Credit Opinion: Berlin, Land of

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1 Credit Opinion: Berlin, Land of Global Credit Research - 25 Jul 2012 Germany Ratings Category Outlook Issuer Rating Bonds Moody's Rating Negative Aa1 Aa1 Contacts Analyst Phone Andrea Wehmeier/Frankfurt am Main Massimo Visconti/Milan David Rubinoff/London Key Indicators Berlin, Land of GDP per capita 25,257 27,787 27,972 28,649 29,153 Intergovernmental revenues as a % of Operating Revenues Interest payments as a % of Operating Revenues Gross Operating Balance as a % of Operating Revenues Financing surplus(deficit) as a % of Total Revenues Net Direct and Indirect Debt as a % of Operating Revenues [1] Capital expenses as a % of Total expenses [1] 2011 indirect debt data not available Opinion SUMMARY RATING RATIONALE The Land of Berlin's Aa1 issuer and long-term bond ratings, reflect the state's continuous efforts towards financial consolidation, the Land's limited financial flexibility in a context of a volatile economic development, high spending needs and extremely high debt levels. The implementation of a more stringent fiscal plan, coupled with a rigid budgetary policy will be key to the state's ability to contain budgetary deficits going forward. The Aa1 rating also reflects Moody's assessment of a very high likelihood that the Federal Republic of Germany (Aaa, negative) would act to prevent a default by the Land. On July , Moody's assigned a negative outlook to Berlin's long-term ratings following the outlook change for the German sovereign rating to negative from stable. National Peer Comparison Berlin is rated in line with the average of German Länder, whose ratings span from Aaa to Aa1. Berlin's position relative to its peers reflects its extremely high indebtedness, which is unique in a German context. These higher

2 relative to its peers reflects its extremely high indebtedness, which is unique in a German context. These higher levels of debt at an equivalent level of credit risk are supported by the strong equalisation system in Germany, the Land's very good access to liquidity and the very high likelihood of support by the German government. Credit Strengths Credit strengths for Berlin include: - Robust legal framework, featuring strong support under the German constitution (Basic Laws) - Strong support from the other Länder and the Federal Government under the equalisation system - Capacity to access the capital markets is high, coupled with acceptable cost of funding Credit Challenges Credit challenges for Berlin include: - Extremely high debt levels - Consistently poor financial flexibility, in common with most Länder - Significant contingent liabilities Rating Outlook The negative outlook on Berlin mirrors the corresponding change of outlook on the German sovereign. The extremely strong financial and operational linkages between the central government and German Länder imply a high correlation between the credit standing of the German federal government and that of the Länder. What Could Change the Rating - Up A stabilisation of the outlooks or upward rating pressure for Berlin would require a stabilisation of the sovereign rating, or evidence of Berlin's capacity to display comparatively stronger credit fundamentals than peers. What Could Change the Rating - Down Given that the negative outlook on Berlin mirrors the negative outlook on Germany's sovereign rating, downward ratings pressure on Berlin would likely be prompted by a deterioration in the creditworthiness of the sovereign. Additionally, a deterioration in the budgetary fundamentals or a crystallization of contingent liabilities could exert downward rating pressure. DETAILED RATING CONSIDERATIONS The ratings assigned to the Land of Berlin reflect the application of Moody's Joint-Default Analysis (JDA) rating methodology for regional and local governments (RLGs). In accordance with this methodology, Moody's first establishes the baseline credit assessment (BCA) for the state and then considers the likelihood of support coming from the Federal Government to avoid a default by the state, should this extreme event ever occur. Baseline Credit Assessment Berlin's BCA of 5 (on a scale of 1 to 21, where 1 represents the lowest risk) reflects the following factors: Financial Position and Performance Berlin's BCA takes account of the state's financial performances, its poor financial flexibility in a context of high spending needs, its very sizable debt levels and off-balance sheet guarantees. Budgetary results for 2011 still reflect persisting pressures: The operating deficit was at 2.6%, compared with an operating deficit of 3.1% in 2010 in While revenues recovered substantially, they have not yet fully returned to pre-crisis levels, thus imposing sustained budgetary pressures. Tax revenues for the 16 federal states (Bundesländer) are expected to increase by 4.4% in 2012 and 3.6% in However, for 2012 the weaker economic outlook could again impose greater budgetary stress, although there is a strong and growing commitment

