United StatesAfter years of improving corporate balance sheets, we now perceive a risk of re-leveraging among investment grade issuers. Specifically, for ‘A’-rated US companies.
The catalyst for corporate re-leveraging in 2025 looks set to be a ramp-up in mergers and acquisitions (M&A). A combination of factors could encourage many highly rated US companies to pursue transformative deals, potentially to the detriment of their credit ratings. Avoiding any such downgrades will be key for investment grade investors in this environment.
The scene is set for dealmaking – and borrowing
Fears of recession have muted M&A activity over the past couple of years and have encouraged companies to strengthen their balance sheets. That switch has now flipped.
There was a 36% year-on-year increase in large transactions (valued at between US$1bn and $10bn) globally in the second half of 2024.1 Looking ahead, recent estimates project a 50% increase in global M&A volume, by value, in 2025.2 According to Morgan Stanley, deal pipelines are at their highest in seven years.3
Source: Dealogic / Morgan Stanley Research forecasts, January 2025. Data excludes rejected/cancelled deals and includes carve-out deals.
Subhead: Announced M&A volume (US$tn)
Overview: This bar chart illustrates the value of global mergers and acquisitions (M&A) activity each year between 1995 and 2025. Data for 2024 and 2025 is forecast.
Overall, this chart shows how M&A activity has been highly cyclical, with peaks in 1999, 2007, 2015 and 2021 followed by troughs. Having fallen to a near-two decade low in 2023, global M&A activity is forecast to have recovered in 2024 and to rise sharply in 2025.
Values:
| Year | $UStn |
| 1995 | 1.1 |
| 1996 | 1.5 |
| 1997 | 2.1 |
| 1998 | 2.9 |
| 1999 | 4.5 |
| 2000 | 4.2 |
| 2001 | 2.4 |
| 2002 | 1.7 |
| 2003 | 1.9 |
| 2004 | 2.9 |
| 2005 | 3.8 |
| 2006 | 6.7 |
| 2007 | 10.4 |
| 2008 | 6.5 |
| 2009 | 4.1 |
| 2010 | 4.4 |
| 2011 | 4.3 |
| 2012 | 3.8 |
| 2013 | 4.2 |
| 2014 | 5.7 |
| 2015 | 6.8 |
| 2016 | 5.6 |
| 2017 | 5.8 |
| 2018 | 6.0 |
| 2019 | 5.6 |
| 2020 | 5.3 |
| 2021 | 7.8 |
| 2022 | 5.5 |
| 2023 | 3.6 |
| 2024 | 4.5 |
| 2025 | 6.7 |
A combination of three factors provides a strong backdrop for M&A activity.
First, recession fears have diminished. The New York Federal Reserve now ascribes a 29% probability to the US economy falling into recession by the end of 2025 – down from its late 2024 estimate of 60%.4 Odds have tumbled based on strong economic indicators, specifically employment numbers and consumer spending, and the prospect of pro-growth policies under the new Trump administration. The economic tide has lifted profit expectations, perhaps giving companies more confidence to lever up in pursuit of improved earnings per share.
Second, credit markets remain accommodative. We expect investment grade issuance to be robust in 2025, with an upcoming maturity wall driving up gross supply by 17%.5 Tightening spreads indicate that supply is being digested by investors attracted by yields that remain well above their 10-year average.6
Third, the new US administration clearly favours deregulation. New appointees at the Federal Trade Commission (FTC) and the Securities and Exchange Commission (SEC), and steps including the ‘10-to-1’ Deregulation Initiative – under which 10 existing rules must be repealed for each one introduced – indicate a less interventionist direction of travel.
Evaluating issuers’ commitment to credit ratings
We maintain a cautious view on US investment grade spreads overall and watch for signals that companies are shifting their attention away from deleveraging. Four sectors appear particularly at risk of leverage-driven M&A activity.
First, technology. The race for scale in artificial intelligence (AI) and battery storage technologies, both of which are being rapidly adopted, lays the foundations for ambitious deals.
Second, financials. Less stringent capital requirements are expected to make US banks more willing to pursue M&A as a way to achieve economies of scale. Size can help banks offset margin compression driven by compliance costs, large digital investments, and the rise of non-traditional lenders.
Third, energy. The fast-growing and fragmented renewables sector looks ripe for consolidation through M&A. Strategic partnerships could help drive the deployment of carbon capture.
Fourth, healthcare. Many US healthcare organisations are looking to add capabilities, including wellness centres, home health services and specialised clinics, to their core services. Meanwhile, large pharmaceutical companies frequently turn to acquisitions to offset upcoming patent cliffs.
Why ‘A’-rated issuers may be tempted to lever up
Across the economy, we think ‘A’-rated issuers could face a particular temptation to make more aggressive use of their capital in the current climate.
Unlike their less numerous ‘AA’-rated counterparts, which generally boast stronger balance sheets, ‘A’-rated companies will often have to turn to debt to finance deals. However, ‘A’-rated companies have much more wiggle room for highly leveraged M&A than their ‘BBB’-rated counterparts, for whom a downgrade can carry material financial costs.
In contrast, the penalty for a downgrade from ‘A’ to ‘BBB’ is very low, in a historic context: the spread differential among US bonds is currently around 30 basis points.7 This dynamic, which lowers the premium due on additional borrowing costs, removes an obstacle to large deals.
Source: Federal Reserve Bank of St. Louis, 28 January 2025
Subhead: Spread to worst (basis points)
Overview: This line chart compares the historic spread to worst of ‘A’ and ‘BBB’ rated US corporate bond indices between January 2011 and January 2025.
Category one: ICE BofA BBB US Corporate Index
Category two: ICE BofA Single-A US Corporate Index
Overall, this chart shows that the spread differential between ‘A’ and ‘BBB’ rated US corporate bonds has converged in recent years. Aside from a spike in 2020, ‘A’ and ‘BBB’ spreads have trended downward over the period.
As we navigate through 2025, we are focused on evaluating management teams’ willingness to add leverage and their commitment to maintaining high investment grade ratings. Avoiding downgrades, and the spread widening that usually accompanies them, is crucial for investment grade investors seeking outperformance.
1 WTW, January 2025: Quarterly Deal Performance Monitor
2 Dealogic / Morgan Stanley Research forecasts, January 2025
3 Nishant, N. & Bautzer, T., 16 January 2025: Morgan Stanley’s profit more than doubles on boost from dealmaking, stock sales. Reuters
4 Federal Reserve Bank of New York, January 2025: Probability of US Recession Predicted by Treasury Spread
5 Morgan Stanley, December 2024: US Credit Strategy 2025 Supply Outlook: Dialing Up the Volume
6 Federal Reserve Bank of St. Louis, 28 January 2025
7 Federal Reserve Bank of St. Louis, 28 January 2025
References to specific securities are for illustrative purposes only and should not be considered as a recommendation to buy or sell. Nothing presented herein is intended to constitute investment advice and no investment decision should be made solely based on this information. Nothing presented should be construed as a recommendation to purchase or sell a particular type of security or follow any investment technique or strategy. Information presented herein reflects Impax Asset Management’s views at a particular time. Such views are subject to change at any point and Impax Asset Management shall not be obligated to provide any notice. Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary. While Impax Asset Management has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability or completeness of third-party information presented herein. No guarantee of investment performance is being provided and no inference to the contrary should be made.