Germany Banking System Outlook

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BANKING SYSTEMOUTLOOK

BANKOCTOBER 19, 2012

Table of Contents:

SUMMARY OPINION 1KEY DEVELOPMENTS SINCE PRIOR

BANKING SYSTEM OUTLOOK 3RATING UNIVERSE 3OPERATING ENVIRONMENT 5PROFITABILITY AND EFFICIENCY 7ASSET QUALITY AND CAPITAL 10FUNDING AND LIQUIDITY 15MOODYS RELATED RESEARCH 19APPENDIX 1 20GLOBAL COMPARISON CHARTS 24Analyst Contacts:

FRANKFURT +49.69.70730.700

Katharina Barten +49.69.70730.765

Vice President Senior Credit Officer

[email protected]

Carola Schuler +49.69.70730.766

Managing Director Banking

[email protected]

GermanyOur outlook for the German banking system remains negative. The outlook expresses ourexpectation of how bank creditworthiness will evolve in this system over the next 12-18 months.

Summary Opinion

Our outlook for the German banking system is negative, as it has been since 2008. Theoutlook reflects (1) margin pressure for banks owing to intense competition, limited loan

growth and low interest rates; (2) a weakening operating environment in Germany amidrecessionary trends across Europe; (3) rising risk charges and deteriorating asset quality; and(4) the limited loss-absorption capacity of many banks. These negative drivers are only partlyoffset by relatively stable funding conditions compared with European peers and the progresssome banks have made in repairing their franchises and reducing legacy problem assets.

The negative banking system outlook pertains mainly to the larger, wholesale-orientedGerman banks, which are the focus of this report. Many of the more retail-oriented Germansavings banks and local cooperative banks are less stressed, although they, too, face growthand margin pressures. We downgraded several large German banking groups in June 2012and subsequently assigned stable outlooks to most of those bank ratings that now incorporatethe above-mentioned challenges.1 However, a worsening euro area crisis would create

additional pressures for many banks. Also, Germanys Aaa government bond rating carries anegative outlook, reflecting the sovereigns level of exposure to the ongoing crisis.

Operating environment. We expect banks to face challenging operating conditions in thenext 12-18 months, despite Germanys so-far sound economic indicators (high employment,modest household leverage, and fair overall corporate sector health). Under our centralscenario, gross domestic product (GDP) will grow between 1%-2% in 2013, althoughdownside risks from the ongoing euro area crisis are significant. Moreover, many banks stillneed to repair their franchises and further reduce their risk exposures, while loan growthprospects are low.

Profitability and efficiency. Intense competition and low interest rates are causing margin

pressure that will likely further erode already-weak bank revenues and profits. Before 2008,many German banks ventured into foreign markets, not least because of low margins athome. Now, they are re-focusing on domestic operations, which reduces risk exposures but

will add to structural margin pressure, raising concerns about the sustainability of some bankfranchises. Uneven profitability across sub-sectors will likely persist, with savings banks andlocal cooperative banks benefiting from their strong retail franchises, while German

wholesale banking will remain fiercely competitive.

1 SeeKey Drivers of German Bank Rating Actions, 6 Jun 2012, andKey Drivers of Rating Actions on Firms with Globa l Capital Markets Operations, 21 Jun 2012
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2 OCTOBER 19, 2012 BANKING SYSTEM OUTLOOK: GERMAN

Asset quality and capital. Domestic asset quality is gradually deteriorating, as indicated by rising riskcharges in individual bank results in 2012 to date. Legacy exposures to stressed euro area countries andconcentrations in highly-cyclical sectors (like commercial real estate and shipping) leave many Germanbanks vulnerable to a worsening of the sovereign debt crisis in Europe and to macroeconomic stress.Over the outlook period, high balance-sheet leverage and low pre-provision profits will make it

difficult for many German banks to cope with major (unforeseen) losses.

Funding and liquidity. Most German banks face only modest funding risk, which is a relative strengthof this banking system. They benefit from broadly matched maturity profiles, recurring access to intra-sector funds (for the Landesbanken and cooperative central institutions), improved liquidity buffersand gradually decreasing dependence on market funds.

Systemic support.After reducing the support assumptions implied in our ratings of German banksduring 2011,2 we expect a more stable support environment over the coming 12-18 months. Ourexpectation reflects the governments commitment to contributing to financial stability, particularly ina crisis. Whilst the German government has enacted an advanced bail-in regime, it has not utilised theregime to date. However, if the government deployed the resolution regime, this could trigger a review

of our current support assumptions.

EXHIBIT 1

Outlook Overview

Key credit drivers Assessment (negative/positive/stable)

Operating environment Negative

Asset quality and capital Negative

Funding and liquidity Stable

Profitability and efficiency Negative

Systemic support Stable

Banking system outlook Negative

Banking System Outlook Definition

Banking system outlooks represent our forward-looking assessment of fundamental credit conditionsthat will affect the creditworthiness of banks in a given system over the next 12-18 months. As such,banking system outlooks provide our view of how the operating environment for banks, includingmacroeconomic, competitive and regulatory trends, will affect asset quality, capital, funding, liquidityand profitability. Banking system outlooks also consider our forward-looking view of the systemicsupport environment for bank creditors.

Since banking system outlooks represent our forward-looking view on credit conditions that arefactored into our bank ratings, a negative (positive) outlook suggests that negative (positive) rating

actions are more likely, on average.

2 During 2011, we excluded systemic support from all senior subordinated debt ratings in Germany and reduced the support content in our senior debt and deposit

ratings for most private-sector banks and all of the Landesbanken.


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Key Developments Since Prior Banking System Outlook

Portigon AG, formerly WestLB, had to discontinue banking business as of 1 July 2012, as therequired change of ownership previously agreed with the EC was not feasible. Portigons

senior debt remains unaffected as the owners committed additional capital funds to ensure a

partial sale (to Landesbank Hessen-Thueringen), combined with an orderly unwinding.

In March 2012, the government re-opened the so-called SoFFin support fund that was firstestablished in 2008 to provide capital and liquidity support. 3 We note that the banks have not

drawn on these funds in 2012.

Deutsche Bank AG (A2, stable; C-/baa2, stable)4 and Commerzbank AG (A3, negative; D+/baa3negative) were included on the initial list of global systemically important financial institutions

(G-SIFIs) released in November 2011 by the Financial Stability Board.5 G-SIFIs will face

additional capital requirements, closer supervision, and resolution-related requirements.

Since January 2011, a new restructuring act for German bank financial institutions6 has been ineffect, granting the government major intervention powers to deal with cases of bank distress, by

orchestrating a bail-in, for example.

Rating Universe

This report focuses on the 41 German banks, mortgage credit institutions and special lenders thatwe rate (see Exhibit 2 below). These institutions account for the bulk of the German banking and

mortgage market, holding roughly 85% of market share of system loans as of year-end 2011. The

remainder of the banking system is characterised by smaller regional and specialised institutions

and the cooperative retail banks.

The trends discussed in this report mainly apply to privately-held German banks and the centralinstitutions of the two other large banking sectors in Germany, i.e., the public-sector banks andcooperative sector banks. Besides the Landesbanken covered in our report, the public-sector

banking group comprises a large number of savings banks (Sparkassen) that pursue public policy

mandates and are mostly controlled by local municipal authorities.7 Similarly, the cooperative

banking sector includes many local cooperative banks (Volksbanken and Raiffeisenbanken). These

two groups have leading franchises in German retail banking, but very limited international and

wholesale operations. Not all of the trends discussed in this report apply to them.

