Rating BANCO DO ESTADO DO RIO GRANDE DO SUL S.A. - BANRISUL. Banks. Analytical Report. Rating Fundamentals

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1 Analytical Report Rating A+ The bank indicates good intrinsic financial solidity. These institutions have safe and valued business, and show good current and historical financial conditions. The business and sector environment may vary and yet the bank s operating conditions will not be affected. The risk is very low. Date: 09/29/2008 Validity: 02/28/2009 About the Rating Perspective: Stable Note: - Background: Dec/06: Statement: A (stable) Jun/07: Statement: A (stable) Dec/07: Upgrade A+ (stable) Assignment: A-2 (CP) Jun/08: Statement: A + (stable) Statement: A-2 (CP) Last Review: Dec/07 Next Review: Dec/08 Analysts: Cátia Mota Tel.: catia.mota@austin.com.br Rodrigo Indiani Tel.: rodrigo.indiani@austin.com.br Austin Rating Serviços Financeiros Rua Leopoldo Couto Magalhães, 110 conj. 73 São Paulo SP CEP Tel.: Fax: Rating Fundamentals During the meeting held on September 29, 2008, Austin Rating s Risk Rating Committee maintained the long-term rating A+ and the short-term A-2 rating to Banco do Estado do Rio Grande do Sul S.A. (Banrisul). The bank s perspective remained stable. The maintenance of the grade is based on good capitalization; maintenance of the institution s position; diversification of assets and liabilities, as well as of revenue sources; quality of credit assets, suitable liquidity levels and profitability and physical expansion with the opening of strategic branches, not limiting to the state of Rio Grande do Sul. The bank has operated autonomously, reporting high profitability indices on shareholder s equity and reduced oscillations. Banrisul is a state government-owned bank with specific purpose, whose goal is to be a commercial, development and social institution. Due to the origin and purpose of its creation, it is favored by the proximity with the public sector, holding a strong reach in Brazil s southern region, especially in its state of origin. The bank entered into an agreement with the state to formalize the management of the payroll of public servants and supply of other services, aside from the contract closed between the bank and over 322 municipalities for financial centralization and payroll management. These facts contributed for the stability of deposits, including in the short term, and favored the assessment of liquidity risks. In spite of the diversity of products of its commercial portfolio, Banrisul maintained its focus on the growth of pre-approved credit modalities for individuals, especially payroll-discounted credit for public servants. In the corporate segment, the bank sought to increase the diversification of its portfolio and got closer to small and medium businesses, reducing its exposure to large clients. In addition to the commercial portfolio, Banrisul manages development, real estate and agricultural funds, which were kept at minimum levels so that to commit with legal requirements. The bank also maintained the investments in technology, whose standouts are new internet banking services/facilities and Banrisul internet card, aside from a wide range of products and services. As well as in 2007, the result was affected by the activation of tax credits, in the amount of R$86.2 million, which pushed the net income up to R$308.2 million. Regardless of the nonrecurring events in 2007 and 2008, the profit increased by 12.9% vs. the previous year. Consequently, the annualized profitability on the shareholders equity reached 15.3%, according to the median posted by similar-sized banks, although it was down the institution s background. Shareholders equity rose by 57.4%, having reached R$1,845.9 million. This growth is related to the initial public offering (IPO) held in July 2007, which yield the bank with R$800 million, in addition to the incorporation of profit reserves. The expansion of the bank s equity base enables higher volume of active operations without hindering the limit imposed by the Basel index, settled at 11% by the Central Bank of Brazil, while Banrisul ended 2007 at 22.2%.

