(Reuters) -Top-rated U.S. companies have financed their acquisitions mostly with equity and cash instead of debt this year, and could continue doing so even as M&A activity and hopes of interest rate cuts rise, bankers and investors said.

High debt costs and worries of credit-rating downgrades for taking on debt made funding acquisitions with cash and stock with sky-high valuations more compelling, they said.

Last week, rail operator Union Pacific announced an $85-billion deal to acquire Norfolk Southern, and analysts expect it to finance the deal mostly with stock, some cash, and $15 billion to $20 billion of debt. 

The deal could set a record for the largest buyout in the sector.

Such cash-and-stock deals have become popular due to a narrowing gap between the pre-tax costs of equity and debt, according to Piers Ronan, co-head of debt capital markets at Atlanta-based investment bank Truist Securities.

Some $250 billion, or 11% of total M&A funding this year, was stock funding, while 15.3% of deal volume was funded by a mix of cash and stock, according to LSEG data.

This compares with $441 billion, or 14% of all M&A funding in 2024 that was stock-funded and 7% cash-and-stock funded, the data showed.

"Debt is not really so attractive right now -- because equity is so attractive," Ronan said, pointing to its attractive earnings yield.

Many corporations have posted strong earnings and generate healthy free cash flow, which has contributed to "an uptick in equity financing of M&A transactions and a little less reliance on debt financing," said Natalie Trevithick, head of investment grade strategy at Los Angeles-based asset manager Payden & Rygel.

Investment-grade companies have also grown wary of adding debt to avoid downgrades, which could increase their funding costs. 

Ratings agencies Moody's, S&P, and Fitch warned their ratings on Union Pacific could be downgraded if the company pushes its leverage higher due to its planned Norfolk Southern acquisition.

"(A ratings downgrade) is going to have a pretty big impact on how your bonds trade in the secondary market," said Mike Sanders, head of fixed income at Madison, Wisconsin-based asset manager Madison Investments.

Sanders pointed to the poor trading performance of media company Warner Bros Discovery's bonds following its announced split into two separate publicly-traded companies and downgrade to junk status in June.

Less reliance on debt by M&A-intent companies could cause end-of-year volumes for investment-grade issuance to fall short of their $1.5-trillion level in 2024, bankers said.

The average spread on investment-grade bonds was last at 82 basis points, just shy of the 77-bps level it touched in 1998, according to the ICE BofA U.S. Corporate Index.

Kyle Stegemeyer, head of investment-grade debt capital markets and syndicate at Minneapolis-based U.S. Bank, expects M&A-related bond supply to total $225 billion in 2025.

"As we move deeper into the year, it becomes less likely that we get the large multinational transformational M&A financed this year to help drive the numbers materially higher," Stegemeyer said.