Net Net: Promoting innovation and managing change

Watch out: Your company could soon be 'junk'

VIDEO4:2104:21
Junk bonds, slow moving train wreck: Pro

Investors are missing a serious threat ahead in the bond market, according to one analyst who sees the ranks of the "fallen angels" swelling.

The term refers to companies formerly with investment-grade ratings that for one reason or another — often unsustainable debt loads — get downgraded to junk.

Michael Contopoulos, high-yield strategist at Bank of America Merrill Lynch, warned clients to watch out for a "migration cycle" of downgrades could affect $300 billion or more worth of junk debt. That number presumably would shoot even higher if the next cycle is even more serious than historical norms would indicate.

Should his scenario play out, that would grow the entire high-yield space by 25 percent, in the process lowering aggregate credit quality, increasing default risk and causing a glut of junk paper that would cut into the market's value and hit investment returns.

"The overall indigestion to the market could prove massive," Contopoulos wrote. "We hear so much about the potential for outflows, but very little about the potential for new paper through downgrades. The latter dwarfs the former."

Related Tags