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Rating Action:

Moody's downgrades COFIDE's issuer rating and lowers its standalone baseline credit assessment, outlook negative

 The document has been translated in other languages

25 Aug 2017

New York, August 25, 2017 -- Moody's Investors Service today downgraded the local- and foreign currency issuer ratings of Peru's Corporación Financiera de Desarrollo S.A. (COFIDE) to Baa3 from Baa2. At the same time, Moody's lowered COFIDE's standalone baseline credit assessment (BCA) to b3 from b1. In addition, COFIDE's outlook has been revised to negative from stable.

The following ratings of COFIDE were downgraded:

Baseline credit assessment: to b3 from b1

Long-term local currency issuer rating: to Baa3 from Baa2, with negative outlook

Long-term foreign currency issuer rating: to Baa3 from Baa2, with negative outlook

RATINGS RATIONALE

The downgrade reflects a sharp deterioration in COFIDE's asset risk profile, and consequently of its profitability as well. Despite the company's very weak standalone financial profile, reflected in its b3 BCA, its Baa3 issuer ratings benefit from the government's demonstrated high willingness to provide support in case of need.

Non-performing loans jumped to 9% of gross loans as of June from just 0.05% twelve months earlier as several infrastructure projects to which COFIDE has large exposures have been put on hold due to Peru's recent corruption scandal related to public infrastructure projects. The company expects that most of these loans will start to perform again once the projects are restarted and/or it will be able to recover a substantial portion of any losses, but Moody's considers there to be a very high degree of uncertainty regarding the ultimate recovery prospects that will depend on how much the projects are delayed and how much the construction costs increase.

Although COFIDE has historically carried very high loan loss reserves, the recent increase in delinquencies obliged it to hike its provisions substantially, which together with a decline in interest income caused it to record a net loss in the first half of 2017 equal to 0.8% of tangible assets on an annualized basis.

COFIDE is 99% owned by the Government of Peru (A3 stable) via its holding company FONAFE, the National Fund for the Financing of State Entrepreneurial Activities. As part of its mandate, COFIDE's portfolio of infrastructure loans had grown significantly in recent years, reaching 53% of its lending book as of June 2017 up from 22% at year-end 2011. Although COFIDE lends to such projects through financial institutions and historically recorded these loans as exposures to the financial institutions, in fact it retains the full project risk exposure..

The rise in delinquencies revealed significant governance shortcomings that were addressed by the replacement of COFIDE's president and a large part of its management in January 2017. The company's new administration moved swiftly to establish tighter underwriting standards for future financings in April, limiting COFIDE's exposure to a single project to 25%, or up to 50% as an exception with FONAFE's board approval, versus up to 100% of exposure as was the case in the past. In addition, going forward, the company will now record these loans as direct exposures to the projects themselves, rather than to the banks through which COFIDE lends. Nevertheless, Moody's believes that the company is likely to need to register additional problem loans and incur further provisioning expenses in the coming quarters, which will result in continued net losses.

The rating also captures COFIDE's very limited loss absorption capacity. While COFIDE's capitalization ratios remain strong, it has significant illiquid investment holdings, specifically non-tradeable shares in the Corporación Andina de Fomento (CAF, rated Aa3), a multilateral development bank of which Peru is a member, that comprise 18% of the company's balance sheet and account for virtually all of its tangible equity. Netting these shares out would leave COFIDE with tangible common equity of less than 1% of its risk-weighted assets.

To offset the negative effect of the extraordinary provisions and to restore the entity's balance sheet, COFIDE's management put in place a recapitalization plan. The plan entails the commitment of the National Government to acquire up to 20% of COFIDE's CAF shares - as described in a Comfort Letter issued in May, the capitalization by the government of multilaterals borrowings of up to $104 million by year end 2017, the reinvestment of future dividends related to the period 2017-19, and the reimbursement of dividends received by FONAFE for the period 2016. Despite this plan, COFIDE's loss absorption capacity is likely to remain very weak in Moody's view, as its remaining CAF shares will continue to account for the large majority of its capital.

Nevertheless, this plan is a clear indication of the government's high willingness to provide extraordinary financial support to COFIDE, which in turn derives from the government's ownership and control of the company as well as COFIDE's public policy mandate to help promote economic growth by financing targeted sectors such as infrastructure and SMEs. COFIDE is expected to continue to play an important role in helping to the country to fill its significant infrastructure needs. This support results in six notches of ratings uplift from the company's b3 BCA.

The negative outlook on COFIDE's ratings reflects the risk that further increases in delinquencies and the resulting need for additional provisions may exceed Moody's expectations, as well as uncertainties regarding the implementation of the company's recapitalization plan.

WHAT COULD CHANGE THE RATING UP/DOWN

While upward movement in COFIDEs standalone BCA is unlikely given the negative pressures, the outlook could stabilize if the company is able to absorb further provisioning expenses without a significant deterioration of its capital ratios. Conversely, downward pressure on the standalone BCA could result from a significant decline in capitalization or deterioration in asset quality in excess of Moody's expectations.

The methodologies used in these ratings were Banks published in January 2016, and Government-Related Issuers published in August 2017. Please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Maria Valeria Azconegui
Vice President - Senior Analyst
Financial Institutions Group
Moody's Latin America ACR
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M. Celina Vansetti-Hutchins
MD - Banking
Financial Institutions Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

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JOURNALISTS: 1 212 553 0376
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