This report also largely excludes so-called development banks (such as Kreditanstalt fuerWiederaufbau, Aaa, negative), which are government-controlled. These institutions differ from

typical commercial banks in that they focus on politically-mandated activities like lending

programmes for small businesses or public finance. Their creditworthiness is mainly driven by the

credit profile of their government owners.

3 The Sonderfonds Finanzmarktstabilisierung(SoFFin) was established under the German Financial Market Stabilisation Agency (FMSA), based on the Second Financial

Market Stabilisation Act, effective since 1 March 2012. Source: FMSA, seehttp://www.fmsa.de4 The ratings shown are the banks deposit r ating, its standalone bank financial strength rating/baseline credit assessment and the corresponding rating outlooks.5 Source: Financial Stability Board; seehttp://www.financialstabilityboard.org/publications/r_111104bb.pdf6 Seehttp://www.bafin.de/EN/Supervision/BanksFinancialServicesProviders/Measures/Restructuring/restructuring_artikel.html7 For more information on German savings banks, see our latestCredit Analysis on Sparkassen Finanzgruppe
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The average (asset-weighted) standalone bank financial strength rating (BFSR) for German bankswas D+/baa3 as of end-September 2012 (excludingSparkassen-Finanzgruppeand the development

banks). The asset-weighted average global local-currency deposit rating was A3.

EXHIBIT 2

Rated German Banks

Rating Universe

Total GroupAssets at YE2011

(EUR million)

Loan marketshare at YE2011

(%)

Depositmarket share

at YE2011 (%)

LT BankDeposit Rating

and OutlookBFSR andOutlook

StandaloneCredit

Assessment

Sparkassen-Finanzgruppe 7) 2,384,200 38.0 36.6 Aa2/STA C+/STA a2

Deutsche Bank AG 1) 2,164,103 12.9 18.7 A2/STA C-/STA baa2

Commerzbank AG 1) 661,763 9.4 7.9 A3/NEG D+/NEG baa3

Kreditanstalt fuer Wiederaufbau 5) 494,818 3.7 -- Aaa/NEG - -

DZ BANK AG 2) 405,926 3.7 2.9 A1/STA C-/STA baa2

UniCredit Bank AG 1) 385,514 4.4 3.3 A3/NEG C-/NEG baa2

Landesbank Baden-Wuerttemberg 3) 373,059 3.8 2.5 A3/STA D+/STA ba1

Bayerische Landesbank3)

309,144 4.9 2.9 Baa1/STA D-/STA ba3Norddeutsche Landesbank GZ 3) 227,630 3.6 2.0 A3/STA D/STA ba2

Hypothekenbank Frankfurt AG(previously Eurohypo AG) 6)

202,981 3.2 1.0 Baa2/NEG E/NOO caa1

Deutsche Postbank AG 1) 191,982 3.4 4.2 A2/STA D+/STA ba1

Sparkassenverband Baden-Wuerttemberg 7) 175,470 3.1 3.5 Aa3/STA - -

Landesbank Hessen-Thueringen GZ 3) 163,985 2.6 1.3 A2/STA D+/STA baa3

NRW.Bank 5) 152,546 2.0 0.7 Aa1/NEG - -

HSH Nordbank AG 3) 135,906 2.8 1.3 Baa2/RUR E+/RUR b3

DekaBank Deutsche Girozentrale 3) 133,738 1.0 0.8 A1/STA C-/STA baa2

Landesbank Berlin AG 3) 131,175 1.5 1.2 A1/STA D+/STA baa3

Sparkassenverband Westfalen-Lippe 7) 114,343 2.3 2.5 Aa3/STA - -

ING DiBa AG 1) 109,478 2.3 2.8 A2/NEG C/NEG a3

Deutsche Pfandbriefbank AG 6) 108,779 1.7 0.4 A3/RUR E+/RUR b1

WGZ BANK AG 2) 93,945 1.1 0.6 A1/NEG C-/NEG baa2

Landwirtschaftliche Rentenbank 5) 88,877 0.1 0.2 Aaa/NEG - -

Volkswagen Financial Services AG 1) 76,946 2.0 0.9 A3/POS - -

L-Bank 5) 67,992 0.7 0.3 Aaa/NEG - -

KfW IPEX-Bank GmbH 5) 46,393 0.7 0.0 Aa3/NEG C-/STA baa1

SEB AG 1) 43,831 0.6 0.6 Baa1/STA D+/NEG ba1

Deutsche Apotheker- und Aerztebank eG 2) 38,840 0.8 0.6 A2/NEG D/NEG ba2

Volkswagen Bank GmbH 1) 37,866 1.0 0.8 A3/POS C-/STA baa1

Muenchener Hypothekenbank eG 2) 37,348 0.8 0.3 A2/NEG D/NEG ba2

Deutsche Hypothekenbank AG 3), 6) 34,998 0.6 0.3 Baa2/STA E+/STA b1

Bremer Landesbank Kreditanstalt Oldenburg GZ 3) 34,862 0.7 0.3 A3/STA D+/STA baa3

Sparkasse KoelnBonn 4) 29,333 0.7 0.5 A1/STA D-/STA ba3

Kreissparkasse Koeln 4) 24,427 0.6 0.5 Aa2/STA C/STA a3

DVB Bank S.E. 2) 22,031 0.6 0.1 Baa1/STA D-/STA ba3


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EXHIBIT 2

Rated German Banks

Rating Universe

Total GroupAssets at YE2011

(EUR million)

Loan marketshare at YE2011

(%)

Depositmarket share

at YE2011 (%)

LT BankDeposit Rating

and OutlookBFSR andOutlook

StandaloneCredit

Assessment

LfA Foerderbank Bayern5)

21,945 0.1 0.1 Aaa/NEG - -Landesbank Saar 3) 19,760 0.3 0.2 A3/STA D/STA ba2

Debeka Bausparkasse AG 6) 9,422 0.2 0.2 A3/STA C/STA a3

UBS DEUTSCHLAND AG 1) 8,658 0.0 0.1 Baa2/STA C-/STA baa2

Siemens Bank GmbH 1) 5,408 0.1 0.0 A1/STA - ba2

Volvo Auto Bank Deutschland GmbH 1) 2,620 0.0 0.0 Ba3/STA E+/STA b2

Bausparkasse Mainz AG 6) 2,602 0.1 0.1 Baa1/STA C-/STA baa1

1) private sector bank; 2) cooperative sector bank; 3) Landesbank (pub lic sector); 4) savings b ank (public sector), 5) development bank, 6) mortgage bank,

7) carries a corporate family rating that does not apply to single members (p ublic sector).

Note: Table includes all Moody's -rated German banks, banking groups and fin ancial corporations. BFSR = standalone bank financial strength rating, on a scale from A (highest) to E (lowest).

Standalone Credit Assessment (or, Baseline Credit Assessment, BCA), on a scale from aaa (highest) to c (lowest). Both BFSRs and BCAs reflect a banks standalone credit strength.

Source: Moodys, Deutsche Bundesbank

Operating Environment

While macro-economic indicators may remain relatively benign for some time yet, the operating environment forGerman banks is nonetheless challenging given growing competition, low interest rates, risk aversion and risingrisk charges. In addition, the ongoing euro area debt crisis implies substantial downside risks.