2 Positive Factors Banks Well-defined strategy, in line with the purpose of operating as an agent that develops the state while generating value; Expansion of the service network to other states located in the southern region. Currently, 93% of its branch s structure is located in the State of Rio Grande do Sul, which may limit the growth as result of the regional market saturation, once it serves 97.4% of the population of Rio Grande do Sul and accounts for 97.3% of the state GDP; Background maintenance of satisfactory profitability indices; Diversified structure of depositors and borrowers, which contributes to the bank s liquidity management; Diversified funding structure and lower average funding costs compared with other institutions; Fundraising by means of the public offering of shares allowed to increase equity base and expand credit portfolio; Banrisul is Rio Grande do Sul s main financial institution in the collection of state taxes and tributes; Professionalization of the organizational culture, despite the changes in the management with the substitution of the Executive Board every four years; Closing of the agreement with the State Government on the exclusive rights to handle the payroll of state servants, as well as other bank services, for a five-year term; The economy of the state of Rio Grande do Sul the bank s main market exceeded the national average in 2007; Implementation of the Plano de Remuneração Variável (Variable Remuneration Plan) in accordance with the bank s targets, aiming to stimulate the employees in face of the growing competition. Factors under Observation Higher competition and reduced spreads; Growth strategy mainly focused in the Southern Region. In spite of offering a growth potential in the short term, this factor might become restrictive in the long term; In the medium and long terms, the bank s challenge is to continue to be competitive, maintaining good profitability and efficiency levels by improving the quality of its loan portfolio, without leaving aside its commitment with the economic development. LONG AND MEDIUM-TERM STRATEGY The strategy includes increasing the commercial credit portfolio to individuals especially in the modality of payroll-discounted loans - and to medium businesses with good guarantees, reducing the average ticket per operations. Regarding the other credit portfolios, the bank s target is to maintain them at the levels needed to meet liabilities. The growth in the credit portfolio relies on the exploration of the client base by means of cross selling - offering pre-approved credit to individual and corporate clients and on the expansion of the service network, with the opening of new branches and bank service outlets (PABs) in Southern Brazil, including the states of Santa Catarina and Paraná. Banrisul increased its credit portfolio up the average posted by the Brazilian Financial System. As a result, the bank s strategy is focused on the quality maintenance, thus improving the results expected and mitigating the risks. 2

3 Aside from the interval that still exists in the Basel index to expand the loan portfolio (the target is to reach a portfolio of approximately R$12 billion by 2010), the resources will be used to expand the number of branches in Santa Catarina and Paraná, in addition to stations in Rio Grande do Sul, where the bank currently has two branches: one in Curitiba and one in Cascavel. The R$76.4 million investment in Information Technology in the first six months of 2008 benefits the internal controls, while increasing the transparency/readiness in information collection and security, as well as reducing the maintenance costs through more efficient and simplified operating structures. Banrisul offers all the products traditionally offered by commercial banks, aside from operating as the financial arm of the state of Rio Grande do Sul, managing specific development, agriculture and real estate credit portfolios. In terms of management, Banrisul improved and modernized its management models and the operation of credit products (especially in the retail segment), including requirements to improve the management of client services supplied by the branch network. The program also implemented new control tools focused on economic results, integrating decision and execution procedures in several hierarchical levels. Banrisul set up another strategy aimed at expanding its client base: the creation of Banco SIM Banrisul. The latter is focused on the population having no access to bank services; dispenses the presentation of income statement; and offers a wide range of products such as Banricompras debit and credit cards, savings and current accounts, as well as access to Banrisul s network of branches and bank correspondents. The strategy included the increase in shareholders compensation, which went from 25% to 35% of the Adjusted Net Income. Austin believes this can be a factor limiting the institutions organic growth, which is worsened by the liquidity in both International and domestic markets once the distributed profits could hinder the expansion/support to the growth of its active operations. The recurring deficits of its controlling shareholder, the Rio Grande do Sul State Government, also impact this