DBRS Assigns Rating to Palladium Securities 1 S.A. Series 148 Instruments – Republic of Italy Collateral

DBRS Ratings Limited (DBRS) has today assigned a final long-term obligation rating of A (low) (sf) to the EUR 122.3 million Series 148 Fixed Rate Instruments due 2024 (the Notes) issued by Palladium Securities 1 S.A. acting in relation to Compartment 148-2014-23 (the Issuer), ISIN XS1136288633.

The Issuer is a public limited liability company (société anonyme) incorporated under the laws of the Grand Duchy of Luxembourg. The transaction is a credit-linked note (CLN) of one sovereign inflation-linked bond issued by the Republic of Italy (the Collateral), ISIN IT0005004426. The noteholders and other transaction counterparties have recourse only to the assets in Compartment 148-2014-23 in accordance with Luxembourg law.

The transaction uses an asset swap to transform the payout profile of the collateral security. The noteholders are effectively exposed to the risk that either the Collateral or the Hedging Counterparty defaults. The transaction documents do not contain any downgrade provisions with respect to the Hedging Counterparty. As such, DBRS regards the rating of the Notes to be linked to those of the Collateral and Hedging Counterparty. Deutsche Bank AG, London Branch will act as the Hedging Counterparty.

Under the asset swap:
-- The Hedging Counterparty sells the par amount of EUR 122.3 million of the Collateral to the Issuer and receives payment on 25 February 2015 (the Trade Date).
-- The Issuer passes the interest payments received from the Collateral to the Hedging Counterparty as and when they occur.
-- The Hedging Counterparty makes the interest payments as specified in the Asset Swap Agreement to the Issuer. The notes will pay interest annually on the 25th of February, beginning in 2016 and ending in 2024.
-- The Hedging Counterparty pays a fixed rate of 2.4% per annum for the first two years of the transaction. The subsequent payments on the Notes will be 1.00% fixed plus a floating bonus interest rate subject to a bonus threshold. The floating bonus interest is equal to the ten-year EUR Constant Maturity Swap (CMS) less 1.00% as calculated each year, with a maximum rate of 3.00% and a minimum rate of 0.10% per annum (such that the aggregate maximum would be 4.00%). The bonus threshold in respect of each interest period is determined by the euro-U.S. dollar exchange rate being below or equal to 1.40.
-- At the scheduled maturity, the Hedging Counterparty will receive the Collateral from the Issuer and will pay EUR 122.3 million.

The significant counterparties to the Issuer are various subsidiaries and affiliates of Deutsche Bank AG as listed below. DBRS maintains private ratings on these counterparties, which are not published.
-- Deutsche Bank AG, London Branch acts as the Hedging Counterparty, Initial Purchaser of the Notes, Calculation Agent, Paying Agent, Selling Agent and Arranger, and pays the fees and expenses of the Issuer.
-- Deutsche Bank Luxembourg S.A., a wholly owned subsidiary of Deutsche Bank AG, acts as Custodian, Luxembourg Paying Agent and Servicer.
-- Deutsche Trustee Company Limited acts as Trustee.

DBRS maintains public ratings on the foreign and local currency, the long- and short-term debt of the Republic of Italy, and has used them to evaluate the credit risk of the Collateral and will monitor its credit risk on an ongoing basis. As of the rating date of this transaction, both local and foreign currency long-term ratings were A (low) with Negative trends, and both short-term ratings were R-1 (low) with Stable trends.

In addition to the credit profiles of the Collateral and the Hedging Counterparty, the rating of the Notes is based on DBRS’s review of the following items:
-- The transaction structure.
-- The transaction documents.
-- The legal opinions addressing, but not limited to, true sale of the Collateral, bankruptcy remoteness of the Issuer, the asset segregation of the Compartment, enforceability of the contracts and agreements and that no tax is to be withheld at the Issuer level.

DBRS did not address the following:
-- The pricing of the Asset Swap; that is, whether there will be sufficient cash flows from the Collateral to fully compensate the Hedging Counterparty for its obligations. As the Hedging Counterparty is contractually obliged to make the payments as specified under the Asset Swap Agreement, the risk that it defaults is addressed by the DBRS private rating.
-- Cash flow modelling to assess the returns due to the noteholders, as the returns are reliant on the swap counterparty.