Economic environment: gradually more challenging and with substantial downside risk

The weaker economic prospects for Germany are partially mitigated by low levels ofunemployment (5.5% as of August 20128), modest household leverage (at around 90% of

German GDP, see Exhibit 4 below) and high savings. Whilst we do not expect these favourablemetrics to deteriorate quickly, various market indicators point towards a notable cooling of the

German economy.9 Our central scenario for German GDP growth is that it will slow down

significantly in 2012, and range between 1% and 2% in 2013. This is significantly weaker than

annual growth above 3% recorded in 2010 and 2011.10

8 Source: Eurostat9 Source: IFO Institute, June 2012: Ifo Economic Forecast 2012/2013: Increased Uncertainty Continues to Curb German Economy10 See our report Update to the Global Macro-Risk Outlook 2012-13, August 2012
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EXHIBIT 3

Real GDP (% change)

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012F

2013F

2014F

2015F

2016F

France Germany Italy Spain United Kingdom

Source: Moodys Country Credit Statistical Handbook, May 2012

EXHIBIT4

Gross debt-to-income ratio of households

0%

50%

100%

150%

200%

250%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Austria France Germany ItalyNetherlands Spain United Kingdom

Source: Eurostat

Our growth forecast for Germany is based on our central scenario, which does not include majoreconomic shocks (see Exhibit 3). However, given the high risk of setbacks on the path to resolving

the euro area debt crisis, the respective uncertainty represents another important factor in our

negative banking system outlook. Considering the high dependence of the German economy on

other EU countries for its exports (the share was 58% in H1 2012),11 and the resulting economic

interdependence with the other European nations, an escalation of the crisis would further weaken

Germanys trading partners. In our view, this implies a substantial downside risk to our base-case

expectations for the German economy, which is reflected in the negative outlook assigned to

Germanys Aaa rating in February 2012.

At the same time, if the continued risk mutualisation between European sovereigns unduly affectsGermanys credit profile (Aaa negative), German banks would also be affected because they partly

rely on implicit systemic (government) support for their overall risk profiles, stability and investor

confidence.

11 Source: Destatis, Press Releases August 2012


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Regulatory environment

The transition to the EUs current proposal on capital requirements under Basel III (CRD IV)poses challenges to some German institutions, although higher capital levels, once reached, will

ultimately benefit creditors. Challenges are primarily:

1) The lack of transparency regarding core Tier 1 (CT1) ratio-compliance under Basel III,considering that very few German banks have started reporting respective pro-forma ratios;

2) The planned SIFI capital surcharges, effective from 2016, affecting Deutsche Bank andCommerzbank; and

3) The implementation of the total exposure-based 3% leverage ratio. The formal definition of the CT1-leverage ratio is expected only in 2013 and implementation

targeted for 2018. While this offers a comfortable phase-in period, we expect that the classic

covered bond franchises12 that generally rely on very thin (non-risk weighted) capital levels will be

under pressure from a regulatory perspective. We also caution that investors will demand

compliance with the Basel III criteria for capital ratios long before regulatory timelines and will

likely penalise banks that need to take full advantage of the phase-in periods. Several European

banks already show pro forma ratios of > 9%; however, Commerzbanks 7.7% ratio is the highest

that German banks have reported so far.

Profitability and Efficiency

Over the outlook period, system profitability will remain weak or even deteriorate, reflecting eroding revenues,increased funding costs and rising provisioning needs; risk-adjusted profitability is weak and likely to deteriorate

further.

Weak prospects for German banks profitability are a key driver for the negative banking systemoutlook, because loss-absorption in the income statement and internal capital generation willlikely remain weak or erode even further.

Banking market will remain fiercely competitive

Unfavourable market factors mostly ancillary effects of the European debt and banking crisis offset the relatively benign economic factors and materially counteract German banks efforts to

improve their weak performance. These factors are

The low interest-rate environment and the prospect of rates remaining at low levels for anextended period, implying sustained pressure on margins;

Risk aversion of retail clients, and the resulting low level of transaction volumes in assetmanagement;

Low levels of activity in mergers & acquisitions and other areas of investment banking inresponse to the uncertain economic outlook; and

Weakening loan demand from the corporate sector in an environment where banks competefiercely for market shares in corporate banking.

12 Four banks in our rating universe fall into this category: Deutsche Pfandbriefbank, Hypothekenbank Frankfurt, Mnchener Hypothekenbank, Deutsche

Hypothekenbank.


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Collectively, these factors result in sustained pressure on bank revenues. The pressure isexacerbated by the fact that major franchise-adjustments and further deleveraging remain urgent

for many German banks so that they are able to either (1) comply with Basel IIIs higher

capitalisation requirements; or, in some cases (2) compensate for earlier state aid measures.

However, the current market conditions mean that banks can only sell assets at a loss.

Moreover, the long-standing structural weaknesses of the banking industry have not changed; thesystem remains overbanked, fragmented and fiercely competitive. With almost all banks adjusting

their focus towards their domestic market, the above-described market conditions thus exacerbate

the banking systems intrinsic limited potential to generate commensurate risk-adjusted returns.

Consequently, we consider the adverse market factors to be key drivers of our negative outlook for

the German banking system.

Margins will likely stay at the lower end of international peer range

At 1.5%, the systems risk-adjusted returns before risk provisions are the lowest in our peer group(pre-provision income as a percentage of RWA, see Exhibit 5). Moreover, earnings are very

unevenly distributed across the system, with below-average performance from specialised mortgage

lenders (i.e., specialised in mortgage and public-sector finance) and the Landesbanken. The

savings banks and private-sector banks achieve risk-adjusted earnings above the German average,

but at the system level, margins significantly lag banks in many other countries (see Exhibit 5).

EXHIBIT 5

System Aggregates for Pre Provision Income (PPI) / RWA

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

2007 YE 2008 YE 2009 YE 2010 YE 2011 YE

AUSTRIA FRANCE GERMANY ITALY

NETHERLANDS SPAIN UNITED KINGDOM

Note: Savings banks are missing from the underlying data pool in 201 1. Averages for rated banks; data as of year-end.Source: Moodys Banking Financial Metrics

The systems average net interest margin (NIM) has been in the range of 1.0%-1.2% since 2009.Whilst Germanys savings banks typically achieve NIMs between 2.5%-2.8%, most other sub-

segments struggle to generate a NIM of 0.8%. Specialised mortgage lenders and Landesbankenshow particularly weak margins, and are therefore considerably more vulnerable to margin erosion

and cyclical credit losses. The private-sector banks margins are broadly in line with the system

average.


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EXHIBIT 6

Net Interest Margin (Net Interest Income / Average Interest Earning Assets)

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

2007 YE 2008 YE 2009 YE 2010 YE 2011 YE

AUSTRIA FRANCE GERMANY ITALY NETHERLANDS SPAIN

Note: Savings banks are missing from the underlying data pool in 2011.Data as of year-end.Source: Moodys Banking Financial Metrics

In addition, ongoing restructuring and franchise adjustments leave many banks below their fullearnings potential, which is a weakness that the affected banks may overcome in time; however,

we expect progress to be slow. Several banks remain considerably behind self-set earnings targets,

partly because the sale of assets and participations below book value repeatedly cause losses. If the

euro area debt crisis worsens, we expect additional losses from accelerated asset sales and/or credit

losses and write-downs.

Given these various pressures, as well as rising risk charges in the home market, net income haslittle potential to improve from the 2011 level (which, at 0.7% of RWA on average, was at a six-

year high), partly because net profits last year were strongly supported by unusually low risk

charges. However, the exceptionally benign credit environment in the domestic market turned in

late 2011 and most banks performance in H1 2012 increases the likelihood of considerably

higher risk costs in 2012-13.

Efficiency expected to remain at the weaker end of the peer group

Revenue erosion, loss of economies of scale and additional costs more than offset cost savings

The efficiency of German financial institutions remains poor. A combination of weak economiesof scale and additional expenses, such as costs required to respond to regulatory changes and the

German bank levy introduced last year, have translated into eroding efficiency metrics for German

banks. Due to persistent revenue pressures, we believe that there is little room for improvement, if

any.

At year-end 2011, the system cost-to-income (CTI) ratio was 71.8% up from 66.6% in 2010 (seeExhibit 7). In both years, these were the weakest ratios in our peer group.


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EXHIBIT 7

System Aggregates for Cost Income Ratio (Operating Expense / Net Revenues)

40%

50%

60%

70%

80%

90%

100%

110%

2007 YE 2008 YE 2009 YE 2010 YE 2011 YE

AUSTRIA FRANCE GERMANY ITALY NETHERLANDS SPAIN

Note: Savings banks are missing from the underlying data pool in 2011.Averages for rated banks; data as of year-end.Source: Moodys Banking Financial Metrics

The banks with the weakest CTI ratios are under pressure to improve their cost positions andboost profits to ensure the viability of their business models. This is particularly relevant for banks

that received government support and need to comply with compensation measures agreed with

the EU Commission.13 Most of these banks need to continue deleveraging and will therefore face

headwinds in their efforts to improve efficiency, as visible cost reduction usually lags revenue

losses.

Asset Quality and Capital

German banks regulatory capitalisation is in line with that of peers, but high leverage and risk concentrations inloan books and investment portfolios leave them more vulnerable to unexpected losses

Asset quality is weakening as Germanys credit cycle has turned

Ship finance assets and exposure to Europes periphery are key areas of concern

Domestic asset quality will likely deteriorate gradually to manageable levels, but large exposures tocyclical asset classes pose considerable risks under macroeconomic stress. The extent of asset-

quality deterioration will depend on how the euro area crisis develops. Under our central

macroeconomic scenario, which assumes no significant worsening of the crisis, German banks will

see their asset quality weaken, but not beyond our through-the-cycle expectations. However,

banks are vulnerable to the noteworthy downside risks, as described in this section.

Notwithstanding the solid indicators shown to date, we expect German banks asset quality todecline. The notable cooling of the German economy in Q2 2012 and the implications of the

recessionary trends across large parts of Europe on German economic activity will likely be felt

over the next few quarters. Importantly, the still-sizeable non-domestic exposures including risks

relating to sovereigns and banks pose major downside risks for the banking system.

13 Banks under state aid proceedings: Aareal Bank (NR), BayernLB, Commerzbank and subsidiary Frankfurter Hypothekenbank, Deutsche Pfandbriefbank / HRE Group,

DsselHyp (NR), HSH Nordbank, IKB Deutsche Industriebank (NR), Landesbank Baden-Wuerttemberg, NORD/LB, Portigon AG (former WestLB, NR). Note: NR

(not rated) refers to senior debt and deposit ratings.


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However, system problem loans remained stable at a modest 4% of gross loans at year-end 2011(see Exhibit 8). Individual bank results so far in 2012 have shown moderate deterioration in asset

quality. Whilst we expect the ratio to increase gradually from this low level, it shows the German

banks low impairment levels compared with many other systems in Europe, afforded by the

recent growth and the German economys relative resilience.

EXHIBIT 8

System Aggregates for Problem Loans / Gross Loans to Customers

0%

2%

4%

6%

8%

10%

12%

AUSTRIA FRANCE GERMANY ITALY NETHERLANDS SPAIN UNITEDKINGDOM

UNITED STATES

2008 YE 2009 YE 2010 YE 2011 YE

Note: Savings banks are missing from the underlying data pool in 2011.Averages for rated banks; data as of year-end.Source: Moodys Banking Financial Metrics

German banks lending operations include activities that are particularly vulnerable to the risk of aworsening euro area debt crisis and the likely knock-on effects of even deeper and/or prolonged

recessionary trends in Europe. In our view, the asset classes below will be most affected by a

weakening European and global economy, along with loans to German export-oriented

manufacturers. Asset-side vulnerabilities can have severe implications for the following:

The global shipping sector, which faces weakened demand amid sluggish global economicgrowth and evolving structural overcapacity. For the top-ten banks, shipping-related

exposures were 98 billion, or 60% of that groups Tier 1 capital, at year-end 2011 (see

Exhibit 9).

International and German CRE markets, with non-domestic CRE exposures of severalGerman banks concentrated in markets that will likely see further falling prices after

corrections in previous years. The total non-domestic CRE exposure of Germanys top ten

banks was 170 billion at the end of 2011, equivalent to 104% of their Tier1 capital (see

Exhibit 9).

Legacy exposures to structured credit products, including complex and subprime-relatedsecuritisations, comprising 106 billion, or 65% of that groups Tier1 capital (see Exhibit 9).

Exposures to stressed euro area countries, i.e. Greece, Ireland, Italy, Portugal, Spain (orGIIPS) are vulnerable to the ongoing euro area crisis. Government-related GIIPS exposures of

the top ten German banks amounted to 43 billion, or 26% of their Tier1 capital (see Exhibit

9) at year-end 2011. Some banks also have large interbank, corporate and household

exposures to GIIPS countries, but consistent data is not available for all top ten German

banks.


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BANKING


EXHIBIT 9

Investments in highly cyclical and higher-risk Asset Classes by the top ten German banks

104%

60%

26%

65%

0%

50%

100%

150%

200%

250%

300%

%o

fTier1capital

Non-domestic CRE Shipping

GIIPS (Gov.) Structured credit products

169.7

98.1

42.5

106.3

0

50

100

150

200

250

300

350

400

450

inEURbillion

Non-domestic CRE Shipping

GIIPS (Gov.) Structured credit products

Note: Data as of year-end 2011. Banks included in this chart are BayernLB, Commerzbank, DekaBank, Deutsche Bank, DZ BANK, Helaba, HSH, LBBW,NORD/LB, and UniCredit Bank AG,Source: Company Reports, Moodys Investors Service

We also note that Germanys export-dependent manufacturing industries, in particular for capitalgoods, are very sensitive to the global economic cycle. According to Germanys statistics office

DESTATIS, 59% of German exports were sold to other EU countries in 2011.

Thin absolute capital levels imply modest resilience to shocks

Modest loss-absorption capacity leaves German banks vulnerable to stressed scenarios; balance-sheet leverage is akey weakness.

Notwithstanding their strengthened regulatory capital ratios compared with low historical levels,we believe that the capital positions of several German banks remain vulnerable to erosion under

stress. One key reason for this is their high balance-sheet leverage (see Exhibit 10 below) in the

context of (1) their above-described exposure to cyclical and higher-risk asset classes, which islikely to be affected by any worsening of the operating environment in Europe; (2) elevated risks

from the ongoing euro area crisis; and (3) their low pre-provision earnings.

For the rated German banks, Tier 1 capital as a percentage of total assets (see Exhibit 10) was only3.7%;14 based on this measure, it is one of the most weakly capitalised systems in Europe. This is

partly due to the focus of many institutions on asset-based finance activities that require low

regulatory capital because of available collateral. In addition, many German banks in particular

the Landesbanken and cooperative central institutions hold large interbank and sovereign assets

that far exceed their liquidity buffer needs.

14 The 3.7% ratio as of 2011 does not contain data for Germanys savings banks; including these banks, the ratio would be closer to 4%.


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BANKING


EXHIBIT 10

System Aggregates for Tier 1 Leverage Ratio (Tier 1 Capital / Average Total Assets)

0%

1%

2%

3%

4%

5%

6%

7%

8%


UNITED STATES

2008 YE 2009 YE 2010 YE 2011 YE

Note: 1. Averages for rated banks; data as of year-end. 2. Aggregated data for Germanys savings banks which improved their Tier1 leverage in 2011are included for the years 2006-2010, but missing for the year 2011.Source: Moodys Banking Financial Metrics

Moreover, leverage varies considerably among the sub-segments within the German bankingsystem. The savings banks display non-risk-weighted (or absolute) capital levels of more than

5% and private-sector banks of close to 4%. However, absolute capitalisation levels that are

considerably below the German average are those of the mortgage banks (2.7% as of 2011), the

central institutions of the cooperative sector (2.8%) and the Landesbanken (3.6%).15

Exhibit 11 below shows the aggregate of the expected loss (EL) of 28 rated banks (23 groups) thatwe included in stress-testing simulations, and an estimate of the total capital needs for those banks

that show a shortfall below a 9% Tier 1 hurdle level. Our central scenario analysis, which includes

mild stress assumptions, results in a modest total shortfall of 5 billion, incurred by eight (mostly

smaller) banks. However, our adverse scenario results in a major capital shortfall incurred by 17

groups, which would require 32 billion in order to replenish a 9% Tier 1 ratio.

EXHIBIT 11

System Aggregates for Expected Losses and additional Capital Needs in Moodys Base/Stress CaseSimulationsMoodys Scenario Analysis on System Tier 1 Capital (in billion)

69

305

154

92

32

020

40

60

80

100

120

140

160

Gross EL Net EL (after LLR/Tax) vs. 9% Tier 1 hurdle Gross EL Net EL (after LLR/Tax) vs. 9% Tier 1 hurdle

Stress Test Losses Capital ReplenishmentNeeds

Stress Test Losses Capital ReplenishmentNeeds

Central Scenario Stressed Scenario

Source: Bank Annual Reports, Moodys Estimates

15 Source: Moodys Banking Financial Metrics


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BANKING


Rated German banks boosted their average regulatory Tier 1 ratio to 12.3% at year-end 2011, upfrom 9.1% at year-end 2008 (see Exhibit 12). However, German banks Tier 1 capital ratios are

not directly comparable to some European peers because of differences in regulatory rules.

These differences include that German banks are generally not subject to the limitations ofthe benefits from lower risk weights under their internal rating-based (IRB) models compared

with a standard approach. These so-called transitional floors reduce the reported Tier 1 ratios

of some of their European peers.

Moreover, some government-injected capital will have to be repaid, and asset-portfolioguarantees or risk shields16 will be gradually reduced. We expect capital repayments (or

guaranty reductions) to offset further improvements in regulatory capitalisation for the

respective banks,17 as they aim to reduce costs of capital and accept reductions of what they

may consider to be excess capital.

EXHIBIT 12

System Aggregates for Tier 1 Capital Ratio

0%

2%

4%

6%

8%

10%

12%

14%


UNITED STATES

2008 YE 2009 YE 2010 YE 2011 YE

Note: 1. Averages for rated banks; data as of year-end. 2. Aggregated data for Germanys savings banks which improved their Tier1 in 2011 areincluded for the years 2007-2010, but missing for the year 2011. Data as of year-end.Source: Moodys Banking Financial Metrics

We recognise that most German banks have not only improved their regulatory capital ratios, butalso the quality of their capital through various measures over recent years. This process

accelerated in late 2011, following the EBAs higher CT1 capital requirements, which some

German banks could not meet initially because of the relatively high levels of hybrids that the

EBA does not include in its definition of core Tier 1. However, in our opinion, the improved

capitalisation of most banks is more than offset by the elevated and rising risk of external

shocks and losses that may arise in the context of the evolving European debt crisis.

Many German banks aim to reduce low-yielding assets in the context of deleveraging strategies,which would reduce balance-sheet leverage. However, they face a difficult choice between holdingthese investments until they mature, thus maintaining the risk exposure with the aim of being

repaid in full, or selling and crystallising losses on assets that trade below par. We expect non-core

asset sales to continue, given the uncertainty about the risk profiles of sovereign and bank assets in

parts of Europe, which will weigh on earnings and thus limit internal capital generation.

16 Risk shields transfer credit risk to a guarantor to achieve RWA-relief; risk shields were used by public-sector stakeholders to support Landesbanken in distress.17 Four Landesbanken currently benefit from portfolio risk shields: BayernLB, HSH Nordbank, LBBW and NORD/LB.


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BANKING


Funding and Liquidity

German banks display only modest funding risk, underpinned by broadly matched maturity profiles, recurringaccess to intra-sector funds, decreasing reliance on market funds and improved liquidity buffers.

Deleveraging and reliable upstream funding within sub-sectors provide funding stability Notwithstanding German banks partial reliance on wholesale funding, we consider their

dependence on confidence-sensitive funding sources as manageable; in some cases, the banks have

low dependence. German banks relatively limited and decreasing funding risks reflect a number

of factors, including:

Ongoing deleveraging is gradually leading to less dependence on market funds, in particularfor several of the larger universal banks and wholesale lenders.

The dependence of the Landesbanken and the central institutions of the cooperative sector onmarket funds is mitigated by their access to intra-sector funds, i.e., funds from their partner

institutions, savings banks (for Landesbanken) and local cooperative banks (for DZ BANK

and WGZ BANK). Members of the group of public-sector banks have strong incentives tomaintain liquidity in the group, as intra-group lending carries a zero risk weight under local

regulation, since the German regulator recognises the groups cross-support schemes.

Some specialised lenders that would be critically exposed to challenging market conditions asstandalone entities, are well embedded in their respective groups (and/or sectors) and benefit

from transfer funding from their parent banks (and/or partner institutions). Examples include

Commerzbank-owned Hypothekenbank Frankfurt AG (formerly Eurohypo AG) and

Deutsche Hypothekenbank (owned by NORD/LB).

Covered bonds represent a major share of total market funds in the system, comprising 18%of system market funds at the end of 2011,18 as well as pass-through funds provided by

development banks. German issuers maintain good access to the covered bond market 73

billion new Pfandbriefe were issued during 201119 as reflected by over-subscribedbenchmark issuances and very attractive, low pricing. Of the development banks,

Kreditanstalt fuer Wiederaufbau (KfW; Aaa negative) alone raised 80 billion in long-term

debt during 2011, most of which was channelled into the domestic banking system. KfW

aims to raise the same amount in 2012.

