After sentiment in the European high-yield bond market turned on a dime this week, bankers are telling prospective borrowers to bring deals now - because things are about to get worse.
Prior to Monday, average junk bond yields had compressed steadily to 3.8% - in from a March 23 peak of 8.86%. But borrowers got a nasty shock this week when yields shot back up over 4% as a combination of equity sell-off, rise in Covid cases and concerns over the US elections turned market sentiment sour.
"Monday acted to spook people," said one senior leveraged finance banker. "July to September saw relentless tightening in secondary levels and every day saw the market brush off another negative headline. We're telling issuers to go now; our advice is that this volatility is here to stay."
The fourth quarter is set to be "catalyst-heavy" for volatility, said the banker, thanks to a confluence of Brexit noise, the US elections and the potential for further coronavirus restrictions.
"It would take a brave borrower to hold off. You're going to see those pre-Covid 19 M&A underwrites look to come now - unless there's a sustained period of volatility," said the banker.
What has helped to scare both bankers and borrowers into action is that the yield widening on Monday seemed to be partly down to further restrictions in the UK.
"Even though UK-based companies represent a very small proportion of the high-yield index, it still triggered a massive spike in volatility, and deals that launched Monday didn't price where they would have last week," said the banker.
Bankers are now looking once more at their pre-Covid 19 M&A underwrites. The majority of that pipeline was cleared in the first possible window after the markets started rallying in May.
Banks managed to get away a €10.3bn loan and bond financing backing the buyout of ThyssenKrupp in June, and a €1.344bn-equivalent deal the following month to fund pub owner Stonegate's acquisition of Ei Group - a sector heavily exposed to Covid-19.
But some financings are still to come, including PureGym's €445m acquisition of Fitness World, Permira's €450m purchase of Golden Goose and BC Partners' acquisition of Pasticceria Bindi.
"Collectively, the banks have de-risked the vast majority of their exposure, but there's a few deals out there," said a second banker.
"Before the sell-off we've seen in the last couple of days the plan on those would have been to come to market in late September or early October to de-risk them - and now it's likely to be delayed."
He stressed that there is now an "incredibly small" number of deals left hung on banks' balance sheets.
Unless the fourth quarter sees a major sell-off, which would involve M&A underwrites being cleared at a level beyond bank caps, those deals will be sold in the fourth quarter, said a third banker.
"It would take an incredibly brave gamble for a borrower to think things will get better. You're not going to see anyone want to hold on beyond year-end."
However, borrowers with spread-specific refinancing needs are wondering whether to wait for a better window.
"Issuers are nervous," said the third banker. "They saw a great market up to this point and are now worried that they've missed the boat."
That applies mainly to borrowers that needed the market to improve dramatically before refinancing made sense.
"They're trying to figure out whether it's worth bringing them now - or whether they want to wait."
INVESTOR OPPORTUNITY
While borrowers are spooked, investors are still looking to add risk and will be taking advantage of the current climate to demand larger issuer premiums in primary, said bankers.
"I don't think investors have changed their tune," said the third high-yield banker. "The cash position hasn't changed - no one is expected to see any outflows, and central banks are remaining supportive," he said.
However, Monday's wobble has reminded the buyside that the market will continue to see volatility, and they are looking for deals with a bit more spread on them, he said.
"We were starting to see a market where anything goes and deals were multiple times subscribed - everyone thought we were back to January, and that's not right," said the third banker.
"Now investors are also starting to ask for larger new issue premiums - because they're saying 'NIPs protect us from days like Monday'. That's very fair."
Investors are hoping that there is a bit more of a sell-off so they're given an opportunity to pick up risk that looks cheap, said the first banker.
"The spread environment has been out of kilter with the economic reality - I was surprised with how quickly spreads retraced [after March]."