Credit Opinion: Banco Indusval S.A. (BI&P)

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1 Credit Opinion: Banco Indusval S.A. (BI&P) Global Credit Research - 23 Mar 2015 Sao Paulo, Brazil Ratings Category Moody's Rating Outlook Stable Bank Deposits B1/NP NSR Bank Deposits -Dom Curr Baa2.br/BR-3 Baseline Credit Assessment b1 Adjusted Baseline Credit Assessment b1 Contacts Analyst Phone Ceres Lisboa/Sao Paulo Alcir Freitas/Sao Paulo M. Celina Vansetti/New York City Thiago Scarelli/Sao Paulo Key Indicators Banco Indusval S.A. (BI&P) (Consolidated Financials)[1] [2]9-14 [2]12-13 [3]12-12 [3]12-11 [3]12-10 Avg. Total Assets (BRL billion) [4]13.8 Total Assets (USD billion) [4]3.2 Tangible Common Equity (BRL billion) [4]3.5 Tangible Common Equity (USD billion) Problem Loans / Gross Loans (%) [4]-6.1 [5]2.4 Tangible Common Equity / Risk Weighted Assets (%) Problem Loans / (Tangible Common Equity + Loan Loss [6] [5]9.5 Reserve) (%) Net Interest Margin (%) PPI / Average RWA (%) [5]4.2 [6]-0.5 [5]-0.4 [5]83.9 Net Income / Tangible Assets (%) Cost / Income Ratio (%) Market Funds / Tangible Banking Assets (%) Liquid Banking Assets / Tangible Banking Assets (%) [5] [5]34.4 Gross Loans / Total Deposits (%) [5]122.8 Source: Moody's [1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - fully-loaded or transitional phase-in; LOCAL GAAP [3] Basel II; LOCAL GAAP [4] Compound Annual Growth Rate based on LOCAL GAAP reporting periods [5] LOCAL GAAP reporting periods have been used for average calculation [6] Basel III - fullyloaded or transitional phase-in & LOCAL GAAP reporting periods have been used for average calculation Opinion SUMMARY RATING RATIONALE

2 Moody's assigns a baseline credit assessment of b1 to Banco Indusval S.A. (BI&P), that remained unchanged following the implementation of the new bank methodology on 16 March The b1 BCA reflects BI&P's volatile financial fundamentals, particularly those involving its earnings recurrence generation and capital replenishment capacity. The bank's limited recurring earnings generation over the past three years has been impacted by its efforts to clean up legacy non-performing loans, challenging margin conditions and high credit cost, effects of the bank repositioning its franchise towards the more selective SME lending and agribusiness segments. Moreover, while the bank has been able to manage operating costs related to active pursuit of partnerships and acquisitions to diversify its operations over the past years, the bank's overall business have been operating close to breakeven point. While the performance of these new platforms are taking on more time than expected, in an environment of intense competition among investment banks and slow macroeconomic conditions that are delaying growth plans, the fee-related business has grown 80% in In these conditions, the bank's capital replenishment capacity as weak, after years of rapid capital consumption because of both poor bottom line results and robust loan growth. However, we note that BI&P's partners have contributed with BRL398 million as capital since April 2011, proving their commitment to the bank's strategic shift and growth plans. The loan growth was primarily in agricultural segment, which reached 25.6% of total loans in Over the past three years, BI&P has cleaned up its loan book from potential problematic loans originated under its previous administration; these increments to reserves have rapidly dragged down the bank's capitalization in 2014 (13.1% Tier 1 ratio), a thin loss-absorption buffer compared to those of other banks in Brazil that are similar in size. The annualized provisioning expense of the new portfolio improved materialy as a result of the portfolio cleanup promoted in BI&P'S RATING IS SUPPORTED BY THE MODERATE+ MACRO PROFILE ON BRAZIL Brazil's macro profile reflects its large and diversified economy, its high and rising indebtedness and the dominance of public sector banks. Notwithstanding the size of the economy, growth has fallen below potential for more than three consecutive years, weighed down by increased economic uncertainty, a slowdown in consumption and weak investment. In addition, persistently high inflation has raised questions regarding the credibility of the central bank's inflation targeting regime. Moreover, the banking system has become bifurcated, with public banks controlling a 54% share of the system's credit market as a result of years of rapid loan growth driven by government stimulus measures, while private banks remained more conservative. However, loan growth has moderated over the past year, which has alleviated pressure on banks' capital and funding following a period of robust credit market expansion. Brazil`s sizeable international reserve position, limited reliance on foreign borrowings and sound banking system support its low susceptibility to event risk. Rating Drivers - Improved credit risk policies, following the change in management, which has been translating into relatively lower delinquency ratios - Inherent sector concentration risk, as the banks reinforces its focus on the agribusiness sector - Weak profitability and relatively low capital ratios compared to peers - Challenging operating environment, which will keep asset quality, business generation and efficiency under pressure - Expansion of services platforms adds income diversification as the operation matures - Efforts to enhance funding structure with more granular deposit-like instruments taking advantage of its brokerage house to access retail depositor base Rating Outlook All ratings have stable outlook. The stable outlook incorporates the changes in business strategy in recent years, which have been adding complementary platforms, as well as reinforced its risk structure and enhanced management expertise. Moody's also acknowledges efforts made towards diversifying funding, which has added more granular and thus, less vulnerable retail-based clients, benefiting overall funding cost. Although funding and liquidity remain a negative rating driver for BI&P, as well as for other midsized banks in Brazil, given the vulnerability of its wholesale nature, Moody's acknowledges the improvement these efforts have made in replacing institutional deposits with deposit-like LCA and LCI instruments (notes linked to an agribusiness loan or a real estate loan), which are covered by local FDIC and offer tax exemptions to individual investors. The bank was able