3 by Berlin and other Länder to control expenditures. In 2011, both capital revenues and expenditures decreased - by 2% and 14%, respectively, reflecting the ending implementation of the national economic stimulus programme. The combined effect of a slightly improved operating and capital revenues was a stabilisation of the overall budget, with a financing deficit of 5.2% of total revenues, vs a 6.8% deficit in 2010 and 7.3% in 2009 and a 4.2% surplus in Improved operating revenues should again translate into better - albeit still negative - financial results than initially budgeted in the course of That said, Moody's believes Berlin will face some further budget challenges. The most significant risk factors are the general containment of increases in the key expenditure items and potentially rising interest rates in the medium term. This is particularly important in a context whereby all federal contributions to promote the economic development of former East German Länder and Berlin are gradually declining - disappearing in 2020 in accordance with the National Solidarity Pact. A mitigating factor for the expected deterioration in credit metrics is the so-called debt brake, a mechanism the Federal Republic of Germany and the 16 regions (Länder) agreed on in summer According to this debt brake the Länder will be required to have balanced budgets from In order to reach the target, Berlin is further increasing its efforts for budgetary consolidation and is required to do so under the following agreements: (i) Together with a number of other Länder, Berlin qualifies for special subsidies for budgetary consolidation in order to allow these Länder to reach the target. These subsidies will only be available if the Land agrees on certain targets for budgetary consolidation. As a result, Berlin announced it will limit the total expenditure growth to 0.3% per year from 2012 and agreed with the federal government a consolidation path, limiting its net new borrowings (i.e. debt borrowed minus principal repaid in a given year) from 2011 on. (ii) Additionally, the stability council, supervising the financial situation of the Länder, identified Berlin as one of five regions needing to address a challenging budgetary situation with a five year consolidation plan in order to avoid a so-called budgetary emergency. If a budgetary emergency is stipulated for region, the region would qualify for extraordinary support in the form of additional special transfers. However, Moody's notes that this "budgetary emergency" does not relate to any liquidity strains or problems with capital market access. Debt Profile Berlin's direct debt (excluding guarantees and company debt) rose 2% in 2011 and totaled EUR 61.5 billion. In relative terms, debt was equivalent to 311% of its operating revenues in 2011, down from 314% in 2010 vs 317% in 2009 but up from 290% in The sharp rise in 2009 was primarily boosted by the fall in operating revenues (denominator). The ratio remains extremely high compared to Berlin's European peers, and is high even in the German context, whereby the average for all Länder was 245% in If we include other indirect debt at non-selfsupporting majority-owned companies and guarantee obligations, the ratio rises to a spectacular 490% of operating revenues in 2010 (up from 465% in 2008), though EUR 21.5 billion (or 109% of operating revenues) are linked to a guarantee that is highly unlikely to materialize in full. Notwithstanding the magnitude of such numbers, Berlin's capacity to tap capital markets is high thanks to a sophisticated state treasury and excellent liquidity management. Market access has remained good even during the recent crisis. Berlin owns (or has shares in) several companies. The majority are public limited companies (GmbH) and some receive subsidies. Berlin successfully completed the sale of its 80.95% stake in Landesbank Berlin Holding AG in 2007, which was the most critical company in its portfolio. Proceeds of EUR 4.6 billion from this sale have been used to balance risks arising from the real estate portfolio assumed by Berlin in 2002 to prevent a default of Bankgesellschaft Berlin (BGB). Governance and Management Factors In recent years, Berlin has demonstrated its ability to meet or even exceed fiscal targets more often than in the past, not only due to positive economic trends, but also due to its ability to promptly adjust its budgetary policies. Budgets are timely and transparent, as strictly required by German law. Berlin's institutional capacity is very high even though budget amendments are still overly dependent on the economic cycle, with an overall weak room for manoeuvre on the cost side. Economic Fundamentals The City-State of Berlin, with its 3.5 million inhabitants, is the capital of the Federal Republic of Germany.

