Take Five: John Loffredo on how to play the Detroit muni mess

Detroit officially entered default status on Monday when it failed to make a $39.7 million payment on debt issued to fund pensions. But even as Michigan's largest city moves a step closer to bankruptcy, there are still opportunities to invest in Detroit municipal bonds, according to John Loffredo, manager of the $1.1 billion MainStay High Yield Municipal Bond Fund (MMHIX). InvestmentNews: What is the outlook for holders of Detroit muni bonds? Mr. Loffredo: The outlook is still unsettled because there are so many different variations of Detroit debt. If you have a revenue stream tied to your debt you're in better position, versus a pledge of a certain revenue source. Water and sewer bonds, for example, are well-protected. And state aid bonds are well protected. But there is a lot of uncertainty about how unlimited-general-obligation bonds, limited-general-obligation bonds and certificates of participation bonds will be treated. InvestmentNews: Are there any Detroit munis that you would recommend? Mr. Loffredo: Based upon dollar price, we still believe that we like the water and sewer revenue streams. We believe those will eventually be spun off to another authority. InvestmentNews: What is the strategy behind creating a new state government authority to oversee that water and sewer operations? Mr. Loffredo: Right now, Detroit owns the water and sewer, but it is providing services to a large part of the southeastern section of the state. Going forward, it would be easier to get financing for future water and sewer bonds if it is moved outside of Detroit. InvestmentNews: Now that Detroit has defaulted, what are the chances that the city will enter bankruptcy? Mr. Loffredo: We believe the chances are over 75% that Detroit will end up filing for Chapter 9 bankruptcy protection. I think they need bankruptcy as a way to sort out all the stakeholders. Bankruptcy procedure gives them better structure to finalize the plan. InvestmentNews: Detroit is now the largest city to default on its debt, and if it files it would become the largest city ever to go bankrupt. What kind of an impact will this have on the $3.7 trillion muni bond market? Mr. Loffredo: The problems in Detroit are well-known, so [it] doesn't have much of an impact on the overall muni bond market. However, the outcome has a huge impact on how [the] muni market will treat munis in Michigan. If unlimited-general-obligation debt, which is voter approved, takes a haircut, that has ramifications on all similar debt issued by municipalities in Michigan.