DBRS Confirms Palladium Securities 1 S.A. Acting in Relation to Compartment 121-2013-21, Series 121 CMS Structured Floating Rate Instruments—Collateral Issued by Republic of Italy at A (low) (sf)

DBRS Ratings Limited (DBRS) has today confirmed the A (low) (sf) rating on the EUR 150 million Series 121 CMS Structured Floating Rate Instruments due 2021 (the Notes) issued by Palladium Securities 1 S.A. Acting in Relation to Compartment 121-2013-21 (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 cash flow securitisation collateralised by a sovereign inflation-linked bond issued by the Republic of Italy (the Collateral), ISIN IT0004604671. The noteholders and other transaction counterparties have recourse only to the assets in Compartment 121-2013-21 in accordance with Luxembourg law.

The transaction is a credit-linked note in which the Issuer uses an asset swap to transform the payout profile of a debt security. The noteholders are effectively exposed to the risk that either the Collateral or the counterparties default. The transaction documents do not contain any downgrade provisions with respect to Deutsche Bank AG, London Branch (acting as the Hedging Counterparty). As such, DBRS regards the rating of the Notes to be linked to those of the Collateral and Hedging Counterparty.

DBRS maintains an internal assessment on the Collateral Guarantor to evaluate the credit risk of the Collateral and monitor its credit risk on an ongoing basis. DBRS does not rate the Collateral or the Collateral Guarantor. The internal assessment of the Collateral Guarantor is an opinion regarding its creditworthiness based primarily upon pubic ratings. Internal assessments are not ratings, and are not published.

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

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 150 million of the Collateral to the Issuer and receives payment on 7 October 2013 (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 7th day of October, beginning in 2014 and ending in 2017.
-- The Hedging Counterparty pays a Fixed Rate of 4.50% per annum for the first four years of the transaction. The subsequent payments are set as follows:

(30-year EUR CMS minus 2-year EUR CMS) multiplied by three.

In addition, this Structured Floating Rate is subject to a minimum of 0.00% per annum and a maximum of 5.00% per annum.

-- At the scheduled maturity, the Hedging Counterparty will receive the Collateral from the Issuer and pay EUR 150 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, 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 long-term ratings were A (low), Stable trend and both short-term ratings were R-1 (low), Stable trend.

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.
-- The documentation has been assessed as to its compliance with the DBRS “Legal Criteria for European Structured Finance Transactions” and the DBRS “Derivative Criteria for European Structured Finance Transactions” methodologies.

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.

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:
(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.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable is “Rating CLOs and CDOs of Large Corporate Credit”. Other methodologies and criteria referenced in this transaction are listed at the end of this press release.

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

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

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.

The last rating action on this transaction took place on 1 June 2015, when DBRS confirmed the rating of the Notes at A (low) (sf).

Information regarding DBRS ratings, including definitions, policies and methodologies are available on 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 121 Instruments to BBB (high) (sf).

For further information on DBRS’s historic default rates published by the European Securities and Markets Administration 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: Simon Ross
Initial Rating Date: 7 August 2013
Initial Rating Committee Chair: Jerry van Koolbergen

Lead Surveillance Analyst: Alfonso Candelas, Vice President
Rating Committee Chair: Jerry van Koolbergen, Managing Director

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

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

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