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Muni Outlook:A Year of the Coupon February 2013

Sheila Amoroso of Franklin Templeton Investments believes thatafter a bumpy few years, the municipal bond market could verylikely offer relatively steady income in 2013

Municipal bond investors were relieved and rewarded in2012. Y ields fell as fundamental conditions strengthened,

and earlier fears of widespread defaults proved unfounded.

Healthy fundamentals are likely to persist this year, says

Sheila Amoroso, senior vice president and co-director of the

Franklin Templeton Municipal Bond Department. But with

yields so low, she encourages muni bond owners to be

content to collect income--the main reason for holding

munis in the first place--and not to expect further prodigious

price appreciation. Prices have gone up dramatically, she

observes. I find it hard to believe that were going to get the

same kinds of increases again this year. I believe 2013 willbe the year of the coupon.

A favorable supply/demand balance that helped the muni

market to repair itself, she says, accounts for some of the

strength in 2012. J ust as many issues were retired as

brought into the market, and cash flows were strong; so there

was not enough supply to meet demand. That was one of the

big drivers of munis outperforming Treasuries. The yield

on the 10-year Treasury note fell last year to 1.78% from

1.89%, according to the Federal Reserve Bank of St. Louis,

less than the decline in municipal bond yields. Other factors

that Amoroso credits with compressing spreads include a

steady rebound in state and local-government revenues and a

flattening of the muni yield curve, with rates coming down

more on longer-dated paper.

Spreads over Treasuries narrowed despite a bout of selling

late in the year, Amoroso notes, as investors reacted to

uncertainty over tax rates and to whether there would be a

cap put on the tax exemption for municipal bonds. Theresult, she recalls, was two weeks that were pretty sloppy

for the market, and she acknowledges that the prospect of

munis becoming a casualty of tax policy initiatives could

remain a concern in 2013. Its hard to say at this point if

politicians are going to learn how to work together and

develop solutions to the problem of the nations wide fiscal

deficits, Amoroso says. She doubts, however, that the

exemption for munis will be reduced. Doing so would not be

effective, in her view, because it would bring in

comparatively little revenue and would hinder the ability of

state and local governments to finance public services.

One negative influence on sentiment that has largely

dissipated heading into 2013 is concern about defaults. The

panic created about two years ago, when high-profile

analysts warned of a serious default risk in municipal bonds,

turned out to be a false alarm, Amoroso says. Meanwhile,

she continues to see a favorable supply/demand balance as

the year begins, with minimal issuance. But she warns that

its hard to predict what cash flows are going to look like.

Thats something that state and local authorities know all

about, Amoroso notes, but the slow but steady economic

recovery and the stabilization of the housing market--and

therefore the stream of property tax revenues on which

governments depend--have helped to buoy munis. States

have closed over $500 billion in budget gaps since 2009,

she says, although she concedes that authorities have had

difficulty coming to grips with their significant pension

obligations.

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Befitting her forecast of moderating returns, Amoroso

recommends a balanced approach to allocation within

munis. Franklin Templetons portfolios hold revenue bonds

and general-obligation bonds in roughly a 2-to-1 ratio, she

says--broadly in line with the muni universe. And she has no

significant preference for one sector over another. She does

profess a bias toward higher-quality issues and toward bonds

with longer maturities within each time horizon--closer to 10years than to eight years in intermediate-term portfolios and

25 years or more rather than 15 years in long-term

portfolios.

Amoroso emphasizes that in any case munis are an asset

class in which security selection is usually best done issue

by issue rather than category by category. Its a complicated

market that requires a lot of legwork to get right, she says,

but she reminds investors-- especially after the strong year

that just ended--that munis are typically included in broad

portfolios to fulfill a simple role: to provide income. Clients

need to stay diversified, not pick highs and lows in markets,

she says. They need both income and growth in their

portfolios because they never can tell which one is going to

outperform in any given year.

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Investors should carefully consider the investment objectives and risks as well as charges and expenses of a mutual fundfund before investing. To obtain a prospectus, contact your Financial Advisor or visit the fund companys website. Theprospectus contains this and other information about the mutual fund fund. Read the prospectus carefully before investing.

Shelia Amorosos comments and opinions do not provide a complete analysis of every material fact regarding any region, or market, and are forinformational purposes only. Because market and economic conditions are subject to change, her comments, opinions, analyses, and holdings areonly valid as of the date of the interview and may change without notice. Her opinions are intended to provide insight as to how she analyzessecurities and her commentary is not intended as individual investment advice or a recommendation or solicitation to buy, sell or hold any security orto adopt any investment strategy. Please consult your own professional adviser before investing.

Data from third party sources may have been used in Sheila Amorosos comments and neither Sheila Amoroso nor Franklin Templeton Investmentshas independently verified, validated or audited such data. We do not guarantee its accuracy. Franklin Templeton Investments and Sheila Amorosoaccept no liability whatsoever for any loss arising from use of this posting or any information, opinion or estimate herein.

Interest on municipal bonds is generally exempt from federal income tax; however, some bonds may be subject to the alternative minimum tax(AMT). Typically, state tax-exemption applies if securities are issued within one's state of residence and, if applicable, local tax-exemption applies ifsecurities are issued within one's city of residence.

Bonds rated below investment grade may have speculative characteristics and present significant risks beyond those of other securities, includinggreater credit risk and price volatility in the secondary market. Investors should be careful to consider these risks alongside their individual

circumstances, objectives and risk tolerance before investing in high-yield bonds. High yield bonds should comprise only a limited portion of abalanced portfolio.

Diversification and asset allocation do not assure a profit or protect against loss in declining financial markets.

The investor should note that funds that invest exclusively in one sector or industry involve additional risks. The lack of industry diversificationsubjects the investor to increased industry-specific risks.

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economicuncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, sincethese countries may have relatively unstable governments and less established markets and economics.

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Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this

risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduledmaturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amountoriginally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to thecredit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are alsosubject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interestrate.

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