3 to leverage distribution from its broker dealer Guide Investimentos, and several partnerships with distributors, private banks and independent investment advisor offices. What Could Change the Rating - Up Long-term consistency in the fundamentals could move the standalone credit assessment up. However, there is limited upward pressure on the ratings at this point. What Could Change the Rating - Down Persistence of poor profitability and further capital erosion, which could come from a delay in the results envisaged in the strategic plan, would pressure the bank's rating down. Additionally, weakening in the liquidity position or excessive borrower concentration could also trigger further downgrades. DETAILED RATING CONSIDERATIONS BETTER RISK GUIDELINES IMPROVED HISTORICAL NPLS, BUT SIZEABLE SECTOR CONCENTRATION POSES DOWNSIDE RISKS TO THE FRANCHISE Despite the timid growth of 6.9% of loans in 2014, BI&P reported a relative stable nonperforming loans ratio of 1.7% in The legacy portfolio, however, was responsible for a slight deterioration of 20 bps in delinquency, while the portfolio originated under the revised credit guidelines (adopted since mid-2011) continues to present stable NPLs. As part of the new strategy and addressing the challenging economic scenario, the bank continues to focus on corporate clients (with annual revenues between BRL500million and BRL3 billion) which accounted for 62% of total loans in 2014 (52% in 2013). Additionally, management see that the segment offers more cross selling opportunities, as the bank transits to a new business platform offering more sophisticated products, such as derivatives and investment banking. On the other hand, we see that this strategy may expose the bank to additional risk concentration per client, as indicated by the increase in average ticket since However, BI&P poses a relevant sector concentration risk, as its credit operations in the agribusiness sector (in particular with soy producers) continue to increase rapidly. In Moody's view, BI&P's expertise in this field helps mitigating the risks, which are inherent to the consolidation of its franchise as a specialized agribusiness player, but nevertheless the concentration should be monitored, since agriculture segment already accounts for more than 25% of the bank's BRL4.1 billion extended credit portfolio (including credit exposure in marketable securities portfolio and sureties). Our assessment of ba3 for asset risk considers the high exposure to the agribusiness sector that accounts for 1.75x the reported Tier 1 equity and the still volatile long-run loan losses since CAPITAL BUFFERS GRADUALLY ERODED BY WEAK RESULTS Capitalization has been affected by the poor results and the past years of high loan growth. In 2014, BI&P reported a regulatory capital ratio of 13.1% (fully composed of Tier 1), its lowest ratio since 2006 and one of the lowest among its peers. The shareholders (including the US private equity fund Warburg Pincus and recognized executives in the investment banking market) have proven to be committed with the bank's new strategy by injecting more than BRL 290 million in capital since 2010, which were necessary to cover the provisions built in the portfolio cleanup process. The capital also benefited from an BRL107.5 million increase following the acquisition of Banco Intercap in the end of 2013, when two experienced executives, one of them with relevant expertise in the agribusiness segment joined the board. Our TCE ratio of 9.3% scores ba3 and applies 50% risk-weighting on the bank's holdings of Brazilian government securities (Baa2), as per Basel guidelines, adjusting the risk weighted assets (RWA), as well as considers a portion of DTA arising from temporary differences related to loan loss provisions as per our analytical approach that DTAs may not have the ability to absorb losses during the resolution of a bank. Going forward, the bank will face the challenge to maintain healthy capital levels while it continues to grow in a competitive segment. In Moody's view, current BIS ratios offer a limited cushion to absorb losses, in particular considering the bank's inherent sector concentration risks. POOR EARNINGS STABILITY REFLECTS CHALLENGING MARKET CONDITIONS AND STILL WEAK EFFICIENCY After three years of portfolio cleanup, BI&P continues to report volatile profitability ratios, negatively pressured by its shift toward the Corporate and upper-middle market (where competition for the best borrowers keeps credit spreads low), and it is still modest scale (which compromises the bank's efficiency ratios). For 2014, the bank reported net losses of BRL5.2 million, still showing breakeven on a quarterly basis since the 2Q, and despite the

