Municipal bonds are providing good returns and investors still like them, according to BlackRock.

Municipal bonds issuance and performance have continued to do well through the first five months of this year and they are outperforming Treasury bills, BlackRock officials said at their municipal bond meeting on Wednesday in Manhattan.

“Munis’ outperformance of Treasurys has them looking less cheap on a relative basis, but we believe the appeal of tax-exempt income and munis’ record of high quality and relative stability remain well intact,” according to a BlackRock report.

But investors should still be picky about munis, BlackRock officials said, noting a few states and the commonwealth of Puerto Rico are having problems paying their bills.

The municipal bond index for the year was recently up some 3 percent. However, Peter Hayes, head of BlackRock’s municipal bonds group, said he doesn’t believe that it will continue at the same pace through the end of the year, so investors should not expect a 6 percent gain.

He estimated that the muni bonds would probably earn about another 1.5 percent over the rest of the year.

Hayes also noted that demand for munis “has been very solid” and predicted “pretty good performance, maybe not spectacular, in the municipal bond sector over the rest of the year.”

But there are some problems, he noted. For instance, Puerto Rico will likely miss its next scheduled payment to bond owners on July 1.

Proposed congressional legislation would help the troubled commonwealth pay its bills, but “we don’t know what is going to happen with that,” Hayes said.
BlackRock officials recommend other places where investors should be underweighted in municipal bonds, including New Jersey, Kentucky, Pennsylvania and Illinois.

Illinois, Hayes added, is in an odd situation. Unlike Puerto Rico, it has the money to pay its bills. But it can’t agree on a plan to raise taxes or cut spending enough to solve its problems.

Hayes also noted that Illinois is in the process of trying to go to the bond market at the same time that the state’s Democratic legislature and Republican governor can’t agree on a budget.

Indeed, Illinois is poised to enter its second fiscal year without a budget as state leaders failed to agree on a spending plan.

“The General Assembly will require super-majority approval to pass a budget before the July 1 start of the new fiscal year,” BlackRock said in a report.

“Notably, the impasse arose from a failure among Democrats within the legislature to agree on a spending plan and not from a Republican governor veto.”

Without a budget, Illinois may face past due bills of about $10 billion, unfunded schools and problems paying for some other services. Lawmakers have agreed to work on a stopgap measure. However, extending the current patchwork approach could make the red ink bigger, BlackRock officials said. That, they added, could lead to rating downgrades.

Hayes suggested that states that are in a similar situation as Illinois—going to market for more credit while not having a budget—should possibly be penalized by investors.

New Jersey, Hayes noted, also has the resources to solve its problems. It could also solve its budget problems by raising one of the lowest gas taxes in the nation. However, the Democratic-controlled state legislature and Republican governor would have to agree on a package.