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FINANCIAL INSTITUTIONS

CREDIT OPINION29 August 2017

Update

Contacts

Maria ValeriaAzconegui

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VP-Senior [email protected]

Rodrigo MarimonBernales

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Ceres Lisboa 55-11-3043-7317Senior Vice [email protected]

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Corporacion Financiera de Desarrollo S.A.Update Following COFIDE's Downgrade

Summary Rating RationaleMoody's downgraded the local- and foreign currency issuer ratings of Peru's CorporaciónFinanciera de Desarrollo S.A. (COFIDE) to Baa3 from Baa2, and lowered its standalonebaseline credit assessment (BCA) to b3 from b1. The standalone BCA reflects the moderateloss absorption capacity of COFIDE's capital, its large and increasing exposure to projectfinance risk, its deteriorating asset risk profile, and modest earnings generation. Thedowngrade reflects a sharp deterioration in COFIDE's asset risk profile, and consequentlyof 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 demonstratedhigh willingness to provide support in case of need.

Asset risk deteriorated significantly lately as several infrastructure projects to which COFIDEhas large exposures have been put on hold due to Peru's recent corruption scandal relatedto public infrastructure projects. The company expects that most of these loans will start toperform again once the projects are restarted and/or it will be able to recover a substantialportion of any losses, but Moody's considers there to be a very high degree of uncertaintyregarding the ultimate recovery prospects that will depend on how much the projects aredelayed and how much the construction costs increase.

COFIDE is 99% owned by the Government of Peru (A3 stable) via its holding companyFONAFE, the National Fund for the Financing of State Entrepreneurial Activities. As partof its mandate, COFIDE's portfolio of infrastructure loans had grown significantly in recentyears. Although COFIDE lends to such projects through financial institutions and historicallyrecorded these loans as exposures to the financial institutions, in fact it retains the fullproject risk exposure. Going forward the company will now record these loans as directexposures 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 additionalproblem loans and incur further provisioning expenses in the coming quarters, which willresult in continued net losses.

The rating also captures COFIDE's very limited loss absorption capacity. While COFIDE'scapitalization ratios remain strong, it has significant illiquid investment holdings, specificallynon-tradeable shares in the Corporación Andina de Fomento (CAF, rated Aa3), a multilateraldevelopment bank of which Peru is a member, that comprise 18% of the company's balancesheet and account for virtually all of its tangible equity. Netting these shares out would leaveCOFIDE 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'sbalance sheet, COFIDE's management put in place a recapitalization plan that entails the

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commitment of the National Government to acquire up to 20% of COFIDE's CAF shares, the capitalization by the government ofmultilaterals borrowings, the reinvestment of future dividends related to the period 2017-19, and the reimbursement of dividendsreceived by FONAFE for the period 2016.

Credit Strengths

» High probability of support from the government due to ownership, policy mandate, and financial linkages

Credit Challenges

» Large and increasing exposure to long term project finance led to severe asset risk deterioration

» Capital has moderate loss absorption capacity

» Increasing leverage and weak liquidity

» Worsening profitability pressured by low margins and high provisions and operating costs relative to earnings

Rating OutlookThe outlook on all ratings is negative reflecting the risk that further increases in delinquencies and the resulting need for additionalprovisions may exceed Moody's expectations, as well as uncertainties regarding the implementation of the company's recapitalizationplan.

Factors that Could Lead to an UpgradeWhile upward movement in COFIDEs standalone BCA is unlikely given the negative pressures, the outlook could stabilize if thecompany is able to absorb further provisioning expenses without a significant deterioration of its capital ratios.

Factors that Could Lead to a DowngradeDownward pressure on the standalone BCA could result from a significant decline in capitalization or deterioration in asset quality inexcess of Moody's expectations.

Key Indicators

Exhibit 1

Corporacion Financiera de Desarrollo S.A. (Consolidated Financials) [1]6-172 12-162 12-152 12-142 12-132 CAGR/Avg.3

Total Assets (PEN million) 12,824 13,437 13,545 9,715 8,111 14.04

Total Assets (USD million) 3,950 4,008 3,970 3,264 2,900 9.24

Tangible Common Equity (PEN million) 2,276 2,420 2,371 1,890 1,877 5.74

Tangible Common Equity (USD million) 701 722 695 635 671 1.34

Problem Loans / Gross Loans (%) 9.1 0.3 0.7 2.5 0.0 2.55

Tangible Common Equity / Risk Weighted Assets (%) - 19.0 20.0 117.3 27.8 46.06

Problem Loans / (Tangible Common Equity + Loan Loss Reserve) (%) 23.5 0.9 1.9 5.8 0.1 6.45