4 The City-State of Berlin, with its 3.5 million inhabitants, is the capital of the Federal Republic of Germany. After 3.7% growth in 2008 (Germany 1.0%), Berlin's real GDP declined by only 0.4% in 2009 compared to 5.1% of Germany as a whole, as the regional economy is less exposed to the downturn in the industrial and export sectors. The recovery in 2010 and 2011, however, was also less pronounced, with GDP growth of 2.7% in Berlin vs. 3.7% in Germany in 2010 and 2.4% in Berlin vs. 3% in Germany in Moody's forecasts Germany's GDP to grow by % in 2012 and notes a persisting high level of uncertainty linked to the euro area debt crisis. The impact of the global financial crisis affected the labour market, albeit to a lesser extent, resulting in only a modest increase of the structurally high unemployment rate to 14% in 2009 from 13.8% in A recovery has already been noted in 2010, with the unemployment rate in Berlin dropping to 13.6%, which remains comparably high vs. the national level (7.7), but down from 19% in The changes in the city's economic structure reflect the trends of many new Länder - the public and manufacturing sectors have become less significant, while the financial, trade, transport and value-added service sectors have become more prominent. The city continues to attract foreign direct investment, with services being the largest beneficiary, as many multinational corporations have sought to locate representative offices or relocate their European headquarters to the capital. Operating Environment The operating environment for German RLGs, typical of advanced industrial economies, is reflected in the relatively high GDP per capita, low GDP volatility and high ranking on the government effectiveness index. These characteristics represent a minimal level of systemic risk, as reflected in the Aaa rating assigned to the Federal Republic of Germany. As such, conditions that historically precede national crises that are associated with RLG defaults are not present in this context. Institutional Framework The institutional framework, which encompasses the arrangements determining intergovernmental relations at all levels and jurisdictional powers and responsibilities, is mature and highly developed, with minor changes occurring at a measured pace and in a clear/transparent way. Germany has one of the strongest equalisation systems worldwide, which combines revenue equalisation - both horizontal and vertical - and investment support from the federal government. This scheme protects all Länder against above-average revenue shortfalls, yet limits their revenue flexibility. More than 90% of revenue stems from shared taxes and transfers and German states do not have tax rate-setting rights. A regional tax base that would grow above the national average would have only a limited effect on the Land's budgetary performance. Above-average tax revenue growth goes hand-in-hand with decreasing transfer income from the equalisation pool. Debt levels are among the highest internationally and some jurisdictions continue to add to their respective stock of debt. In order to ensure the long-term sustainability of the budgetary situation in Germany, the federal government and the Länder agreed on a so-called "debt-brake" in July The instrument will limit the structural deficit of the federal government to 0.35 per cent of gross domestic product from 2016 onwards, while after 2019 Germany's 16 regional governments are no longer allowed to run fiscal deficits. In addition to the limit, a stronger joint supervision of Bund and Länder budgets is being implemented. The debt brake appears more binding than the arrangement of article 115 of the German Basic Law and respective Länder constitutional rules that stipulated that revenue from borrowing may not exceed the total expenditure for investment provided for in the budget estimates. A rule-driven fiscal policy approach seems less exposed to political interference in Moody's view. Given the massive fiscal expansion caused by economic stimulus packages to dampen the effects of the global economic crisis, the `debt brake' means that the both the federal government and the Länder must follow significant tightening of fiscal policy until 2015 and 2019 respectively, in order to be able to achieve the debt brake's deficit target. Extraordinary Support Considerations Moody's assigns a very high likelihood of extraordinary support from the Federal Government, reflecting Moody's opinion of (i) the elevated reputation risk for Germany as a whole in case of default by a Land, and (ii) the Bundestreuekonzept, according to which all German Länder must express mutual solidarity in the event that one of them or the Federal Republic faces a severe budgetary crisis. Also, the debt volumes and structure of German Länder are extremely complex and an event of non-payment would be considered to have a corresponding impact on Germany as a whole. (In accordance with Moody's Joint-Default Analysis rating methodology, a 100% support probability is given only in the presence of explicit guarantees from another RLG or when conditions for