Our statistics of loans and deposits (see Exhibit 13) show the relative strength of the Germansystem with regard to its increasing capability to internally fund lending operations. Total loans

were about 10% less than total deposits at year-end 2011.

18 German covered bonds outstanding at year-end 2011: EUR 586 billion (7.4% of system liabilities, or 18% of system market funds as of Dec-2011). Source: Deutsche

Bundesbank, Monthly Report, July 201219 Source: 2011 ECBC European Covered Bond Fact Book; seehttp://ecbc.hypo.org
http://ecbc.hypo.org/http://ecbc.hypo.org/http://ecbc.hypo.org/http://ecbc.hypo.org/


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BANKING


EXHIBIT 13

Loans / Deposits for rated banks, averages by system

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

140.0%

160.0%


UNITED STATES

2008 YE 2009 YE 2010 YE 2011 YE

Note: Averages for rated banks; data as of year-end.Source: Moodys Banking Financial Metrics

The positive effects of deleveraging were further underpinned by rising deposits in the system (anincrease of 400 billion between 2007-11), fuelled by steady growth of German households cash

assets and savers reluctance to invest in stocks, bonds and mutual funds.20 At the same time, total

bank loans to non-bank borrowers decreased by 1.4% during 2011 due to subdued loan demand,

although lending volumes recovered in H1 2012.

Exhibit 14 shows market funds ratios (MFR, defined as market funds less liquid assets as apercentage of total assets) by banking system. Since 2008, the German banking system has

reduced its net reliance on market funds to 13% from 22%. We believe the 13% MFR as of 2011

somewhat overstates the risk attached to their reliance on market funds, partly because the more

stable sector funds and pass-through funds are included in total market funds (which includes

interbank borrowings).

EXHIBIT 14

Market Funds Ratio ((Market Funds - Liquid Assets) / Total Assets)

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

AUSTRIA GERMANY ITALY NETHERLANDS SPAIN UNITED KINGDOM UNITED STATES

2008 YE 2009 YE 2010 YE 2011 YE

Note: Averages for rated banks; data as of year-end.Source: Moodys Banking Financial Metrics

20 Source: Deutsche Bundesbank, Monthly Report, July 2012; Ergebnisse der gesamtwirtschaftlichen Finanzierungsrechnung fr Deutschland, June 2012


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BANKING


Special lenders with long asset durations may face funding risks

Liquidity is ample in the system. However, Exhibit 14 reflects that many of the larger institutionscannot fully meet their funding requirements internally (or through intra-sector funds), and

continue to rely on market access. This applies in particular to special lenders that focus on asset-

based finance with long asset maturities (and partly in US dollars), as these require long-termfunds to limit duration mismatches between assets and liabilities. Ship financiers in particular may

face challenges to raise long-term funds, given the high pressure in the shipping sector. However,

within the group of Moodys-rated banks, most of these specialised lenders belong either to the

cooperative or the public sector and would likely be able to rely on intra-group liquidity support,

if required.

Systemic Support

The key supportive factor for system support assumptions, i.e. the governments commitment to maintainingfinancial stability, is likely to remain unchanged over the next 12-18 months because we do not expect the currenteuro area crisis to be resolved during this timeframe. However, once markets stabilise, the extent and predictabilityof future systemic support may decline.

We recognise the governments commitment to improving stability in the European financialmarkets. As such, our bank ratings continue to include a degree of systemic support, even though

the German government introduced an advanced bail-in regime in January 2011. Following

support-related rating actions during 2011, our outlook on support is stable over the coming 12-

18 months.

The bail-in regime has not been deployed to date, but we consider the governments readiness todeploy the new restructuring tools to be high in principle. However, we expect a very cautious

approach during times of financial market instability,21 in particular with regard to including

senior bond holders. Whilst the government has made promises to the public to shield taxpayers

from the costs of future bank rescues, it also reopened the so-called SoFFin fund under the

German Financial Market Stabilisation Agency22 in March 2012, which offers 60 billion of

capital support,23 amongst other measures. The reopening of the SoFFin fund, which was first

established in late 2008 and discontinued at the end of 2010, was partly aimed at enabling banks

to respond to the higher regulatory capital requirements demanded by the European Banking

Authority (EBA) in Q3 2011, following a dedicated capital stress testing exercise that included

haircuts on certain sovereign exposures.

Our current assumptions for support may be subject to a review once the financial crisis subsidesand markets return to sustained stability. However, over the 12-18 month outlook period we do

not expect a return to sustained stability. A first-time deployment of the resolution regime that

includes burden sharing by senior bond investors could trigger a review of current support

assumptions across the German banking system.

21 See our report German Bank Restructuring Act Reduces Systemic Support for Subordinated Debtholders, February 17, 2011.22 Based on the Second Financial Market Stabilisation Act, effective since 1 March 2012; source: FMSA, seehttp://www.fmsa.de/de/fmsa/soffin/23 The exact amount is 60.2 billion, as 19.8 billion are drawn under the existing 80 billion facility; source: FMSA
http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_131128http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_131128http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_131128http://www.fmsa.de/de/fmsa/soffin/http://www.fmsa.de/de/fmsa/soffin/http://www.fmsa.de/de/fmsa/soffin/http://www.fmsa.de/de/fmsa/soffin/http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_131128


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BANKING


EXHIBIT 15

Uplift in Ratings due to systemic, cooperative and parental support

Standalone Rating (BCA) Parental / Coop Support Systemic SupportAaa

Aa2

A1

A3

Baa2

Ba1

Ba3

B2

Caa1

Caa3

C

Note: The average weighted uplift for systemic support of 2 notches is b ased on the rated banks excluding Sparkassen Fin anzgruppe and developmentbanks.Source: Moodys Investors Service

For German banks, we factor parental, cooperative, regional government and systemic supportinto our ratings, as applicable. For the Landesbanken, we consolidate various sources of support

into one, because past experience has shown that the readiness of concerted support actions

remains high, whilst the likelihood of support for each individual source is difficult to predict.

On average, our support assumptions translate into two notches of uplift for systemic supportfrom the standalone ratings, and another 1.8 notches for support from non-government sources.

The level of systemic support is below the average uplift for systemic support compared with

European peers, in recognition of the German bail-in regime. The remaining two-notch uplift

recognises both the governments Aaa (negative) rating and its commitment to maintaining

financial market stability during the ongoing crisis.