The transaction can terminate early on the occurrence of an Event of Default, mandatory cancellation or cancellation for taxation and other reasons.

Events of Default include, but are not limited to, the following:
-- Failure to pay any amount due on the Notes beyond the grace period.
-- The Issuer fails to perform its obligations under the Series Instrument.
-- An order by any competent court ordering the dissolution of the Issuer or the Company for whatever reason that includes, but is not limited to, bankruptcy, fraudulent conveyance and merger.

Mandatory cancellation includes the following:
-- The Collateral becomes repayable other than by the discretion of the relevant Collateral Obligor in accordance with the terms of the Collateral.
-- The Collateral becomes, for whatever reason, capable of being declared due and payable prior to its stated maturity.
-- The Collateral defaults.

Similarly, cancellation for taxation, etc., includes the following:
-- The Issuer becomes required to withhold tax on the next payment date.
-- Termination of the Hedging Agreement.

Under the Series Instrument, the amount payable to the noteholders is determined as the market value of the Collateral minus the Early Termination Unwind Costs.

The Early Termination Unwind Costs are determined as the sum of
(1) The amount of (a) all costs, taxes, fees, expenses (including loss of funding), etc., incurred by the Hedging Counterparty (positive amount) or (b) the gain realised by the Hedging Counterparty (negative amount) as a result of the cancellation of the Asset Swap; and
(2) Legal and other costs incurred by the Issuer, Trustee, Custodian and Hedging Counterparty.

It should be noted that the DBRS rating assigned to this security does not address changes in law or changes in the interpretation of existing laws. Such changes in law or their interpretation could result in the early termination of the transaction, and the noteholders could be subjected to a loss on the Notes.

There will not be any reporting by the Trustee or the Custodian that would be expected in a typical structured finance transaction; therefore, DBRS will receive such information -- as it deems necessary to monitor the transaction and thus to assess the rating -- on at least an annual basis.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable is Rating Methodology for CLOs and CDOs of Large Corporate Credit (January 2014), which can be found on www.dbrs.com at http://www.dbrs.com/about/methodologies. Other methodologies and criteria referenced in this transaction are listed at the end of this press release.

The sources of information used for this rating include the Issuer, Palladium Securities 1 S.A. and the Arranger, Deutsche Bank AG, London Branch.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

DBRS considers that the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating concerns a newly issued financial instrument. This is the first DBRS rating on this financial instrument.

Information regarding DBRS ratings, including definitions, policies and methodologies are available on www.dbrs.com.

To assess the impact of the changing the transaction parameters on the rating, DBRS considered the following stress scenarios as compared with the parameters used to determine the rating (the Base Case):

-- A one-notch downgrade to the Collateral rating.
-- A one-notch downgrade to the Hedging Counterparty rating.

DBRS concludes that a hypothetical downgrade to the Collateral rating by one notch, ceteris paribus, would lead to a downgrade of the transaction to BBB (high) (sf). A hypothetical one-notch downgrade to the Hedging Counterparty rating, ceteris paribus, would not affect the current rating. A scenario combining both the downgrade of the Collateral rating and the Hedging Counterparty rating would lead to a downgrade of the Series 148 Instruments to BBB (high) (sf).

For further information on DBRS’s historic default rates published by the European Securities and Markets Administration (ESMA) in a central repository, see
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Kathy Schroeder
Rating Committee Chair: Jerry van Koolbergen
Rating Date: 25 February 2015

As this is the initial rating, there is no last rating date.

DBRS Ratings Limited
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Registered in England and Wales: No. 7139960.

The rating methodologies and criteria used in the analysis of this transaction can be found at http://www.dbrs.com/about/methodologies.

-- Rating Methodology for CLOs and CDOs of Large Corporate Credit
-- Legal Criteria for European Structured Finance Transactions
-- Derivative Criteria for European Structured Finance Transactions