Net Interest Margin (%) 0.5 1.3 1.7 1.9 2.5 1.65

PPI / Average RWA (%) - 1.1 1.8 1.6 1.8 1.66

Net Income / Tangible Assets (%) -0.8 0.6 0.6 0.8 0.9 0.45

Cost / Income Ratio (%) 50.2 37.5 35.1 48.2 36.3 41.45

Market Funds / Tangible Banking Assets (%) 67.7 68.0 68.9 62.2 65.2 66.45

Liquid Banking Assets / Tangible Banking Assets (%) 26.4 28.3 27.8 21.2 41.2 29.05

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.

2 29 August 2017 Corporacion Financiera de Desarrollo S.A.: Update Following COFIDE's Downgrade


Gross Loans / Due to Customers (%) 8,863.1 5,866.3 3,369.1 2,704.6 7,239.0 5,608.45

[1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel II; LOCAL GAAP [3] May include rounding differences due to scale of reported amounts [4] CompoundAnnual Growth Rate (%) based on time period presented for the latest accounting regime [5] Simple average of periods presented for the latest accounting regime. [6] Simple average ofBasel II periods presentedSource: Moody's Financial Metrics

Detailed Rating ConsiderationsHIGH PROBABILITY OF GOVERNMENT SUPPORT DUE TO OWNERSHIP, POLICY MANDATE AND FINANCIAL LINKAGESThe entity's Baa3 issuer ratings benefit from six notches of uplift from the b3 standalone BCA, based on our assumption of a highprobability of support from the Peruvian government, given its ownership, financial linkages, and mandate to promote economicgrowth. About half of COFIDE's loans are funded directly by the government through capital or through guaranteed funding. Inaddition, COFIDE's management and board of directors are appointed by FONAFE.

COFIDE's capitalization plan is a clear indication of the government's high willingness to provide extraordinary financial support toCOFIDE, as well as its public policy mandate to help promote economic growth by financing targeted sectors such as infrastructure andSMEs. COFIDE is expected to continue to play an important role in helping to the country to fill its significant infrastructure needs.

LARGE AND INCREASING EXPOSURE TO LONG TERM PROJECT FINANCEAsset quality risk is inherent in COFIDE's sizeable and growing portfolio of infrastructure loans, particularly as the company retainsthe credit risk of the projects it helps finance, although loans are made through other financial institutions. COFIDE assesses both thecreditworthiness of the on-lending institution and the cash flows of the project. COFIDE also buys bonds and issues guarantees relatedto infrastructure projects.

As part of COFIDE's mandate, the company is responsible for channeling financing to infrastructure projects. The company's loanportfolio has grown significantly during the last years, and the portfolio is largely focused on infrastructure related to energy andtransportation - growing to 53% of its lending book as of June 2017 up from 22% at year-end 2011. Although COFIDE lends to suchprojects through financial institutions and historically recorded these loans as exposures to the financial institutions, in fact it retainsthe full project risk exposure. Non-performing loans jumped to 9% of gross loans as of June from just 0.05% twelve months earlieras several infrastructure projects to which COFIDE has large exposures have been put on hold due to Peru's recent corruption scandalrelated to public infrastructure projects.

The rise in delinquencies revealed significant governance shortcomings that were addressed by the replacement of COFIDE's presidentand a large part of its management in January 2017. The company's new administration moved swiftly to establish tighter underwritingstandards for future financings in April, limiting COFIDE's exposure to a single project to 25%, or up to 50% as an exception withFONAFE's board approval, versus up to 100% of exposure as was the case in the past. In addition, going forward, the company willnow record these loans as direct exposures to the projects themselves, rather than to the banks through which COFIDE lends. Reservescovered 9.03% of total loans as of June 2017, higher than the 4.2% for commercial banks, indicative of the higher risk associated withlong term project finance.

Loans to SMEs and microfinance entities comprise roughly 25% of the loan book and are also made through financial institutions.COFIDE's direct risk is to the financial institution and not to the SME or microfinance borrower. If the financial institution defaults,however, the right to collect on the loans transfers automatically to COFIDE. In this case, COFIDE assesses the creditworthiness of on-lending institutions and relies on them to assess the credit risk of the SME and microfinance borrowers.

COFIDE has a dedicated Chief Risk Officer (CRO) who reports to the CEO. A risk committee of eight members meets twice a month,and includes the Board Chairman, the CEO, and the CRO.

