouse terms have been fairly attractive over the last few years, and we’ve managed to generate strong returns from the warehouse period. Of course, warehouse returns don’t account for the total return, but they are a nice sweetener for captive CLO equity strategies. Ultimately, the benefit of captive equity strategies is the flexibility for the manager to tactically navigate and take advantage of different market conditions.
4. European CLOs ended last year with elevated cash balances. What factors are driving this?
Yes, cash balances are clearly higher. That reflects a lack of assets, but it’s also compounded by high prepayment rates. Refinancings often bring repayments that aren’t necessarily welcome. Ironically, these repayments tend to come from loans you wouldn’t want to be repaid – i.e. the higher quality borrowers offering better spread per unit of credit risk.
So, we’re dealing with bifurcated secondary market pricing, limited primary supply, and high repayment rates. This wave of repayments hasn’t decreased; if anything, it increased toward the end of the year. As a market, we’ve been repaid more than we’ve been able to redeploy, which explains the higher cash balances at year-end.
In our case, we’d been running fully invested for a long time. When conditions changed just before year-end, with no primary supply, the choice was either to live with cash or buy secondary assets at par or above, as assets that were available below par often meant taking on additional credit risk, which wasn’t ideal. We preferred to let the cash balance tick up slightly rather than stretch for riskier assets or pay high prices that didn’t make sense. Many managers were in the same position, waiting for the start of this year to hopefully see more primary supply.
This also creates a good backdrop for repricings. When people are slightly over-invested or expect supply to come, they’re more willing to let paper go if the pricing gets too tight or accept the risk of being repaid. The bar is clearly higher at the moment.
5. How has CLO arbitrage evolved in recent months, and what are you seeing going forward?
If we look at the day one CLO arbitrage, it has clearly deteriorated over the last few months. Some research desks have been monitoring this, and by the end of last year the arbitrage was near the lowest levels we’ve seen in recent years, excluding the disruptions of 2022. Obviously, if asset spreads keep tightening, the arbitrage will deteriorate further.
On the liability side, we’re expecting some tightening at the start of this year, which would improve the arbitrage. It’s still early days, but triple-A spreads are already tighter than they were at the end of last year. However, given the wave of repricings we’re seeing on the asset side, it’s fair to think this will have a bigger impact than liability-side tightening, and the arbitrage may continue to be squeezed in the near term.
6. What are your expectations for CLO equity performance in 2026?
We already saw distributions come down in Q4. Several waves of repricing reduced portfolio weighted-average spreads, and higher cash balances also negatively impacted equity distributions. Distributions are therefore expected to be lower overall.
That said, CLO distributions move up and down over the life of a deal. We expect to see the full impact of repricings over the next few quarters. I would expect the next two quarters of distributions to be lower than what we saw in 2025.
7. With a record number of warehouses currently open, how challenging has ramping been?
Ramping is clearly challenging in the current market. If we look at the percentage of loans trading above par, it’s still a large number, around 50% recently before the renewed wave of repricings. That made secondary ramping difficult unless you were willing to buy those assets and take on the negative convexity. As a result, most managers have relied on the primary market to ramp portfolios, which naturally takes longer.
We haven’t seen much supply, and most of it has been recycling. As a matter of discipline, we prefer to ramp over a longer period, so that we have time to select the assets we want and achieve the best possible arbitrage. Longer warehousing phases have therefore become more common.
This is true across the market. Many managers are running multiple warehouses concurrently, to account for longer ramp-up periods, which explains why we’re seeing a record number of warehouses open.
8. What conditions would need to change to meaningfully slow CLO issuance?
It ultimately comes down to arbitrage. If the arbitrage no longer makes sense, things will slow down. That said, expectations are high for this year in terms of new issuance. There’s a strong desire from CLO managers to deploy more capital, with equity having been raised and some managers looking to grow AUM, even if that’s not always optimal for equity returns.
Some managers have return hurdles, and while they may not stop issuing altogether, they may delay or slow activity. Toward the end of last year, we saw a lot of resets and some postponement of new issues. That’s likely what slows activity. It doesn’t stop it, but it encourages managers to wait for better windows.
9. Triple-C exposure has been increasing across European CLOs. What is driving this trend?
In 2025, we saw more downgrades from ratings agencies as the year progressed, for instance in cyclical sectors. In addition, the derivation of ratings for credits non-rated by Fitch has increased the amounts of Fitch triple-Cs. Once an asset is cut to triple-C, it usually stays there for some time. As the pace of triple-C downgrades has not reduced, the rise in triple-Cs has been fairly mechanical and expected for some time.
On the other hand, there’s been a fair amount of selling by managers who are managing their triple-C buckets and a lot of clean-up linked to CLO resets, whose volumes increased significantly in 2025. Those resets typically permit a maximum percentage of triple-C assets, say around 2.5%, and there has been some clean-up activity on deals that exceeded those levels.
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