Introduction:

PACRA was established in 1994 as a joint venture among IBCA Limited (the international credit rating agency), International Finance Corporation IFC is a member of the World Bank Group. It finances and provides advice for private sector ventures and projects in developing countries in partnership.affilited with the world bank. and member of untied to the World Bank. It would finance private enterprises in developing countries but: (IFC) and the Lahore Stock Exchange. The first credit rating agency in Pakistan, PACRA is widely acknowledged for its professionalism and integrity. To date, PACRA has completed well over a hundred ratings, including major industrial corporate, financial institutions and debt instruments. In addition to local ratings, PACRA has also successfully completed two international rating assignments in collaboration with Fitch.

Purpose:
The primary function of PACRA is to evaluate the capacity and willingness of a corporate entity to honor its debt obligations. PACRA ratings reflect an independent, professional and impartial assessment of the credit risk associated with a particular debt instrument or a corporate entity. By providing a measurement of risk, PACRA's ratings facilitate investors in making prudent investment decisions after determining the acceptable rate of return at the given risk level. However, regardless of the type of rating, it is not a recommendation to purchase, sell or hold a security, in as much as it does not comment on the security's market price or suitability for a particular investor.

Pacra Milestone:
15 June 1994 18 August 1994 09 October 1994 08 November 1994 20 November 1994 15 January 1995 Signing of IFC/IBCA*/LSE Joint Venture Agreement Incorporation of PACRA Establishment of Camp Office Notification of First Rating First Board Meeting IBCA*/PACRA Technical Services Agreement

04 February 1995 28-31 May 1995 October 1995 19-29 November 1995 26 December 1995 14 February 1996 14 March 1996 01 August 1996 10 April 1997 25 September 1998 31 August 2001 30 March 2002 06 June 2002 22 January 2003 20 April 2004 29 April 2004 30 June 2004

Inauguration of PACRA Office First Training Workshop PACRA's recognition by the Financial Times,London, as a Local Rating Agency Second Training Workshop Notification of 10th Rating Registration of PACRA with CLA PACRA's first international consultancy Operation of Second Floor Premises Notification of 50th Rating Notification of PACRA's 100th rating Notification of PACRA's 150th rating Establishment of PACRA's branch office in Karachi PACRA joined ACRAA as founder member Employee Buy-Out PACRA becomes a public limited company PACRA enters into agreement with NESPAK for Real Estate Developers & Projects Grading System Notification of 200th Rating

Entity Rating
Entity rating signifies the level of investment risk and the capacity and/or willingness of an entity to meet its debt obligations to senior unsecured creditors. The risk level is indicated by the long and short term ratings. The benefits of a corporate entity rating are :

To serve as a reliable credit risk indicator to banks / NBFIs.

To assist depositors in selecting a financial institution given the return offered and the risk profile as measured by credit rating. To provide flexibility to management of such entities to determine the rate of return on debt instruments to be issued in future.

PACRA's Standard Rating Scale & Definitions

Long-Term Ratings:AAA: Highest credit quality. AAA ratings denote the lowest expectation of credit risk. They are assigned only in case of exceptionally strong capacity for timely payment of financial commitments. This capacity is highly unlikely to be adversely affected by foreseeable events. AA: Very high credit quality. AA ratings denote a very low expectation of credit risk. They indicate very strong capacity for timely payment of financial commitments. This capacity is not significantly vulnerable to foreseeable events. A: High credit quality. A ratings denote a low expectation of credit risk. The capacity for timely payment of financial commitments is considered strong. This capacity may, nevertheless, be more vulnerable to changes in circumstances or in economic conditions than is the case for higher ratings. BBB: Good credit quality. BBB ratings indicate that there is currently a low expectation of credit risk. The capacity for timely payment of financial commitments is considered adequate, but adverse changes in circumstances and in economic conditions are more likely to impair this capacity. This is the lowest investment-grade category.

Speculative Grades:
BB: Speculative. BB ratings indicate that there is a possibility of credit risk developing, particularly as a result of adverse economic change over time; however, business or financial alternatives may be available to allow financial commitments to be met. Securities rated in this category are not investment grade. B: Highly speculative. B ratings indicate that significant credit risk is present, but a limited margin of safety remains. Financial commitments are currently being met; however, capacity for continued payment is contingent upon a sustained, favorable business and economic environment. CCC, CC, C: High default risk. Default is a real possibility. Capacity for meeting financial

commitments is solely reliant upon sustained, favorable business or economic developments. A CC rating indicates that default of some kind appears probable. C ratings signal imminent default.

Short-Term Ratings
A1+: Obligations supported by the highest capacity for timely repayment. A1:. Obligations supported by a strong capacity for timely repayment. A2: Obligations supported by a satisfactory capacity for timely repayment, although such capacity may be susceptible to adverse changes in business, economic, or financial conditions. A3: Obligations supported by an adequate capacity for timely repayment. Such capacity is more susceptible to adverse changes in business, economic, or financial conditions than for obligations in higher categories. B: Obligations for which the capacity for timely repayment is susceptible to adverse changes in business, economic, or financial conditions. C: Obligations for which there is an inadequate capacity to ensure timely repayment. D: Obligations which have a high risk of default or which are currently in default.

Instrument Rating :Instrument rating covers all non-equity instruments including TFCs (long and short term), convertibles, debentures, redeemable certificates. By indicating the risk profile of the instrument, the assigned rating helps the issuer in deciding the terms of the instrument while guiding the potential investors in investment decisions. PACRA's rating process assumes that the return offered on such instruments (expected profit, markup etc.) is in the nature of a fixed obligation.

Structured Finance Rating :PACRA also has the expertise to rate debt instruments with features of structured finance. Such instruments may have various credit enhancement features designed for reducing either the investment risk, the default risk or both. Structured Finance ratings focus on evaluating specific cash flows identified for meeting the repayment obligations, and also the security arrangements. PACRA's ratings are contingent on examining all the underlying documentation that gives effect to the proposed features of the instrument.

In September 2002, PACRA assigned its first structured finance rating to securitised TFC issue of Paktel Limited amounting PKR 850 million.

Individual & Support Rating : Commercial Banks: On a selective basis, PACRA shall also assign individual and support ratings to commercial banks. These ratings would then be synthecised to generate standard long and short term ratings. This arrangement is expected to ensure that interested parties would be able to evaluate the reason only in some cases the high long and short term ratings of a bank might not appear consistant with the perceived financial strength of the bank.
Rating scales and definitions for support ratings and individual ratings are given below:

Individual and Support Rating Scale (Applicable to Commercial Banks) Individual Ratings:
PACRA's individual ratings, attempt to assess how a bank would be viewed if it were entirely independent and could not rely on external support. These ratings are designed to assess a bank's exposure to, appetite for, and management of risk, and thus represent our view on the likelihood that it would run into significant difficulties such that it would require support. The principal factors we analyze to evaluate the bank and determine these ratings include profitability and balance sheet integrity, franchise, management, operating environment, and prospects. Consistency is an important consideration.

A very strong bank. Characteristics may include outstanding profitability and balance sheet integrity, franchise, management, operating environment, or prospects. A strong bank. There are no major concerns regarding the bank. Characteristics may include strong profitability and balance sheet integrity, franchise, management, operating environment or prospects. An adequate bank which, however, possesses one or more troublesome aspects. There may be some concerns regarding its profitability and balance sheet integrity, franchise, management, operating environment or prospects. A bank which has weaknesses of internal and/or external origin. There are concerns regarding its profitability and balance sheet integrity, franchise, management, operating environment or prospects. A bank with very serious problems which either requires or is likely to require external support.

Support Ratings:

The Support Ratings do not assess the quality of a bank. Rather, they are PACRA 's assessment of whether the bank would receive support should this be necessary. We emphasize that these ratings constitute PACRA 's opinions, although we may discuss the principles underlying them with the supervisory authorities for their comment or endorsement. 1 A bank for which there is a clear legal guarantee on the part of the state OR a bank of such importance both internationally and domestically that, in our opinion, support from the state would be forthcoming, if necessary. The state in question must clearly be prepared and able to support its principal banks. A bank for which, in our opinion, state support would be forthcoming, even in the absence of a legal guarantee. This could be, for example, because of the bank's importance to the economy or its historic relationship with the authorities. A bank or bank holding company which has institutional owners of sufficient reputation and possessing such resources that, in our opinion, support would be forthcoming, if necessary. A bank for which support is likely but not certain. A bank, or bank holding company, for which support, although possible, cannot be relied upon.

4 5

Insurer Financial Strength Rating for Insurance Companies The insurer financial strength (IFS) rating represents an opinion of an issuers financial strength and business continuity from a policy holder's prospective. The rating provides no guarantee against default but offers a well researched opinion as to the likelihood of the issuer to fail to meet its policy holders' obligations. PACRA's Insurer Financial Strength Rating Scale & Definitions AAA Exceptionally Strong. Insurers assigned this highest rating are viewed as possessing exceptionally strong capacity to meet policyholder and contract obligations. For such companies, risk factors are minimal and the impact of any adverse business and economic factors is expected to be extremely small. Very Strong. Insurers are viewed as possessing very strong capacity to meet policyholder and contract obligations. Risk factors are modest, and the impact of any adverse business and economic factors is expected to be very small. Strong. Insurers are viewed as possessing strong capacity to meet policyholder and contract obligations. Risk factors are moderate, and the impact of any adverse business and economic factors is expected to be small.

AA

BBB

Good. Insurers are viewed as possessing good capacity to meet policyholder and contract obligations. Risk factors are somewhat high, and the impact of any adverse business and economic factors is expected to be material, yet manageable. Moderately Weak. Insurers are viewed as moderately weak with an uncertain capacity to meet policyholder and contract obligations. Though positive factors are present, overall risk factors are high, and the impact of any adverse business and economic factors is expected to be significant. Weak. Insurers are viewed as weak with a poor capacity to meet policyholder and contract obligations. Risk factors are very high, and the impact of any adverse business and economic factors is expected to be very significant. Very Weak. Insurers rated in any of these three categories are viewed as very weak with a very poor capacity to meet policyholder and contract obligations. Risk factors are extremely high, and the impact of any adverse business and economic factors is expected to be insurmountable. A 'CC' rating indicates that some form of insolvency or liquidity impairment appears probable. A 'C' rating signals that insolvency or a liquidity impairment appears imminent. Very Weak. These ratings are assigned to insurers that have either failed to make payments on their obligations in a timely manner, are deemed to be insolvent, or have been subjected to some form of regulatory intervention. Within the DDD-D range, those companies rated 'DDD' have the highest prospects for resumption of business operations or, if liquidated or wound down, of having a vast majority of their obligations to policyholders and contractholders ultimately paid off, though on a delayed basis (with recoveries expected in the range of 90-100%). Those rated 'DD' show a much lower likelihood of ultimately paying off material amounts of their obligations in a liquidation or wind down scenario (in a range of 50-90%). Those rated 'D' are ultimately expected to have very limited liquid assets available to fund obligations, and therefore any ultimate payoffs would be quite modest (at under 50%).

BB

CCCCC,CC,C

DDDDDD,DD,D

Fund Rating (Rating Methodology, Scale & Definitions)

Introduction
Mutual fund industry in Pakistan is showing impressive growth. Its acceptance as a useful tool to deploy funds is on rise amongst both individual and corporate investors. However, at the same time, the increasing number of asset managers as well as funds has necessitated the need of an independent opinion on their performance. PACRA follows a comprehensive approach to rate the two distinct ingredients of the mutual fund industry asset managers and funds. These two are rated on separate scales. The asset manager rating seeks to determine the professional capacity of asset managers and the fund rating focuses on relative actual recorded performance of a mutual fund.

Defining a Category
Fund categories define groups of funds whose constituents are similar in their risk factor exposures so that return comparisons are meaningful. Moreover, the observed return differences among funds relate primarily to security selection, or to variation in the timing and amount of exposure to different elements affecting the category. Each of these, over time, may be presumed to exercise a skill-related effect.

Measuring Performance
PACRA considers both absolute and risk-adjusted performance. Absolute return refers to the appreciation or depreciation that a fund has achieved over a period of time and effectively this is what an investor takes home at the end. However, at the same time, the level of risk (extent of variability) that is involved with those returns is also important. Risk-adjusted return shows the trade-off investors make between risk and return. Since star rating is a combination of both risk and return it is likely to provide investors a better measure to gauge historical performance of different funds.

Return PACRA calculates a funds return for a given quarter as follows:

Where

R PE PB A

= = = =

Total return for the month End of month NAV (net assets value) per share/certificate Beginning of month NAV per share/certificate Adjustments on account of cash dividend, bonus issue and addition to

capital. Risk PACRA uses Sharpe Ratio a technique developed by Nobel prize winning economist William Sharpe to measure a funds risk adjusted return. Mathematically, Sharpe Ratio is the return generated per unit of risk. The ratio is calculated as follows:

Where AR = Average monthly return for the trailing 12 monthly periods (as explained above) SD = Standard deviation of the monthly returns of the fund. SD is computed using the returns for trailing 12 monthly periods. PACRA calculates an overall quantitative score by combining these two equally weighted measures of historical performance. The star rating of a fund is then assigned according to the following distribution:

Other elements considered while calculating a score are as follows:

The ratings are calculated on the basis of performance during a particular year. However, in case of long-term star rating the performance during the trailing 36 months is considered. Only those funds are eligible for rating that have remained operational throughout the given period (i.e. one year for star rating and 3 years for long-term star rating). A month is used as a reference period to calculate performance. Funds are rated using performance in 12 months (36 months for long-term star rating) and geometric mean of returns and sharpe ratio over this period are used to calculate the final score. In case of income and money market funds, the score of return would have 50% weightage, the score of risk as calculated using Sharpe ratio would have 25% weightage and the balance 25% weightage is assigned to the credit quality of the assets of the fund.

The Grade Assessment Process: The assessment process for the real estate developer or the real estate project commences at the request of the respective entity. Once the mandate letter is received, PACRA require, inter-alia, the developer's financial statements, organisational structure and project experience. On receipt of the information, a team of analysts takes up the task of preparing a report on that entity, highlighting its business and financial risks. During this process, support is drawn from the inhouse research and database of PACRA. The report prepared by the analysts is presented to the Grading Committee for assessing the entity. The whole process is highly interactive and includes inputs from sector specialists, if and when required. PACRA will ensure strict confidentiality of all information collected during the assessment process.