scenario, which might call for higher interest on the bank s results so as to settle its liabilities. ECONOMIC-FINANCIAL ANALYSIS Balance In general, Banrisul s operations posted a strong growth in 1H08, which started in Total assets grew by 35% between June 2007 and June 2008, reaching R$23,223.1 million, highlights to operations with maturity lower than 360 days, which varied 47.7%. Banrisul s credit portfolio amounted to R$9,951.6 million at the end of 1H08, accounting for a 44.9% increase compared to the previous year. Consequently, the credit operations, which accounted for 39.5% of the bank s total assets in June 2007, became to account for 42.9% in June 2008, thus impacting its credit concentration indicator (of 43.3% in June 2008), up its peer group median. The credit addressed to individuals grew by 38.2% between June 2007 and June 2008, amounting to R$3,446.5 million, highlights to the 72.8% increase in payroll-deductible loans, which corresponded to R$2,419.3 million and accounted for 70.2% of this segment. This variation was impacted by the right to manage the payroll of 322 cities, which expanded the payroll-deductible market to public servants. Meanwhile, the business portfolio addressed to corporate clients amounted to R$3,772.0 million and posted a substantial 75.3% growth in the same period. It is important to highlight the interest on the working capital, which accounted for 74.0% of the business portfolio, having grown by 86.6% in the period. The total credit portfolio was split in 52.2% to corporations and 47.8% to individuals. The operations addressed to medium-sized companies accounted for 51.4% of the portfolio addressed to corporate clients. 3

4 The securities portfolio balance was R$4,396.1 million in June 2008, 7.5% down the figure reported in June 2007, mainly composed of securities held to maturity, accounting for 88.8% of the total and divided into LFTs, NTNs, CVS, TDA, Brazilian debt bonds, mortgage bills and Certificates of Real Estate Receivables. In the segment of liquidity interbank investments, open market investments registered a significant growth of 87.7%. They are composed of Treasury Financial Bills (LFT), National Treasury Bills (LTN) and National Treasury Notes (NTN). Regardless of the conditional operations financed position, the growth corresponded to 17.3%, increasing up to R$2,890.2 million in June In the period, the balance of interbank deposits investments jumped to R$227.3 million, having increased approximately 7 times. The strong increase in Banrisul s equity were offset by resources of R$800 million raised through the initial public offering (IPO), aside from higher fundraising volumes especially from deposits - which rose 19.2% from R$10,911.8 million in June 2007 to R$13,004.8 million in June 2008 and in the open market up R$ 1,717.3 in the third-party portfolio. The balance of time deposits, which accounted for 53.6% of all deposits, reached R$$ 6,964 million, 21.9% above the figure reported in June Cash deposits grew by 29.2% vs. the same period of the previous year. Meanwhile, savings deposits, which amounted to R$4,468.0 million in June 2008, posted a 34.4% evolution in the same comparison period. Banrisul s shareholders equity increased by 57.4% between 1H07 and 1H08, amounting to R$2,906.3 million. The hike is due to the public initial offering (IPO) of R$800 million carried out in July 2007, aside from the incorporation of surplus reserves. The expansion in the bank s equity base allows increasing the volume of active operations without hurting the limit imposed by the Basel index, settled at 11% by the Central Bank of Brazil, while Banrisul ended 2007 at 22.2%. Results The net income has been posting a stable growth for the previous, reaching R$222.0 million in June 2008, compared to the R$196.6 million posted in June 2007 a 12.9% variation. Taking into consideration non-recurring events related to the activation of tax credits, the net income reached R$308.2 million at the end of the first half of 2008, accounting for a 57.5% drop compred the same period of the previous year, when the profit achieved R$725.1 million. Consequently, the 22.8% annualized profitability on the shareholders equity remained above its peer group median. As in 2007, the 1H08 result was impacted by the activation of deferred tax credits and fiscal debits of income tax and social contribution on temporary differences of previous years, amounting to R$86.2 million. The financial intermediation revenue grew by 16.4% in relation to June 2007, increasing from R$1,359.3 million to R$1,582.3 million. This variation was leveraged by the growth in the revenues from credit operations, reaching R$994.1 million, or 62.8% of the revenues. Meanwhile, the expanses posted a 12.8% positive variation, achieving R$787.8 million, having been impacted by the increase in the volume of raised funds, thus pushing the financial intermediation to R$794.5 million. The revenues arising from service rendering kept pace with the growth posted by other sources, reaching R$271.9 million in June 2008, or a 2.0% variation in relation to June The new rules set forth by the Brazilian Central Bank contributed to this result, which include the standardization of tariffs and the discontinuance of the Credit Facility Opening Tariff, effective as of April 30. The efficiency index that measures the ratio between the sum of personnel and administrative expenses in relation to gross intermediation results plus revenues from services remained high (45.2% in June 2006, 65.1% in 4