4 improve risk profile of its portfolio and lower credit costs incurred in the period. On the positive side, the gradual rise of fee-based income offers some earnings diversification to the bank, as the acquisitions and investments made over the previous quarters mature toward the breakeven point. In 2014, the bank reported around BRL60.9 million in net fees and commissions income, more than 35% related to its investment banking activities. Our assessment of caa2 for profitability still reflects the negative bottom line results. Management needs to prove capable to increase profitability in the coming quarters, presenting sustainable earnings recurrence generation. MARKET FUNDING RELIANCE RENDERS ITS FUNDING PROFILE, ALTHOUGH THE BANK HAS FOCUSED ON INCREASING BROKER-SOURCED DEPOSITS As other midsized niche banks, BI&P's funding is primarily concentrated in wholesale, vulnerable to fluctuations in investor sentiment but it has been able to rapidly expand its retail investor-base, leveraging from its sizeable agribusiness portfolio to issue securities backed by rural credit (Letras de Crédito do Agronegócio, LCA and Letra de Crédito Imobiliária, LCI), both deposit-like instruments. These tools grew strongly since 2013 behind the tax exemption feature and its deposit insurance coverage, which allowed mid-size banks, such as BI&P to attract individual investors' interest. Those features combined with BI&P's enhanced distribution platforms helped LCAs and LCIs to account for 40% of total funding in 2014, up from 4% in March 2011, lowering the average funding cost and increasing its granularity. However, our assessment of b2 for funding structure considers that still low quality of the funding, which low-tenure and highly sensitive as a broker-sourced funds. The concentrated and expensive DPGEs (time deposits collateralized with resources from the insurance deposit fund and tenor above 2 years) still accounted for 30% of total funding, or the majority of total deposits in However, one third of DPGEs are already made of the second generation of DPGEs (secured by a loan), which reduces the cost compared to the first DPGEs. The risk behind this structure relates to maturity and ticket concentration, while it helps to extend the average tenor of the liabilities. Efforts around increasing funding tenor also considers trade finance facilities with correspondent banks (5%) and onlending from the federal development bank BNDES (4%). BI&P had a free cash position of BRL749 million in 2014, 13.6% of total assets and 18.7% of deposits, which was largely comprised of government securities. Notching Considerations In the absence of a bail-in resolution regime framework in Brazil, the ratings of subordinated debts, bank hybrids, and contingent capital securities follow the "Additional Notching Guidelines", as per the Rating Methodology: Banks. In these cases, the approach takes into account other features specific to debt classes, resulting in additional from the adjusted baseline credit assessment (BCA) of the issuer. GOVERNMENT SUPPORT The B1 global local currency deposit rating derives from BI&P's standalone baseline credit assessment of b1, and does not benefit from any government support uplift because of the bank's modest market share in local banking system deposits. The global local currency deposit rating of B1 has historically been associated with default frequencies of 10.9% and 19.0% over 3- and 5-year investment horizons, respectively. About Moody's Bank card Our card is designed to capture, express and explain in summary form our Rating Committee's judgment. When read in conjunction with our research, a fulsome presentation of our judgment is expressed. As a result, the output of our card may materially differ from that suggested by raw data alone (though it has been calibrated to avoid the frequent need for strong divergence). The card output and the individual scores are discussed in rating committees and may be adjusted up or down to reflect conditions specific to each rated entity. Rating Factors Banco Indusval S.A. (BI&P) Macro Factors Weighted Macro Profile Moderate + Financial Profile

5 Factor Historic Ratio Macro Adjusted Solvency Asset Risk Problem Loans / Gross Loans Credit Trend Assigned Key driver #1 Key driver #2 2.2% baa1 ba3 Long-run loss performance Unseasoned risk Capital TCE / RWA 9.3% ba3 ba3 Risk-weighted capitalisation Profitability Net Income / Tangible Assets Combined Solvency Liquidity Funding Structure Market Funds / Tangible Banking Assets Liquid Resources Liquid Banking Assets / Tangible Banking Assets Combined Liquidity -0.8% caa2 caa2 Return on assets ba2 b1 36.9% b1 b2 Deposit quality 29.5% baa2 baa3 Quality of liquid assets ba2 ba3 Financial Profile b1 Qualitative Adjustments Adjustment Business Diversification 0 Opacity and Complexity 0 Corporate Behavior 0 Total Qualitative Adjustments 0 Nominal leverage Market funding quality Sovereign or Affiliate constraint card Calculated BCA range Baa2 ba3 - b2 Assigned BCA b1 Affiliate Support 0 Adjusted BCA b1 Instrument Class Loss Given Failure Additional Preliminary Rating Assessment Government Support Local Currency rating Foreign Currency rating Deposits 0 0 b1 0 B1 B1

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