DBRS Confirms Palladium Securities 1 S.A. Series 148 Instruments – Republic of Italy Collateral at A (low) (sf)

DBRS Ratings Limited (DBRS) has today confirmed its rating of A (low) (sf) to the EUR 122.3 million Series 148 Fixed to Floating Rate Instruments due 2024 (the Notes) issued by Palladium Securities 1 S.A. acting in relation to Compartment 148-2014-23 (the Issuer).

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 is a credit-linked note (CLN) in which the Issuer uses an asset swap (the 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.

Under the Asset Swap that the Issuer has entered into with Deutsche Bank AG, London Branch (the Hedging Counterparty:

-- 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 Interest Payment Dates are the 19th day of January, 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, 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 Stable 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 including, but not limited to, the Base Prospectus, the General Trust Terms Module, the Security Module, the ISDA Master Agreement Module, the Custodian Agreement, the Sale and Disbursement Agreement, the Articles of Incorporation, the Final Terms, the Series Instrument and the Asset Swap Agreement letter.
-- 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 no tax 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 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 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:
(i) 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
(ii) 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.

The current rating action is the result of a surveillance annual review of the transaction.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable is Rating CLOs and CDOs of Large Corporate Credit. DBRS has applied the principal methodology consistently and conducted a review of the transaction in accordance with the principal methodology.

A review of the transaction legal documents was not conducted as the documents have remained unchanged since the most recent rating action.

Other methodologies and criteria referenced in this transaction are listed at the end of this press release.

This may be found on www.dbrs.com at:
http://www.dbrs.com/about/methodologies

The sources of information used for this rating include Palladium Securities 1 S.A. and other public sources.

DBRS does not rely upon third-party due diligence in order to conduct its analysis.

DBRS was not supplied with third-party assessments. However, this did not impact the rating analysis.

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

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.

This is the first rating action since the Initial Rating Date (25 February 2015). The lead responsibilities for this transaction have been transferred to Alfonso Candelas.

Information regarding DBRS ratings, including definitions, policies and methodologies is available at www.dbrs.com.

To assess the impact of changing the transaction parameters on the rating, DBRS considered the following stress scenarios, as compared to 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 impact 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 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.

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

Lead Surveillance Analyst: Alfonso Candelas
Rating Committee Chair: Jerry van Koolbergen

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

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

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

A description of how DBRS analyses structured finance transactions and how the methodologies are collectively applied can be found at: http://www.dbrs.com/research/278375.