Banco Internacional de Costa Rica S.A.'BB-/B' Global Scale Ratings Affirmed; Outlook Remains Negative

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1 Research Update: Banco Internacional de Costa Rica S.A.'BB-/B' Global Scale Ratings Affirmed; Outlook Remains Primary Credit Analysts: Ricardo Grisi, Mexico City (52) ; Arturo Sanchez, Mexico City (52) ; Secondary Contact: Fernanda Luna, Mexico City (52) ; Table Of Contents Overview Rating Action Rationale Outlook Ratings Score Snapshot Related Criteria Ratings List SEPTEMBER 6,

2 Research Update: Banco Internacional de Costa Rica S.A.'BB-/B' Global Scale Ratings Affirmed; Outlook Remains Overview Panama-based commercial bank BICSA benefits from a stable revenue base, geographic diversification, and sticky clients, despite the bank's corporate governance issues during However, its funding structure remains concentrated by customer deposits and a stable funding ratio that's below those of its Panamanian peers. We're affirming our global scale issuer credit rating on BICSA at 'BB-/B'. The negative outlook on BICSA's ratings reflects that on Costa Rica. The bank's ratings remain constrained by the sovereign ratings on Costa Rica. Given that BICSA is a government owned bank, we believe the government could restrict the bank's financial flexibility because the sovereign faces a high fiscal deficit and its external profile has deteriorated in recent years. Rating Action On Sept. 6, 2017, S&P Global Ratings affirmed our 'BB-' long- and 'B' short-term issuer credit ratings (ICR) on Banco Internacional de Costa Rica S.A. (BICSA). The outlook remains negative. Rationale Our ratings on BICSA remained constrained by the sovereign ratings on Costa Rica (BB-//B). Although the bank has passed our stress scenario of a hypothetical default of Costa Rica, the ratings still reflect our expectation that the government could restrict the bank's financial flexibility if the sovereign faces fiscal or external stress. We believe that this is the case with Costa Rica, because it faces a high fiscal deficit and its external profile has deteriorated recently. In the past, the bank faced political conflicts between its two shareholders that affected the board's composition, resulting in a deteriorated bank performance due to decreased business growth and operating performance. Our ICR on BICSA also reflects our view that its business position demonstrates stable revenue and sticky clients even in stress situations. The ICR also consider our projected risk-adjusted capital (RAC) ratio of around 8.0% for the next months, as well as BICSA's conservative underwriting standards and its asset quality metrics, which we consider manageable and in SEPTEMBER 6,

3 line with its peers. The bank's funding structure reflects its concentrated customer deposit base and its limited funding sources compared to its stable funding needs, which are below its Panamanian and regional peers. Finally, the bank's liquidity reflects the significant amount of short-term loans that could easily be turned into cash if needed. The stand-alone credit profile remains at 'bb'. The 'bb+' anchor draws on our Banking Industry Country Risk Assessment (BICRA) methodology and our view of the weighted-average economic risk in the countries where BICSA's loan book has exposure. It also draws on our industry risk score for Panama, since BICSA is legally domiciled in Panama and follows its regulatory requirements. BICSA operates mainly in Costa Rica (42%) and Panama (26%), as well as other countries in Central America. As a result, the weighted economic risk for BICSA is '6.9', which is closest to '7'. We expect these countries to remain the largest exposures (see "Banking Industry Country Risk Assessment: Costa Rica," published on May 18, 2017, and "Banking Industry Country Risk Assessment: Panama," published on Nov. 17, 2016). Considering BICSA's exposure to other low-income level countries, which could be vulnerable to external shocks, and its exposure to debt and payment capacity in countries with weak rule of law, the blended economic risk has a higher score. Panama's industry risk incorporates the sooner-than-expected changes in the regulatory framework. The country is drafting Basel III capital (related to market and operational risks) and liquidity rules, which we expect it to introduce between the second half of 2017 and first quarter of We expect the banking system to adopt them afterwards, placing Panama among countries with more stringent regulatory frameworks, particularly in Latin America. We also note Panama's introduction of several norms to better address money laundering issues, which was one of the Financial Action Task Force's (FATF) recommendations. Despite the absence of a lender of last resort and a formal framework to support the banking system in the event of a liquidity crunch or shortfall, the Panamanian government has shown strong commitment in filling this gap by providing liquidity facilities through the public bank, Banco Nacional de Panama (BNP), during adverse economic situations and, most recently, during corruption and money laundering scandals. BICSA's business position assessment is supported by the bank's business stability, demonstrated through its revenue stability, geographic diversification, and sticky client base. In 2016, the bank faced a deteriorating financial performance, but we believe that the corporate governance has been strengthened to avoid similar events in the future. We expect the bank's revenue will continue its positive trend for the next two years with the majority of its income in stable sources; otherwise, we might revise our assessment to a weaker category. The management has also maintained a conservative strategy and was able to withstand last year's corporate governance issues. We believe that corporate governance has been strengthened with a more balanced board of directors that's aiming to make more efficient decisions and restore business growth. However, the bank's small market share within the Panamanian banking system counterbalances these factors. SEPTEMBER 6,