5 extraordinary support are clearly identified within a legal statute requiring the provision of support.) Moody's also assigns a very high default dependence between Land Berlin and the Federal Government, reflecting the fact that all German states and municipalities receive a high level of shared taxes and federal transfers. This suggests that economic factors affecting the creditworthiness of one entity would likely also impact that of the other. Output of the Baseline Credit Assessment Scorecard In the case of Berlin, the BCA scorecard (presented below) generates an estimated BCA of 5, equal to that assigned by the rating committee. The BCA scorecard, which generates estimated baseline credit assessments from a set of qualitative and quantitative credit metrics, is a tool used by the rating committee in assessing regional and local government credit quality. The credit metrics captured by the scorecard provide a good statistical gauge of stand-alone credit strength and, in general, higher ratings can be expected among issuers with the highest scorecard-estimated BCAs. Nevertheless, the scorecard-estimated BCAs do not substitute for rating committee judgments regarding individual baseline credit assessments, nor is the scorecard a matrix for automatically assigning or changing these assessments. Scorecard results have limitations in that they are backward-looking, using historical data, while the assessments are forward-looking opinions of credit strength. Concomitantly, the limited number of variables included in the scorecard cannot fully capture the breadth and depth of our credit analysis. ABOUT MOODY'S SUB-SOVEREIGN RATINGS National and Global Scale Ratings Moody's National Scale Ratings (NSRs) are intended as relative measures of creditworthiness among debt issues and issuers within a country, enabling market participants to better differentiate relative risks. NSRs differ from Moody's global scale ratings in that they are not globally comparable with the full universe of Moody's rated entities, but only with NSRs for other rated debt issues and issuers within the same country. NSRs are designated by a ".nn" country modifier signifying the relevant country, as in ".sk" for Slovakia. For further information on Moody's approach to national scale ratings, please refer to Moody's Rating Methodology published in March 2011 entitled "Mapping Moody's National Scale Ratings to Global Scale Ratings." The Moody's Global Scale rating for issuers and issues allows investors to compare the issuer's/issue's creditworthiness to all others in the world, rather than merely in one country. It incorporates all risks relating to that country, including the potential volatility of the national economy. Country Ceilings for Foreign Currency Obligations Moody's assigns a ceiling for foreign-currency bonds and notes to every country (or separate monetary area) in which there are rated obligors. The ceiling generally indicates the highest rating that can be assigned to a foreigncurrency denominated security issued by an entity subject to the monetary sovereignty of that country or area. In most cases, the ceiling will be equivalent to the rating that is (or would be) assigned to foreign-currency denominated bonds of the government. Ratings that pierce the country ceiling may be permitted, however, for foreign-currency denominated securities benefiting from special characteristics that are judged to give them a lower risk of default than is indicated by the ceiling. Such characteristics may be intrinsic to the issuer and/or related to Moody's view regarding the government's likely policy actions during a foreign currency crisis. Baseline Credit Assessment Moody's baseline credit assessment incorporates the government's intrinsic credit strength and accounts for ongoing operating subsidies and transfers from the supporting government. In effect, the baseline credit assessment reflects the likelihood that a local government would require extraordinary support. Extraordinary Support Extraordinary support is defined as action taken by a supporting government to prevent a default by a regional or local government (RLG) and could take different forms, ranging from a formal guarantee to direct cash infusions to facilitating negotiations with lenders to enhance access to needed financing. Extraordinary support is described as either low (0% - 30%), moderate (31% - 50%), high (51% - 70%), very high (71% - 95%) or fully supported (96% - 100%).

6 Default Dependence Default dependence reflects the likelihood that the credit profiles of two obligors may be imperfectly correlated. Such imperfect correlation, if present, has important diversifying effects which can materially change the joint-default outcome. Intuitively, if two obligors' default risks are imperfectly correlated, the risk that they would simultaneously default is smaller than the risk of either defaulting on its own. In the application of joint-default analysis to RLGs, default dependence reflects the tendency of the RLG and the supporting government to be jointly susceptible to adverse circumstances leading to defaults. Since the capacity of the higher-tier government to provide extraordinary support and prevent a default by an RLG is conditional on the solvency of both entities, the more highly dependent -- or correlated -- the two obligors' baseline default risks, the lower the benefits achieved from joint support. In most cases, the close economic links and/or overlapping tax bases and/or close intergovernmental fiscal arrangements between different levels of government result in a moderate or very high degree of default dependence. Default dependence is described as either low (0% - 30%), moderate (31% - 50%), high (51% - 70%) or very high (71% - 100%). Rating Factors Berlin, Land of Baseline Credit Assessment Sub-Factor Sub-Factor Factor Total Scorecard Value Score Weighting Total Weighting Factor 1: Operating Environment National GDP per capita (PPP basis, $US) 35, % National GDP Volatility (%) % % 1.13 National Govt Effectiveness Index (World Bank) % Factor 2: Institutional Framework Predictability, Stability, Responsiveness % Fiscal Flexibility (A): Own-Source Revenues % % 0.67 Fiscal Flexibility (B): Spending % Fiscal Flexibility (C): Extent of Borrowing % Factor 3: Financial Position & Performance Interest Payments/Operating Revenue (%) % Cash Financing Surplus(Req)/Total Revenue (%) % % 1.20 Gross Operating Balance/Operating Revenue (%) % Net Working Capital/Total Expenditures Factor 4: Debt Profile Net Direct and Indirect Debt/Operating Revenue % Short-Term Direct Debt/Direct Debt (%) % % 1.05 Net Debt/Operating Revenue Trend % Factor 5: Governance & Management Fiscal Management % Investment & Debt Management % Transparency & Disclosure (A) % % 0.36 Transparency & Disclosure (B) % Institutional Capacity % Factor 6: Economic Fundamentals Regional or Local GDP pc PPP - estimated ($US) 33, % % 0.10 Estimated BCA 5

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