Untroubled by soaring levels of corporate debt, large U.S. companies will likely prioritize growth and returning cash to shareholders in 2022.

Companies have actually lowered their leverage during the COVID-19 era despite the increase in debt. The improved balance sheets encouraged record-breaking levels of mergers and acquisitions and share buybacks in 2021 and this activity is expected to continue in 2022 even as the Federal Reserve tapers its bond purchases and indicates rate rises, making debt management more expensive.

"There is a massive push from investors for the companies to increase capital spending and to return cash to shareholders," Karolina Noculak, investment director at the asset manager abrdn, said in an interview. "What is very clear is that the investment community wants to see capital deployed rather than spent on restoring the balance sheet."

Higher debt, lower leverage

The U.S. nonfinancial corporate sector binged on credit during the pandemic, taking advantage of the Federal Reserve's ultra-loose monetary policy to rack up an extra $1.3 trillion of liabilities between the fourth quarter of 2019 and the third quarter of 2021.

Yet the median debt-to-equity ratio — a closely watched measurement of corporate leverage determined by calculating total liabilities as a percentage of shareholder equity — for U.S. companies rated investment-grade by S&P Global Ratings was 85.5% in the third quarter of 2021. That was down from a pandemic peak of 98.8% and lower than the level of 88.5% before COVID-19 washed up on U.S. shores.

The nonfinancial corporate sector has racked up liabilities of $11.41 trillion, according to Federal Reserve data, equating to 49% of GDP. This is down from a pandemic peak of 57% before economic activity recovered, but is still higher than the pre-pandemic level of 47%.

When COVID-19 struck, companies undertook a dash for cash, building up liquidity buffers in the face of freezing debt markets and freefalling earnings. But as the economy improved and the threat of defaults and bankruptcies retreated, companies used available credit to refinance at lower rates and spend on M&A and share buybacks.

The value of mergers and acquisitions in North America climbed 81% year over year to a record $2.459 trillion in 2021, according to data from S&P Global Market Intelligence. Meanwhile share buybacks are believed to have beaten the previous annual record of $806.41 billion, according to S&P Dow Jones Indices.

Lower-rated companies have also improved their leverage metrics. The median ratio for U.S. companies rated non-investment-grade was 128.3% in the third quarter of 2021, down from a peak of 157.2% and a pre-COVID level of 140%.

"I don't foresee rising interest rates and higher inflation causing companies to repay debt," David Sekera, chief U.S. market strategist at Morningstar said in an email. When real interest rates are negative — i.e., inflation runs higher than nominal interest rates — "management teams probably prefer to maintain their low-cost, long-term debt as opposed to paying it down."

Tech sector leads on spending

The information technology sector has the lowest median debt-to-equity ratio of the 10 sectors tracked by Ratings. The liabilities of the highly cash-generative investment-grade-rated tech companies was just 55.4% of equity in the third quarter of 2021.

This strong cash position has enabled tech giants such as Apple Inc. and Microsoft Corp. to lead on share buybacks — spending $20.5 billion and $8.8 billion, respectively, in the third quarter of 2021 — while Microsoft has started 2022 with a bang with the $68.7 billion acquisition of video game company Activision Blizzard Inc.

"We expect M&A and all sorts of shareholder remuneration; repurchases [buybacks] and dividends and other ways," Gregg Lemos-Stein, global head of analytics and research at S&P Global Ratings, said in an interview. "In some cases, these are risky behaviors, in some cases not."

The surge of corporate M&A deals will grow revenues for companies, but typically such activity is bad for credit metrics, Lemos-Stein said.

"More often than not M&A is not positive for credit. It leads to downgrades, a combination of more debt, a higher-rated entity bought by lower-rated, or it just doesn't work out that well," Lemos-Stein said.

But growth, rather than reducing debt, is uppermost in the minds of most investors. Bank of America's monthly global fund manager survey published in December 2021 found that only 22% of respondents wanted companies to improve their balance sheets, the lowest since January 2018.

"Things like improving balance sheet, which were highly featured responses, have now subsided. The pressure is very much on capital expenditure," abrdn's Noculak said. "There's a time to stop spending. I think the investment community is saying that the time has not come yet."

S&P Dow Jones Indices and S&P Global Market Intelligence are owned by S&P Global Inc.