CAPITAL HAS MODERATE LOSS ABSORPTION CAPACITYCAF shares held on COFIDE's balance sheet totaled $692.1 million and absorbed most of tangible equity of $695.2 million, thus limitingits loss absorption capacity for the loan and investment books. This capital constraint is being progressively alleviated to a degree, givensignificant efforts by COFIDE's board of directors to increase capital. The Board approved the retention of 60% of the company's 2014and 2015 earnings, and multilateral borrowings were also capitalized in the past. Further, capital has been supported by periodic capitalinjections from the government to support loan growth. The latest materialized in December 2016 when COFIDE received PEN 32.7million.



In addition, the National Government has committed to acquire up to 20% of COFIDE's CAF shares - as described in a Comfort Letterissued in May 2016. Additionally, the government will also capitalize multilaterals borrowings of up to $104 million by year end 2017,will make a capital injection for $50 million, and has committed to reinvest future dividends related to the period 2017-19, and thereimbursement of dividends received by FONAFE for the period 2016. Despite this plan, COFIDE's loss absorption capacity is likely toremain very weak in Moody's view, as its remaining CAF shares will continue to account for the large majority of its capital.

COFIDE's BIS capital complies with Peruvian capital regulations. Its capital ratio states at 29.6% as of June 2017 while the tangiblecommon equity to risk weighted assets is 19.7%, enabling the entity to continue expanding its business volume.

INCREASING LEVERAGE AND WEAK LIQUIDITYCOFIDE's leverage has been rising over the last 4 years to support loan growth, largely driven by debt issuances in the internationalmarket and bank borrowings, which also serve to diversify its funding. The leverage increase derives from several bond issuances($800 million senior bonds issued in 2015, $300 million issuance of 5-year senior bonds in 2014, $300 million issuance of 15-yearsubordinated bonds in the international market, and the $500 million issuance of 10-year global bonds during 2012). Market fundsto tangible banking assets declined slightly to 67.7% as of June 2017 from 68.04% as of YE2016. Most borrowings coming frommultilateral entities and government agencies are granted or guaranteed by the Republic of Peru.

Efforts to extend maturities have improved tenor matches with COFIDE's long and medium term infrastructure and SME creditportfolios that have tenors averaging eight and five years, respectively. Maturities of US dollar liabilities have been extended to anaverage of more than 10 years as of March 2017 from 4.5 years in 2010, while the average maturity of the local currency liabilities hasalso increased to more than 10 years from 6 years as of year-end 2010. COFIDE has placed bonds in the domestic market with up to30 year maturities. The improvement in tenor matches alleviates COFIDE's otherwise weak liquidity metrics particularly its low liquidasset ratio. COFIDE has also maintained adequate coverage of short term liabilities through solid asset and liability management. Theentity maintains a positive cumulative tenor gap for up to one year, and has improved its coverage particularly in the very short term(less than one month).

WORSENING PROFITABILITY PRESSURED BY LOW MARGINS AND HIGH PROVISIONS AND OPERATING COSTS RELATIVE TO EARNINGSCOFIDE's earnings generation capacity is limited by low margins relative to operating costs despite robust loan growth. Overallprofitability is also deterred by the large holding of CAF shares that do not generate dividends for COFIDE. Almost three quarters ofCOFIDE's financial income derives from investment financing, largely focused on infrastructure, mainly energy and transportation, andthe remaining income is driven by financial intermediation.

Although COFIDE has historically carried very high loan loss reserves, the recent increase in delinquencies obliged it to hike itsprovisions substantially, which together with a decline in interest income caused it to record a net loss in the first half of 2017 equal to0.8% of tangible assets on an annualized basis. On the other hand, operating expenses remained below 1% of total assets, similar tothe average posted by commercial banks. As of June 2017, COFIDE reported a net losses of $25.9 million, largely due to high level ofprovisions related to investment projects and weak earning generation.

Notching ConsiderationsGovernment SupportCOFIDE's issuer rating is based on the b3 standalone BCA that benefits from six notches of uplift to Baa3, to reflect our assumption ofa high probability of support from the Peruvian government, given its ownership, financial linkages and COFIDE's public policy mandateto help promote economic growth.

Ratings

Exhibit 2Category Moody's RatingCORPORACION FINANCIERA DE DESARROLLO S.A.

Outlook NegativeBaseline Credit Assessment b3Adjusted Baseline Credit Assessment b3



Issuer Rating -Fgn Curr Baa2Issuer Rating -Dom Curr Baa3

Source: Moody's Investors Service



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