Exploring how the resilience of collateralized loan obligations amid shifting leveraged finance dynamics set the stage for the coming year.
Leveraged Finance Outlook 2026
US and EMEA leveraged finance markets are set for a strong 2026 rebound, driven by rising M&A, LBO activity, and elevated refinancing. Competition between BSL lenders and private credit will intensify as borrowers seek flexible options, while private equity deploys record dry powder, fueling deal flow in tech and healthcare. Mega deals will favor hybrid financing, and CLO demand will support opportunistic refinancings.
Risks remain involving tariff shifts, inflation, geopolitics, hidden leverage, and weak documentation that could undermine stability. Emerging AI-related credit concerns add to long-term vulnerabilities, keeping investor sentiment fragile despite improving issuance momentum.
Key highlights:
- Deal Activity Will Increase as Companies Shift Between BSL and Private Credit. Borrowers are increasingly shopping between BSL and private credit markets, leveraging competitive pricing and flexible terms. Prospective rate cuts could accelerate BSL takeouts of private credit, while refinancings remain strong, supported by CLO demand and opportunistic issuance. Expect heightened risk as hidden leverage becomes more prevalent through off-balance sheet structures and NAV lending.
- Private Equity Poised to Reignite LBO & M&A Activity. Private equity sponsors face mounting pressure to deploy record dry powder as investment periods mature and valuation gaps narrow. Lower financing costs and stabilizing rates will unlock new deal flow, particularly in noncyclical sectors like technology, healthcare, and business services. Mega deals will increasingly rely on hybrid financing, combining syndicated loans and private credit. Even if traditional LBO volumes remain subdued, sponsor-to-sponsor transactions, dividend recapitalizations, and strategic add-ons will sustain overall activity.
- Tariff Shifts, Inflation, and Geopolitics Remain the Main Downside Risks. Despite constructive credit conditions, global trade policy uncertainty, inflationary pressures, and geopolitical tensions could disrupt base-case projections. Low-rated issuers remain most vulnerable to refinancing challenges and sector-specific shocks.
Declining interest rates will strengthen CLO performance in 2026, as speculative-grade defaults fall sharply in the US and EMEA. US defaults are projected to drop to 3.0% by October 2026 from 5.3% a year earlier, while Europe improves to 2.4% from 3.8%. Lower funding costs and active refinancing will support this trend, alongside rising LBO activity that could spur new CLO issuance. However, competition for quality assets between private credit and syndicated lenders will intensify, heightening structural risks such as looser covenants and PIK features. Tight spreads and limited rating changes will restrict managers’ trading flexibility, leaving little room for collateral quality adjustments.
Key Highlights:
US CLOs: Defaults will decline along with funding costs. US CLO collateral defaults will decline in 2026 as lower interest rates and extended maturities improve borrower liquidity. Fed rate cuts will reduce funding costs, supporting leveraged issuers and middle-market borrowers, though these remain more vulnerable than broadly syndicated loans. Competition with private credit will weaken covenants and add leverage risks, but CLO structures will help absorb defaults. Still, tight loan spreads will limit managers’ ability to optimize portfolios, making credit monitoring essential.
EMEA CLOs: High liquidity will keep defaults down. Strong liquidity and investor demand will keep defaults low and issuance high, with 2026 volumes near 2025’s €55 billion record. Syndicated and direct lenders will offer ample refinancing options, but at the cost of looser terms and weaker collateral. Private credit CLOs will remain niche, while broadly syndicated structures dominate. Robust refinancing and repricing will persist, though tight spreads will limit managers’ flexibility. The key challenge: balancing issuance growth with credit discipline amid rising structural risks.
From Outlook to Action: Get More from Moody’s Research Assistant
Moody’s Research Assistant is a GenAI platform designed to streamline access to Moody’s data and research, offering faster insights across geographies and sectors. It helps you analyze trends around growth resilience, policy divergence, trade dynamics, refinancing risks, and more.
Below are tailored sample prompts to help you explore the most pressing themes from the Leveraged Finance and CLO 2026 Outlooks:
Leveraged Finance Prompts:
1 Prompt: “What are the implications of rising hidden leverage through PIK debt and NAV lending on credit risk for US leveraged finance issuers in 2026?”
Why is this prompt important? This question addresses a structural vulnerability that is not immediately visible in traditional credit metrics. For lenders, CLO managers, and investors, understanding how hidden leverage can distort risk profiles is critical for pricing, covenant design, and portfolio monitoring. It helps anticipate liquidity stress and default risk in scenarios where economic conditions deteriorate or refinancing windows narrow.
Why try this prompt? Moody’s highlights that hidden leverage—through Payment-In-Kind (PIK) debt and Net Asset Value (NAV) lending—is becoming more prevalent in US leveraged finance. These structures often sit outside the rated entity’s balance sheet, making them hard to monitor. While they can improve liquidity and equity returns in stable markets, they amplify cash flow strain and credit risk during downturns.
2 Prompt: “Provide a comprehensive analysis of how the bankruptcies of Tricolor and First Brands illustrate vulnerabilities in hybrid financing structures. Include details on the types of financing these companies accessed (public vs. private), the role of hidden leverage, and how these cases highlight risks for broadly syndicated loan and private credit markets in 2026.”
Why is this prompt important? This question draws lessons from real-world defaults to inform risk assessment. For credit analysts and leveraged finance investors, understanding how hybrid structures and hidden leverage contributed to these failures helps identify warning signs in current portfolios. It also highlights systemic risks as private credit and BSL markets converge, making transparency and covenant strength critical in 2026.
Why try this prompt? The bankruptcies of Tricolor and First Brands underscore vulnerabilities in hybrid financing structures that combine public and private debt. Both cases involved hidden leverage and opaque short-term financing, revealing how off-balance-sheet obligations can trigger liquidity crises even in borrower-friendly markets.
CLO Outlook Prompts
Why is this prompt important? This question help reconcile two opposing forces: improving macro credit conditions versus structural weakening in loan documentation. While fewer defaults suggest stronger CLO performance, covenant-lite structures can erode recoveries and increase loss severity in stress scenarios. Understanding this interplay is critical to assess whether headline improvements truly translate into better tranche stability or if hidden risks remain.
Why try this prompt? Moody’s forecasts a significant decline in speculative-grade defaults (US: 3.0%, Europe: 2.4% by October 2026), driven by supportive financing conditions and strong refinancing activity. At the same time, covenant-lite loan issuance is rising, reducing lender protections and lowering recovery rates on defaults.
4 Prompt: “Summarize Moody’s outlook for refinancing activity in the US and EMEA, including drivers behind the “pull-forward” effect from 2028–2029 maturities.”
Why is this prompt important? This prompt helps professionals understand liquidity dynamics and refinancing risk across major markets. Knowing why maturities are being pulled forward and how CLO capacity interacts with refinancing needs is essential for forecasting issuance volumes, assessing market liquidity, and planning investment strategies. It also informs risk management for sectors facing concentrated maturity walls.
Why try this prompt? Refinancing activity in the US and EMEA will remain strong in 2026, driven by opportunistic transactions and a “pull-forward” effect from 2028–2029 maturities. Issuers are accelerating refinancing to lock in lower rates and manage looming debt walls, while CLO demand provides additional support.
Why is this prompt important? This prompt introduces a scenario that could materially alter CLO performance. Tariff escalation would likely increase downgrades for junior tranches and reduce upgrades overall, reversing the positive trend seen in 2025. This insight is essential for stress testing, scenario planning, and anticipating rating migration that could impact liquidity, capital requirements, and investor confidence.
Why try this prompt? The baseline outlook assumes stable economic conditions and falling defaults, leading to upgrades concentrated in senior CLO tranches. However, persistent tariff escalation could disrupt supply chains, pressure corporate earnings, and increase default risk—especially for sectors heavily exposed to trade.
For more prompt ideas and detailed guidance, you can also visit our Research Assistant prompting hub.
As the global economic environment becomes more fragmented and complex, timely analysis and forward-looking perspectives are essential. Moody’s remains committed to providing the insight and tools you need to navigate uncertainty and seize new opportunities in 2026 and beyond. For more research, insights, and forecasts for the year ahead, explore the Outlooks hub.