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BANKING


Moodys Related Research

Credit Opinion:

Germany, Government ofAnalysis: Germany, Government of, March 2012 (140932)Special Comments:

Update to the Global Macro-Risk Outlook 2012-13: Euro Area Debt Crisis Continues to Posethe Greatest Risk, August 2012 (145035)

Investor Losses in Modern-Era Sovereign Bond Restructuring, August 2012 (144129) Key Drivers of German Bank Rating Actions, June 2012 (142787) Challenges for Firms With Global Capital Markets Operations: Moodys Rating Reviews and

Rationale, February 2012 (139659)

Global Macro-Risk Outlook 2012-2013: Further Slowdown in Growth and Increase inUncertainty, February 2012 (139852)

European Banks: How Moodys Analytic Approach Reflects Evolving Challenges, January 2012(139207)

Euro Area Debt Crisis Weakens Bank Credit Profiles, January 2012 (137981)Sector Comment:

A New ECB Stance on Burden-Sharing Would Be Credit Negative for Senior Bank Creditors,July 2012 (144087)

Recent Rating Actions:

Moodys takes multiple actions on German banks' ratings; most outlooks now stable Moodys changes outlook on 17 German banking groups to negative following outlook change on

German sovereign and sub-sovereigns

Rating Methodologies:

Moodys Consolidated Global Bank Rating Methodology, June 2012 (143152) Local Currency Country Risk Ceiling for Bonds and Other Local Currency Obligations, August

2012 (140182)

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication othis report and that more recent reports may be available. Not all research may be available to all clients.
http://www.moodys.com/research/Germany-Government-of-Credit-Opinion--COP_333700http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_140932http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_145035http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_145035http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_145035http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_145035http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_144129http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_142787http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_142787http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139659http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139659http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139659http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139659http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139852http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139852http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139852http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139852http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139852http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139207http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139207http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139207http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139207http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139207http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_137981http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_137981http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_144087http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_144087http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_144087http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_144087http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_144087http://www.moodys.com/research/Moodys-Reviews-Ratings-for-European-Banks--PR_237914http://www.moodys.com/research/Moodys-Reviews-Ratings-for-European-Banks--PR_237914http://www.moodys.com/research/Moodys-Reviews-Ratings-for-European-Banks--PR_237914http://www.moodys.com/research/Moodys-Reviews-Ratings-for-European-Banks--PR_237914http://www.moodys.com/research/Moodys-Reviews-Ratings-for-European-Banks--PR_237914http://www.moodys.com/research/Moodys-Reviews-Ratings-for-European-Banks--PR_237914http://www.moodys.com/research/Moodys-Reviews-Ratings-for-European-Banks--PR_237914http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_143152http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_143152http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_140182http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_140182http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_140182http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_140182http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_140182http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_140182http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_140182http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_143152http://www.moodys.com/research/Moodys-Reviews-Ratings-for-European-Banks--PR_237914http://www.moodys.com/research/Moodys-Reviews-Ratings-for-European-Banks--PR_237914http://www.moodys.com/research/Moodys-Reviews-Ratings-for-European-Banks--PR_237914http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_144087http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_144087http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_137981http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139207http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139207http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139852http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139852http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139659http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_139659http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_142787http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_144129http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_145035http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_145035http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_140932http://www.moodys.com/research/Germany-Government-of-Credit-Opinion--COP_333700


20/27

BANKING


Appendix 1

Excerpt from Sovereign Credit Opinion (24 July 2012)

Credit Strengths

The credit strengths of Germany include:

Diversified and export-oriented economic base Track record of social and political stability Tradition of prudent and flexible macroeconomic policies Ready market access due to safe haven statusCredit Challenges

The credit challenges facing Germany include:

Contingent liabilities due to financial support in the context of the euro area debt crisis Pension liabilities and rising healthcare expenditureRating Rationale

On 23 July 2012, the outlook on Germany's Aaa government bond ratings was changed to negativefrom stable.

The first rating driver underlying Moody's decision to change the outlook on Germany's Aaa bondrating to negative is the level of uncertainty about the outlook for the euro area and the impact thatthis has on the country's susceptibility to event risk. Specifically, the material risk of a Greek exit fromthe euro area exposes Germany to a risk of shock that is not commensurate with a stable outlook ontheir Aaa rating. The elevated event risk in turn increases the probability that further contingent

liabilities will eventually crystallise, with Germany bearing a significant share of the overall liabilities.

The second and interrelated driver of the change in outlook to negative is the increase in contingentliabilities that is associated with even the most benign scenario of a continuation of European leaders'reactive and gradualist approach to policymaking. The likelihood is rising that the strong euro areastates will need to commit significant resources in order to deepen banking integration in the euro areaand to protect a wider range of euro area sovereigns, including large member states, from marketfunding stress. As the largest euro area country, Germany bears a significant share of these contingentliabilities. The contingent liabilities stem from bilateral loans, the EFSF, the European Central Bank(ECB) via the holdings in the Securities Market Programme (SMP) and the Target 2 balances, and -once established - the European Stability Mechanism (ESM).

The third rating driver is based on the German banking system's vulnerability to the risk of aworsening of the euro area debt crisis. German banks have sizable exposures to the most stressed euroarea countries, particularly to Italy and Spain. Moody's cautions that the risks emanating from theeuro area crisis go far beyond the banks' direct exposures, as they also include much larger indirecteffects on other counterparties, the regional economy and the wider financial system. The Germanbanks' limited loss-absorption capacity and structurally weak earnings make them vulnerable to afurther deepening of the crisis.


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BANKING


Germany remains Aaa-rated as its creditworthiness is underpinned by the country's advanced anddiversified economy and a tradition of stability-oriented macroeconomic policies. High productivitygrowth and strong world demand for German products have allowed the country to establish a broadeconomic base with ample flexibility, generating high income levels. Germany's current accountsurplus supports the resiliency of the economy. Moreover, Germany enjoys high levels of investor

confidence, which are reflected in very low debt funding costs, leading to very high debt affordability.

Rating Outlook

The negative outlook reflects the rising uncertainty regarding the outcome of the euro area debt crisisgiven the current policy framework, and the increased susceptibility to event risk stemming from theincreased likelihood of Greece's exit from the euro area, including the broader impact that such anevent would have on euro area members. Moreover, it is underpinned by the rising contingentliabilities that the German government will assume as a result of European policymakers' reactive andgradualist policy response, which comes on top of a marked deterioration in the country's own debtlevels relative to pre-crisis levels. We also see a vulnerability of the German banking system to the riskof a worsening of the euro area debt crisis. The German banks' sizable exposures to the most stressedeuro area countries, particularly to Italy and Spain, together with their limited loss-absorption capacity

and structurally weak earnings make them vulnerable to a further deepening of the crisis.

What Could Change the Rating - Down

Germany's Aaa rating could potentially be downgraded if Moody's were to observe a prolongeddeterioration in the government's fiscal position and/or the economy's long-term strength that wouldtake debt metrics outside scores that are commensurate with a Aaa rating. This could happen if (i) theGerman government needed to use its balance sheet to support the banking system, leading to amaterial increase in general government debt levels; (ii) any country were to exit the Europeanmonetary union, as such an event is expected to set off a chain of financial-sector shocks and associatedliquidity pressures for sovereigns that would entail very high cost for wealthy countries such asGermany, and cause contingent liabilities from the euro area to increase; (iii) debt-refinancing costs

were to rise sharply following a loss of safe-haven status.

Recent Developments

Against the backdrop of fiscal consolidation and ongoing deleveraging in Germany's main Europeantrading partners, net exports are expected to act as a drag on growth going forward. Real GDP growthis likely to slow to around 0.7% in 2012 from 3.0% in 2011. However, with inflation staying positivein an environment of very low interest rates, nominal GDP is likely to expand fast enough to help tobuild up a downward trend in the government debt to GDP ratio. That said, the German economicrecovery has further broadened into the domestic economy. Apart from investment, inventories andprivate consumption - backed by an ongoing rise in employment - are contributing to overall GDPgrowth. Given tight labour market conditions, substantial increases in wages and real disposableincome, high competitiveness, sound corporate balance-sheet positions and the overall limited need for

household and public balance sheet adjustments, domestic demand is likely to remain a growth driver.However, the euro area sovereign debt crisis remains a key risk to the German growth outlook.