5 June 2007 and 64.0% in June 2008). The Austin Rating Committee believes this index shall remain between 40% and 60% for banks of profiles similar to Banrisul. RISK ASSESSMENT Credit The credit portfolio s risk profile presented improvement. Credits ranging between AA and C levels amounted to R$8,475.4 million in June 2008, accounting for 85.2% (June 2007: 80.3%) of the entire portfolio. Credits rated between levels D and G amounted to R$1,171.8 million (R$1,097.6 million in June 2007), accounting for 11.8% (16.2% in June 2007) of the entire portfolio. The operations rated H and which request 100% provisioning, amounted to R$304.4 million and R$241.4 million in June 2007, accounting for 3.0% and 3.6% of the entire portfolio. Banrisul has maintained a conservative policy regarding credit provisions, despite the good quality of its portfolio. The default indicator measured by Austin Rating (operations overdue for more than 60 days in relation to the total portfolio) remained significantly below the median observed in the bank s peer group, at 1.9%, maintaining the downtrend registered in the past years. Aside from the amount of R$809.2 million in mandatory provisions, additional provisions reached R$108.8 million. The sum of provisions is 4.3 times higher than total credit default, which amounted to R$211.7 million at the end of 1H08. Austin Rating considered the index as satisfactory. Credit operations are concentrated in loans and discounted securities (72.3%), which are guaranteed by receivables. The remainder is distributed in agriculture and agroindustrial loans, real estate financing, infrastructure and development loans, leasing, advances against exchange and other credits. Banrisul s credit portfolio is diversified. Given to the policy settled by the bank s prior management which privileged the segment of individual clients and small businesses -, the concentration among large borrowers diminished. The 20 biggest clients accounted for 10.4% of the portfolio in June 2008, totaling R$1,038.3 million. In general, the institution has good diversification by client, economic sector and product, which limits the impact of eventual default situations. The 20 major default parties accounted for 1.1% of the portfolio with R$115.6 million. Market Market risk is controlled through statistic tools, such as the Value at Risk (VaR) methodology, as well as through the mapping of factors determined by the market, like variations in interest rates, exchange rates and liquidity. The VaR was R$24.9 million in June 2008, equivalent to 0.9% of the bank s shareholders equity in the period. The institution is attentive to opportunity rates in the financial market by fixing the lower and higher levels agreed in fundraising and investment operations. By means of simulations, Banrisul is able to measure the possible losses to which it might be exposed. The impact on results are mapped each day, based on the changes occurred in structural financial-economic indicators like the base interest rate, inflation, exchange rates and other. Of the total amount of R$4,396 million of the securities and derivatives portfolio, 88.8% was included in the category held to maturity, which does not have to be marked to market. All securities rated as for trading and for sale amount to R$494.8 million and are positioned on post-fixed assets. In our opinion, the size and composition of the bank s capital allows maintaining securities until maturity. Systemic amendments were made to the internal models of calculating the capital necessary to cope with market risk so as to adjust to the provisions of the Brazilian Central Bank, effective as of July of the present year, in relation to the new Basel II Accord. 5

6 In general, the derivatives and securities portfolio decreased by 7.5% to R$4,396.1 million. It kept the previous structure, which is split in 1.6% of securities for trading, 9.7% of securities available for sale and 88.7% of securities held until maturity. Out of the securities, the ones with terms ranging between one and three years prevail, accounting for 54.1% of the total, or R$2,519.4 million. The bank operates derivatives aiming at minimizing its exposure to the fluctuations of pre-fixed rates, exchange rate oscillations and reference tax (TR), which amounted to R$104.4 million at the end of 1H08, a 6.7% growth compared to the amount posted in July 2008 (R$97.9 million). Liquidity The bank s liquidity risk is seen as low due to its diversified structure of assets and liabilities, with most deposits coming directly from the branch network and a lower share of institutional investors. Similar to the previous year, deposits kept their representativeness in the bank s capital raising structure, especially time deposits, which accounted for 30% of total liabilities on June Besides, the bank maintains a high sum in cash in the form of liquidity interbank investments, which corresponded to 66.1% of total time deposits at the end of 