By Yoruk Bahceli

(Reuters) – U.S. and European companies have marked another milestone in their road to recovery from COVID-19, seeing their debt levels relative to profits tumbling to the lowest since before the pandemic erupted in 2020.

The net leverage is a measure of financial health. It’s a percentage of EBITDA (earnings before interest, taxes depreciation, amortization) that represents the company’s net debt.

According to BNP Paribas, the U.S. investment-grade companies saw their net leverage fall in the second quarter. This is the lowest level since 2018. European leverage has been the lowest since 2019.

This is good news for the corporate debt market, as it shows that segments with low ratings are performing better this year. It also signals normalising credit quality.

Viktor Hjort from BNP Paribas, global head for credit strategy, said that the earnings recovery was much faster than we expected. This is partly due to corporate earnings becoming increasingly COVID immune.

Graphic: Corporate leverage at pre-pandemic levels https://fingfx.thomsonreuters.com/gfx/mkt/lgpdwkmegvo/MsQWu-corporate-leverage-mostly-back-to-pre-pandemic-levels.png

Earnings at and companies are already some 40% above pre-pandemic levels, according to Refinitiv, with the vast majority of companies beating forecasts.

According to BNP data, the U.S. has seen its leverage drop fastest among firms that have “junk” credit ratings or are below the BBB level.

Analyst at Schroeders Asset Manager Kristjan Mae said deleveraging in U.S. investment grade companies could be attributed to high earnings growth. However, junk and high-yield businesses “have been taking proactive steps as illustrated by their negative debt growth.”

According to data from BofA, U.S. high-yield debt had fallen 1.3% in August compared with the previous year.

Mae said in a memo that some lower-rated companies were under pressure to reduce leverage.

Graphic: Total U.S. junk debt falls https://fingfx.thomsonreuters.com/gfx/mkt/gkplgwlmavb/quz7m-total-u-s-junk-debt-has-fallen-from-pandemic-peak%20(1).png

BNP Paribas data also shows that quick ratios – effectively an indication of how quickly a borrower can pay off short-term obligations with available liquidity – are well above pre-pandemic levels.

Although the U.S. quick ratio is down slightly to 95% from its 10-year peak, it remains at 84% in Europe, which may be due to European companies being anxious about a slower economic recovery.

Hjort explained that it speaks of corporations that still haven’t recovered their confidence and that act as if there is a “pandemic” or are not certain they’ll have the same access to financing as before COVID.

Janus Henderson reported that $5.2 trillion is held by companies around the world. It was a result both of large-scale precautionary borrowings and spending cautiously during pandemic months.

However, spending on dividends has increased and capex expenditures have increased. Cash balances will need to decline. Global capital expenditure is set for the best year since 2007, says S&P Global (NYSE:), predicting a 13% surge.

Hjort stated that the European process will be slower, and could lead to a better performance of the regional corporate bonds in the months ahead.

Graphic: Corporate liquidity ratios remain elevated https://fingfx.thomsonreuters.com/gfx/mkt/xmvjokgxapr/149O3-corporate-liquidity-ratios-remain-elevated-.png