Rating Action: Moody's downgrades Banrisul's national scale ratings, affirms global ratings, outlook negative 12 Feb 2021 New York, February 12, 2021 -- Moody's Investors Service, ("Moody's") today downgraded Banco do Estado do Rio Grande do Sul S.A.'s (Banrisul) long -term national scale deposit ratings to A3.br from A1.br, long-term national scale counterparty risk rating to Aa3.br from Aa1.br, and short-term national scale deposit rating to BR-2 from BR-1. The rating agency also affirmed Banrisul`s long and short-term global local and foreign- currency deposit ratings of Ba3 and Not Prime, as well the bank's foreign currency subordinate debt rating of B1 and contractual non viability debt rating of B2(hyb). Banrisul's global scale counterparty risk ratings of Ba2 and Not Prime and national scale shot-term counterparty risk ratings of BR-1, and its long and short-term counterparty risk assessment of Ba2(cr) and Not Prime(cr), baseline credit assessment (BCA) and adjusted BCA of ba3 were also affirmed. The outlook on all ratings was changed to negative from stable. A full list of the affected ratings and assessments is provided at the end of this press release. RATINGS RATIONALE The affirmation of Banrisul's ba3 baseline credit assessment (BCA) and supported ratings reflects pressures to its asset risk along with its weak profitability and modest capitalization, offset by its funding structure predominantly made up of low-cost core deposits, high levels of liquidity and reserve coverage. The BCA also incorporates Banrisul's strong regional franchise whereby a relevant share of its deposits and operations are based within the state of Rio Grande do Sul (unrated) which is the bank's owner and controller and continues to be under significant fiscal distress. The downgrade of Banrisul`s national scale ratings and negative outlook reflects the heightened risk on the bank's capitalization and profitability following its 5 February announcement that its state owner wants to renegotiate the terms of Banrisul`s contract to provide payroll services to the state civil servants , or to negotiate a new contract to provide these services. Banrisul first acquired the right to provide payroll services in its home state in May 2016, for BRL 1.251 million. Moody's notes Banrisul previously held the rights to provide payroll services to state's employees as well as using public buildings and space to offer its banking services at no cost. The right to provide these services is an intangible asset and, therefore, Moody's deducts it from its tangible common equity (TCE) measure of capitalization to assess loss absorption capacity. In 2016, the decline in the bank's ratio of TCE to risk weighted assets (RWA) as a result of its acquisition was over 200 basis points. Because Banrisul was effectively exchanging interest bearing assets for an intangible asset that generated no return and is still being amortized over a ten-year period, profitability has also suffered. Banrisul now faces heightened risk that the upcoming renegotiation with the state could lead to another steep decline in the bank's capitalization and profitability. Banrisul's Moody's capitalization ratio, measured as tangible common equity relative to risk weighted assets, is still well below the levels it was before the bank acquired the right to provide payroll services and was 8.6% as of December 2020, in line with 2019 levels. Moody`s considers that the bank`s leading deposit market share in Rio Grande Do Sul and the share of its total payroll lending operations to state civil servants are dependent on the banks maintaining the right to provide payroll services. Banrisul's loan book is predominantly focused on low-risk payroll loans to state and federal employees, which accounted for 46% of total loans as of December 2020. Another 30% are loans to small and mid-sized enterprises and unsecured consumer loans concentrated in its home state. The challenges Banrisul' faces in recovering its profitability in 2021 to historical levels are also reflected in its BCA. Banrisul's net income to tangible assets was 0.8% as of December 2020, down from 1.3% in 2019, driven by lower business volumes, lower net interest margin as well as rising provisioning costs and legacy amortization of intangibles. As a state-owned bank, Banrisul has limited flexibility in reducing operating costs to mitigate margin pressures or to invest in products and technology, in line with that of its private bank peers. Asset risk could also come under pressure from rising restructured loan exposures, which made up approximately 13% of its interest income from lending in 2020, as a result of the coronavirus pandemic, with more than half of these to corporates and small to mid-sized enterprises, which have historically caused asset risk to rise at the bank. The bank`s problem loan ratio in 2020 was 2.8%, up slightly from 2.7% in 2019 and loan loss reserves estimated at 300% provide a buffer against asset risk. However, with over 50% of the bank's tangible assets currently invested in sovereign government bonds, Banrisul has a strong liquidity buffer, in addition to limited reliance on market funding, at a modest 12% of its tangible assets. However, these investments are now yielding a lot less in Brazil's low rate environment, also negative for the bank's profitability. FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS At this time, the negative outlook on the bank's ratings precludes any upward pressure. That said, the outlook on the rating could be stabilized if the renegotiation or new contract results in only modest capital and profitability impact and asset risk shows strong signs of improvement. The bank's ratings could be downgraded if the completion of its contract renegotiation, along with increased amortization costs, lead to a significant decline in its capitalization ratio as calculated by Moody's. Further actions by its state owner that could lead to a weakening in the bank`s fundamentals could evidence governance issues that could also lead to a downgrade in the bank`s ratings. PRINCIPAL METHODOLOGY The principal methodology used in these ratings was Banks Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1147865 . Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology. Banco do Estado do Rio Grande Do Sul S.A. is located in Porto Alegre, Brazil and had total assets of BRL 92 billion (USD 17 billion) and equity of BRL 8.4 billion as of 31 December 2020. The following ratings and assessments of Banco do Estado do Rio Grande do Sul S.A. were downgraded: - Long-term Brazilian national scale deposit rating to A3.br from A1.br - Long-term Brazilian national scale counterparty risk rating to Aa3.br from Aa1.br - Short-term Brazilian national scale deposit rating to BR-2 from BR-1 The following ratings and assessments of Banco do Estado do Rio Grande do Sul S.A. were affirmed: - Long-term global local currency deposit rating of Ba3, negative outlook from stable - Short-term global local currency deposit rating of Not Prime - Long-term foreign currency deposit rating of Ba3, negative outlook from stable - Short-term foreign currency deposit rating of Not Prime - Short-term Brazilian national scale counterparty risk rating of BR-1 - Baseline credit assessment of ba3 - Adjusted baseline credit assessment of ba3 - Long-term counterparty risk assessment of Ba2(cr) - Short-term counterparty risk assessment of Not Prime(cr) - Long-term global local currency counterparty risk rating of Ba2 - Short-term global local currency counterparty risk rating of Not Prime - Long-term global foreign currency counterparty risk rating of Ba2 - Short-term global foreign currency counterparty risk rating of Not Prime - Subordinate debt rating of B1 - Tier 2 contractual non viability subordinate debt rating of B2(hyb) - ..Outlook Actions: - ....Outlook, Negative from stable Moody's National Scale Credit 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 credit 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 ".za" for South Africa. For further information on Moody's approach to national scale credit ratings, please refer to Moody's Credit rating Methodology published in May 2016 entitled "Mapping National Scale Ratings from Global Scale Ratings". While NSRs have no inherent absolute meaning in terms of default risk or expected loss, a historical probability of default consistent with a given NSR can be inferred from the GSR to which it maps back at that particular point in time. For information on the historical default rates associated with different global scale rating categories over different investment horizons, please see https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1216309 . REGULATORY DISCLOSURES For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx? docid=PBC_79004. For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices.