Structured Covered Bonds/Sukuk Methodology

VIS Structured Covered Bonds/Sukuk JANUARY 2025 Credit Rating Company Limited 1 VIS Credit Rating Company Limited STRUCTURED COVERED BONDS/SUKUK vis.com.pk VIS Credit Rating Company Limited

2 VIS Credit Rating Company Limited Structured Covered Bonds/Sukuk JUNE 2026 Table of Contents SCOPE OF CRITERIA...........................................................................................................................3 SUMMARY OF CRITERIA CHANGES......................................................................................................3 STRUCTURED COVERED BONDS IN PAKISTAN ....................................................................................3 STRUCTURE........................................................................................................................................3 STRUCTURED COVERED BOND FLOW ................................................................................................4 CREDIT ENHANCEMENT FRAMEWORK................................................................................................4 ANALYSIS FRAMEWORK FOR RATINGS OF STRUCTURED COVERED BONDS .......................................5 A. RATING OF THE ISSUER...............................................................................................................5 B. CREDIT QUALITY OF THE COVER POOL: ......................................................................................5 C. OTHER CONSIDERATIONS:...........................................................................................................6

VIS Credit Rating Company Limited Structured Covered Bonds/Sukuk JUNE 2026 SCOPE OF CRITERIA “Covered bond” is a term that typically refers to a debt instrument that has dual recourse: first, to the issuer – which would typically be a financial institution; and, upon the issuer’s default, to a pool of assets (also known as “cover assets” ). Covered Bonds are ideal for refinancing receivables, typically existing mortgage loans, SME loans, personal unsecured loans, credit card receivables or micro loans etc. To segregate assets of the covered pool from the bankrupt estate of the issuer, some of the jurisdictions have instituted special legislation where legal protection may be affected through ring-fencing the assets of the covered pool from issuer’s other creditors’ claims in case of financial distress/restructuring or issuer’s insolvency. Due to such enabling leg al framework, rating agencies may build multiple-notch rating uplift on the senior unsecured rating of the issuer. In other jurisdictions like Malaysia and India where such specific legislations are not available, subject to tax and regulatory efficiency, existing securitization techniques have been used for such issuances. These instruments are known as Structured Covered Bonds (SCBs) which replicate the ‘dual recourse’ nature and may achieve a higher rating than that of the issuer (senior unsecured rating) as the cash flows generated by the pool of cover assets are used for servicing the instruments in case of non-payment to investors or insolvency of the issuer. SUMMARY OF CRITERIA CHANGES Structured Covered Bond/Sukuk methodology dated January 2025 has been reviewed and the fundamental criteria as outlined in the aforesaid methodology remain the same. STRUCTURED COVERED BONDS IN PAKISTAN Since structured covered instruments have gained confidence in regional countries, where regulatory/legislative support for such structures is also absent, like in Pakistan, VIS is of the view that financial institutions may also take benefit from this innovative method to access liquidity against refinancing, at lower rates given that these are higher rated instruments than the Issuer’s standalone ratings. VIS has published this methodology to assist such issuers. VIS has taken the pioneering role in defining them and formulating an independent methodology for structured covered instruments to deepen the financial market in Pakistan. However, it is important to mention here that instruments resembling plain-vanilla collateralized lending are not considered SCBs by VIS. The pool assets should mirror the debt profile of the issued instrument throughout its life until maturity. Unless covered pool assets do not provide adequate cushion/margin for servicing debt profile, any rating uplift will not be considered for the debt instruments under this methodology. STRUCTURE Covered debt instruments are issued directly from the balance sheet of the Issuer, as distinct from a typical securitized structure. An Issuer will issue Bonds/Sukuk and simultaneously assign a pool comprising a combination of loan

VIS Credit Rating Company Limited Structured Covered Bonds/Sukuk JUNE 2026 receivables/or any other viable low risk assets (cover pool) as security to a third party (SPV/Trust/investor agent etc., (STI)). After assignment, the cover pool comes under the trust/supervision of the third party. In the normal course of business all the cash flows of the pool will be trapped, under an arrangement with the STI, in the designated escrow account. The first recourse of payment for debt servicing obligations under SCB arrangement is upon the issuer. Upon default/ non-payment by the Issuer (first recourse) all the rights, title and interest of the cover pool will be transferred to the third party by way of full redemption call by STI and assignment/liquidation of the cover pool assets by triggering an existing irrevocable authorization to the STI. The pool will then be used to repay the bond/sukuk holders (second recourse). The transfer of the pool at the time of default of the Issuer should not need any further action or deed from the Issuer. In such an event the Bond/Sukuk repayments will be met by the funds generated by the identified pool. As the receivables from the pool assets are collected or/and the investment matures/sold, the funds are transferred to an already available escrow account which is dedicated for the investors under the supervision of the third party. During the period of normal course of business and when the Issuer is solvent, the Issuer may be able to use these funds for its own business depending on the structure of the transaction. STRUCTURED COVERED BOND FLOW CREDIT ENHANCEMENT FRAMEWORK Credit ratings assigned by VIS address timely payment of due principal and markup on the instrument being rated. A particular debt instrument of an Issuer can be rated higher relative to its issuer credit rating if the credit enhancement associated with that debt instrument ensures that the investors are more likely to receive all payments in full and in a timely manner, as perthe instrument’s repayment schedule. ESCROW ACCOUNT ESCROW ACCOUNT TOR AGENT 5. Proceeds from Cover Pool 7. First Resource 6. Repayment

VIS Credit Rating Company Limited Structured Covered Bonds/Sukuk JUNE 2026 Regular debt obligations are rated based on the balance sheet strength of the Issuer. The covered bond investors have the benefit of dual recourse – unlimited first recourse on the Issuer and second recourse on the cover pool assets in the event the Issuer’s insolvency or non-payment to the investors. The covered pool assets are structured to be bankruptcy remote from the Issuer in the event of Issuer’s financial distress, and therefore in ideal circumstances the assets comprising the pool should be transferred/sold to a third party at the outset, however assignment of pool to a third party and transfer at the time of default/pre-defined conditions of issuer is also likely to provide credit enhancement. The assets in the pool are to be completely unencumbered and the investors should have an exclusive charge on the assets underlying the cover pool. ANALYSIS FRAMEWORK FOR RATINGS OF STRUCTURED COVERED BONDS There are many combinations which could be developed while structuring the covered pool. However, major areas which are considered during the analysis are: A. RATING OF THE ISSUER: Credit strength of the structured covered securities is linked to that of the issuer. The primary source of the timely payment of the covered bond will come from the issuer’s overall credit quality and the Issuer’s role. The Issuer’s role as the servicer of the covered pool. A lower-rated issuer has less ability than the higher-rated issuer in terms of providing liquidity support to the structured covered instrument if the cover pool does not have sufficient cash flow to service the instruments. Cover pools may also be fairly dynamic, meaning that the issuer often must replace non-performing receivables or maturing receivables with performing receivables to ensure that the cover pool quality remains satisfactory, and in line with the repayment profile of the issued instrument (total value of the pool shall never be less than the total outstanding value of the instrument at any given point in time plus any desired level of overcollateralization). The issuer’s ability to continue to generate similar quality of assets over the life of the instrument will mitigate any replacement risk. B. CREDIT QUALITY OF THE COVER POOL: In the event of non-payment by the Issuer, either through insolvency or a pre-defined event of default, the most material source of payment to covered instrument investors will be the cash flows of assets in the cover pool. The Issuer will likely provide a pre-defined, disclosed eligibility criterion for the asset which will be part of the cover pool and through the life of the instrument only assets that meet the eligibility criteria will be allowed for replacement. VIS will apply its general credit rating approach to assess the quality of the assets placed in the cover pool and will monitor the stability/performance of the pool. VIS will update its view on the pool quality and its performance whenever possible by analyzing the pool quality report provided by the issuer on a regular basis on which the rating will be reviewed on periodic basis. Cover asset pool may also contain partial cash deposits or highly rated debt instruments and/or sovereign obligations for credit enhancement of the cover pool.

VIS Credit Rating Company Limited Structured Covered Bonds/Sukuk JUNE 2026 Keeping in view the target rating and loss ratios commensurate with it, VIS can determine the gap that needs to be covered through overcollateralization. VIS will also consider backup servicer’s fee that may be chargeable when the pool is transferred and managed by STI, as well as any potential loss of income on the pool of assets, in the event of pre￾payments, distress sale or delays caused by administrator’s actions, for calculating such over-collateralization. The asset-liability mismatch between the cover pool and the structured covered instrument is another area which will have effect on the credit assessment of an issue. VIS believes that if the maturity of the pool assets is well matched with the tenor and outflows to the investors, the replacement risk will be lower and the ability to judge the quality of the pool assets at the outset of the issuance of the instrument will be superior. C. OTHER CONSIDERATIONS: • Guarantee provided by a third party to the cover Bond/Sukuk investors needs to be unconditional and irrevocable. • Cover pool assets as a proportion of total assets of the Issuer will have a bearing on the credit quality of the issuer. If the covered pool is a significant portion of the issuer’s asset base, the entity rating of the Issuer may come under stress. • The current and incremental debt envisaged in the future on the balance sheet may also constrain the ratings. • Any other form of credit enhancement may be built into the structure of the instrument to protect the investor from shortfall owing to delay in repayment, such as excess markup/profit spread or overcollateralization. Any external source of enhancement may also be provided. • The overall management capacity of the appointed backup servicer, especially, from the stand point of it assuming the role of cover pool manager, in case ofIssuer default. In short, the ratings of the SCBs take into account the evaluation of the Issuers credit risk as a first step, and the statistical analysis of the covered pool assets determines the credit enhancement required for the targeted ratings. The covered pool simulation also helps in estimating the ultimate recovery from the pool assets which could be realized or the cash flows which are expected to be generated without disruption in order to satisfy the investors’ obligation. It is important to reiterate that any uplift to ratings over and above the senior unsecured ratings of a banking company, is either a function of providing priority to bond/sukuk holders above general creditors/depositors or ring-fencing superior quality assets from bankrupt estate of the Issuer. This methodology addresses the securitization techniques used for ring-fencing the pool assets to provide any rating up-lift. VIS recommends that a legal framework should be introduced to facilitate the issuances of covered instruments to further deepen the capital markets in Pakistan.

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