4 Our forecasted RAC ratio of 8.0% on average for the next months supports our capital and earnings assessment. We also take into account the quality of the capital and earnings; fully composed of paid-in capital and retained earnings. Finally, we expect that the bank will maintain modest credit growth aligned with the expected growth of the economies where it has its loan portfolio exposures. Our forecasted RAC ratio reflects the following base-case scenario assumptions: GDP growth for Panama and Costa Rica of 5.5% and 4.0% in 2017, respectively, and 5.0% and 4.0% in 2018; Conservative loan portfolio growth the next two years between 7%-8%; A slight increase in its net interest margins for the next two years, as we expect a more profitable asset mix; Nonperforming assets (NPAs) and credit losses will remain below 2.0% as a consequence of good underwriting standards; The reserve coverage ratio will remain below 100%; and No dividend payments or any capital injection during the next 18 months, because internal capital generation will support future growth. BICSA's risk position assessment is supported by its conservative underwriting standards and manageable asset quality metrics that are similar to its Panamanian peers and other banks that operate in the same economic risk score. As of June 30, 2017, its NPAs ratio was 1.9% with a three year average of 1.4%, while its net charge-offs (NCOs) have remained below 1% for the past five years. We don't expect significant deterioration in either of these ratios. On the other hand, its reserve coverage ratio was below 100%, and we don't expect it to increase considering the guarantees in its loan portfolio. Furthermore, BICSA's top 20 clients represented 31.3% of the bank's total loans and 2.2x of the bank's total adjusted capital (TAC) as of March 31, 2017; similar to its main competitors. Our funding assessment reflects the bank's customer deposit concentration, a low stable funding ratio (SFR), and a higher loan-to-deposits indicator compared with other rated banks in the region. As of June 30, 2017, the bank's top 20 depositors represented 55.6% of its total deposits, which is high compared to the 12%, on average, of its Panamanian peers. Additionally, as of the same date, BICSA's SFR was 80.4%--below the 100% of other banks we rate-- given the lower share of deposits in its funding base. As of June 30, 2017, the bank's funding mix consisted of 56% customer deposits, 32% credit lines, and domestic debt issuances made up the remainder. The bank's customer deposits are mainly composed of wholesale deposits, which tend to be less stable than retail ones. BICSA has access to different credit facilities denominated in U.S. dollars that continue to provide access to long-term funding. Over the next two years, we expect the bank to keep a similar funding structure, because the management's strategy to diversify its funding mix will be gradual. BICSA's liquidity assessment stems from our broad liquid assets to short-term wholesale ratio, coupled with a large share of short-term loans that could easily be turned into cash to address potential deterioration in market and SEPTEMBER 6,

5 funding conditions. As of June 30, 2017, when we include these additional liquid assets--around 60% of the bank's loan portfolio-- the ratio stands at 1.7x; comparable to other local peers. For the next 18 months, we expect the bank to maintain similar liquid assets, as we don't expect significant changes in the bank's loan portfolio average duration. Our rating also includes our view of BICSA as a government-related entity (GRE) for Costa Rica (Republic of), because the two largest public banks in the country are the bank's main shareholders. Nonetheless, we think that the bank has limited importance and a limited link with the government. As a result, we base BICSA's rating solely on its SACP, rather than on expected extraordinary support from the government of Costa Rica. This assessment stems from: BICSA's limited important role to the government because we believe it acts as a profit-seeking bank in a very competitive environment, and a private entity, in our opinion, could easily undertake its activities; and Its limited link with the government. We believe the government may not be willing to provide timely support if needed. Outlook The negative outlook on BICSA for the next 12 months reflects that on Costa Rica, because the sovereign ratings continue to constrain those on the bank. Although the bank passed our stress test, we believe the government could restrict the bank's financial flexibility. This could occur because of Costa Rica's high fiscal deficit and its deteriorating external profile. Downside scenario Over the next 12 months, if we were to lower our foreign currency ratings on Costa Rica, a similar action would follow on BICSA. Upside scenario We could revise the bank's outlook to stable in the next 12 months if we take a similar action on Costa Rica. We could also raise the ratings if we have enough certainty that any sovereign interference through its two shareholders would not have a negative impact on the bank's financial performance, but we don't foresee this scenario in the near future. Ratings Score Snapshot To From Issuer Credit Rating BB-//B BB-//B SACP bb bb Anchor bb+ bb Business Position Adequate (0) Adequate (0) Capital and Earnings Adequate (0) Adequate (0) SEPTEMBER 6,

6 Risk Position Adequate (0) Adequate (0) Funding and Liquidity Below Average and Adequate (-1) Average and Adequate (0) Support 0 0 GRE Support 0 0 Group Support 0 0 Government Support 0 0 Additional Factors -1-1 Related Criteria Criteria - Financial Institutions - General: Risk-Adjusted Capital Framework Methodology, July 20, 2017 General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017 General Criteria: Rating Government-Related Entities: Methodology And Assumptions, March 25, 2015 General Criteria: Group Rating Methodology, Nov. 19, 2013 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions, Nov. 19, 2013 Criteria - Financial Institutions - Banks: Quantitative Metrics For Rating Banks Globally: Methodology And Assumptions, July 17, 2013 Criteria - Financial Institutions - Banks: Banks: Rating Methodology And Assumptions, Nov. 9, 2011 Criteria - Financial Institutions - Banks: Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011 General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009 Ratings List Ratings Affirmed Banco Internacional de Costa Rica S.A. Counterparty Credit Rating BB-//B Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at for further information. Complete ratings information is available to subscribers of RatingsDirect at and at All ratings affected by this rating action can be found on the S&P Global Ratings' public website at Use the Ratings search box located in the left column. SEPTEMBER 6,

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