The 2011 general government deficit has come in substantially below initial projections, at 1.0% ofGDP instead of 2.5% as originally planned. This is mainly due to the stronger-than-anticipatedeconomic recovery which led to declining unemployment and higher than anticipated tax revenueincreases. Despite the better than expected deficit outcome in 2011, the general government debt inrelation to nominal GDP is still relatively high at around 81% in 2011, but down from 83.0% in2010. As a reminder, the bulk of the jump in the public debt ratio from 74.4% in 2009 to 83.0% in


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BANKING


2010 was a reflection of the take-over of gross bank debt due to the statistical classification (in thegovernment sector) of the newly established winding-up institutions for banks ("bad banks"), i.e. FMS

Wertmanagement for Hypo Real Estate and EAA for West LB. The further development of this debtburden for the government's balance sheet will depend on the speed and conditions of the winding-down of assets accumulated in the two institutions.

The moderated growth outlook, together with recent agreements for wage increases of more than 6%for the public sector at federal and municipal level represent revenue and expenditure factors thatconstitute some risk for the government's target of a budget close to balance in 2013. At the sametime, fiscal consolidation will continue to benefit from the ongoing phasing-out of stimulus measures.

As a consequence - and in combination with the denominator effect of nominal GDP growth - weexpect that Germany's general government debt in relation to nominal GDP will stabilise at around82% in 2012. German public finances seem structurally set for a medium term downward trend in thegeneral government debt ratio. However, the ongoing euro area debt crisis remains an important riskto the baseline scenario.


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Banking System Outlook TableAs of 1 October 2012

Banking System Positive Stable Negative Banking System Positive Stable Negative

Argentina Negative Poland Negative

Australia Stable Portugal Negative

Azerbaijan Stable Qatar Stable

Bahrain Negative Russia Negative

Baltic Countries Negative Saudi Arabia Stable

Belarus Negative Singapore Stable

Belgium and Luxembourg Negative Slovakia Negative

Bolivia Stable Slovenia Negative

Brazil Stable South Africa Stable

Bulgaria Negative Spain Negative

Chile Stable Sweden Negative

China Stable Switzerland Stable

Colombia Stable Taiwan Stable

Cyprus Negative Thailand Stable

Czech Republic Negative Turkey Stable

Denmark Negative Ukraine Negative

Egypt Negative United Arab Emirates Negative

Finland Negative United Kingdom Negative

France Negative United States Negative

Germany Negative Uruguay Stable

Greece Negative Uzbekistan Stable

Hong Kong Stable Vietnam Negative

Hungary Negative

India Negative

Indonesia StableIreland Negative

Israel Negative

Italy Negative

Japan Negative

Kazakhstan Negative

Korea Stable

Kuwait Stable

Lebanon Negative

Malaysia Stable

Mexico Stable

Netherlands Negative

New Zealand Stable

Norway Negative

Oman Stable

Pakistan Negative

Peru Stable

Philippines Stable


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Global Comparison Charts

Average* Bank Financial Strength Ratings by Country (as of 1 October 2012)

E E+ D- D D+ C- C C+ B- B B+ A- ASingapore (B)(4)

Canada (B-)(7)Liechtenstein (B-)(1)Hong Kong (B-)(17)

Australia (B-)(16)Andorra (C+)(1)

Chile (C+)(7)Saudi Arabia (C)(10)New Zealand (C)(5)

United States (C)(87)Finland (C)(5)

Netherlands (C)(10)Sweden (C)(8)

Japan (C-)(33)Switzerland (C-)(15)South Africa (C-)(6)

Malaysia (C-)(8)Norway (C-)(13)

Channel Islands (C-)(2)Jersey (C-)(3)

Trinidad & Tobago (C-)(1)Bermuda (C-)(2)

Germany (C-)(33)Luxembourg (C-)(6)

Korea (C-)(13)Czech Republic (C-)(4)

Denmark (C-)(9)

Global Universe (C-)(969)United Kingdom (C-)(24)Qatar (C-)(5)Israel (C-)(5)

Brazil (C-)(43)Mexico (C-)(20)

Kuwait (C-)(8)Oman (C-)(5)Italy (D+)(40)

Slovakia (D+)(4)Jordan (D +)(3)

Mauritius (D+)(2)Taiwan (D+)(10)Panama (D+)(4)Belgium (D+)(6)

Colombia (D+)(4)United Arab Emirates (D+)( 11)

Macao (D+)(1)Peru (D+)(2)

Poland (D+)(12)Turkey (D+)(17)Spain (D+)(27)

Thailand (D+)(8)Austria (D+)(13)France (D+)(19)

India (D+)(14)Uruguay (D+)(6)Bulgaria (D+)(3)

Bahrain (D)(8)China (D)(11)

Indonesia (D)(5)Guatemala (D)(1)Morocco (D)(2)Hungary (D)(7)Russia (D)(101)

Philippines (D)(7)Georgia (D-)(2)Tunisia (D-)(5)

Bolivia (D-)(14)Ireland (D-)(15)

Romania (E+)(3)Armenia (E+)(4)Portugal (E+)(7)

Egypt (E+)(6)Albania (E+)(2)

Argentina (E+)(33)Azerbaijan (E+)(7)

Ghana (E+)(1)Lebanon (E+)(3)Lithuania (E+)(1)Mongolia (E+)(4)

Montenegro (E+)(1)Pakistan (E+)(5)Paraguay (E+)(1)Slovenia (E+)(3)Sri Lanka (E+)(2)Vietnam (E+)(8)

Kazakhstan (E+)(12)Ukraine (E+)(14)

Belarus (E+)(5)

Uzbekistan (E+)(11)Latvia (E+)(5)Cyprus (E+)(4)

Greece (E)(7)

* Chart shows asset-weighted average standalone Bank Financial Strength Rating (BFSR) of all banks in each specified domicile. The rating next to

each domicile is the rounded asset weighted average BF SR for banks in th at domicile. The number next to each domicile is th e number of banks

with active BFSRs in that d omicile.


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Average* Long-Term Bank Deposit Ratings by Country (as of 1 October 2012)

Domestic Currency

C Ca

Caa3

Caa2

Caa1

B3

B2

B1

Ba3

Ba2

Ba1

Baa3

Baa2

Baa1

A3

A2

A1

Aa3

Aa2

Aa1

Aaa

* Chart shows asset-weighted average local-currency deposit rating of all banks in each specified domicile. The rating next to each domicile is the

rounded asset weighted average local-currency deposit rating for banks in that domicile. The number next to each domicile is the number of banks

with active local-currency deposit ratings in that domicile.


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Average* Long-Term Bank Deposit Ratings by Country (as of 1 October 2012)

Foreign Currency

CCaa3

Caa2

Caa1

B3

B2

B1

Ba3

Ba2

Ba1

Ba1

Baa3

Baa2

Baa1

A3

A2

A1

Aa3

Aa2

Aa1

AaaC

a

* Chart shows asset-weighted average foreign-currency deposit rating of all banks in each specified domicile. The rating next to each domicile is the

rounded asset weighted average foreign-currency deposit rating for b anks in that domicile. The number next to each domicile is the number of

banks with active foreign-currency deposit ratings in that domicile.


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Report Number: 145492

AuthorKatharina Barten

Production AssociatesKerstin ThomaGinger Kipps

2012 Moodys Investors Service, Inc. and/or its licensors and affiliates (collectively, MOODYS). All rights reserved.

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Germany Banking System Outlook

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