1H08, 43.0% up the previous year. The bank s liquidity indices were maintained below the median observed in its peer group over the past periods. The current liquidity index stood at 90.1% and the immediate liquidity index stood at 50.3%. This move is partially explained by the reduction in the TVM portfolio for trading and for sale, in addition to the stretching of i ts credit operations terms. Despite the lower current liquidity of Banrisul s assets and liabilities structure in relation to its peers, Austin Rating considers that the probability of using held-to-maturity government bonds to cover eventual term gaps is very low, once the bank s deposit structure is characterized by wide diversification and stability. This situation is confirmed by the signing of the agreement on the handling of Rio Grande do Sul s state servants payroll, as well as by the management of the accounts of over 322 municipalities in the state for a five-year term. These factors ease the bank s liquidity risk. Operating risk Banrisul has a risk management structure that is integrated to its internal control structure and relies on the periodic assessments of the bank s internal processes, monitoring, controlling and mitigation of risks, according to the provisions included in the Brazilian Central Bank Resolution Complementary, the bank will adopt the Basic Indicator Approach methodology, enabling the ascertainment of the capital necessary to cover the operating risk. 6

7 Austin Rating s Risk Classification Financial strength AAA The bank presents exceptional intrinsic financial strength. These are usually large institutions having safe and valued businesses, in addition to excellent current and historical financial conditions. The business and sector environments may vary without, however, affecting the bank s intrinsic operating conditions. The risk is nearly null. AA The bank presents excellent intrinsic financial strength. These institutions have safe and valued businesses, and good current and historical financial conditions. The business and sector environments may vary without, however, affecting the bank s operating conditions. The risk is not significant. A The bank presents good intrinsic financial strength. These institutions have safe and valued businesses, aside from good current and historical financial conditions. The business and sector environments may vary without, however, affecting the bank s operating conditions. The risk is very low. BBB The bank presents adequate intrinsic financial strength. These are usually institutions having covered assets. These banks show reasonable and stable financial condition. The business and sector environments may have stronger variations than in the previous categories and show some risk in the bank s intrinsic operating conditions. The risk is low. BB The bank presents reasonable intrinsic financial strength. It shows suitable protection parameters, but is vulnerable to economic, general and sector conditions that may affect the bank s intrinsic operating conditions. The risk is medium. B The bank presents reasonable intrinsic financial strength. It shows suitable protection parameters, but is highly vulnerable to economic, general and sector conditions that may affect the bank s intrinsic operating conditions. The risk is medium. CCC The bank presents low financial strength, requiring possible external assistance, and is highly vulnerable to economic, general and sector factors that may affect the bank s intrinsic operating conditions. The risk is high. CC C The bank presents low financial strength, requiring possible external assistance, and is highly vulnerable to economic, general and sector factors that may affect the bank s intrinsic operating conditions. The risk is very high. The bank presents bad financial strength, requiring possible external assistance. These institutions are limited by one or more elements: business having doubtful value; deficient financial conditions and highly unfavorable business environment. The risk is extremely high. The signs + (plus) and (minus) are used to identify better or worse positions within the same rating scale. Rating is a risk classification with marks or symbols. It expresses the capacity of issuers of marketable or non-marketable debt securities to honor their commitments of interest and amortization of the principal until final maturity. The rating may refer to the issuer, reflecting its ability to honor any commitments in general, or a specific issuance, in which only the issuer s ability to honor the financial obligation is taken into account. The information obtained by Austin Rating was considered suitable and reliable. The opinions and simulations included in this report constitute Austin Rating s judgment on the issuer. Thus, they should not be considered investment recommendations for any purposes whatsoever. For further information on our rating scales and methodologies, visit All rights reserved. No part of this publication may be copied or transmitted by any means - whether electronic or mechanical, including photocopy, recording or any other type of system for storage and transmission of information - without the previous and written authorization by Austin Rating Serviços Financeiros Ltda. 7