DBRS Morningstar Confirms Palladium Securities 1 S.A. Series 124, 141, 142, 145, and 148 Instruments – Republic of Italy Collateral at BBB (high) (sf)

DBRS Ratings GmbH (DBRS Morningstar) confirmed its BBB (high) (sf) ratings on the following five series of notes (the Compartments) issued by Palladium Securities 1 S.A. (the Issuer):

-- Series 124 Fixed to Floating Rate Instrument (Acting in Relation to Compartment 124-2013-24)
-- Series 141 Fixed to Floating Rate Instrument (Acting in Relation to Compartment 141-2014-16)
-- Series 142 Fixed Rate Instrument (Acting in Relation to Compartment 142-2014-17)
-- Series 145 Fixed to Floating Rate Instrument (Acting in Relation to Compartment 145-2014-20)
-- Series 148 Fixed Rate Instrument (Acting in Relation to Compartment 148-2014-23)

The confirmations follow an annual review of the Compartments.

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

The transactions use 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 contain no downgrade provisions with respect to the hedging counterparty. As such, DBRS Morningstar regards the ratings of the Notes to be linked to those of the Collateral and hedging counterparty.

The significant counterparties to the Issuer are listed below. DBRS Morningstar maintains private ratings on these counterparties, which it does not publish, except on European Depository Bank S.A., not rated by DBRS Morningstar.
-- 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 the Luxembourg paying agent.
-- European Depository Bank S.A. acts as the custodian and servicer since 30 October 2019, when it replaced Deutsche Bank Luxembourg S.A. in such capacities.
-- Deutsche Trustee Company Limited acts as the trustee.

DBRS Morningstar 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 these transactions, the Republic of Italy’s local and foreign currency long-term ratings both were BBB (high) with Stable trends, and both the corresponding short-term ratings were R-1 (low) with Stable trends.

In addition to the credit profiles of the Collateral and the hedging counterparty, the ratings of the Notes are based on DBRS Morningstar’s review of the following items:
-- The transactions’ 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 the fact that no tax will be withheld at the Issuer level.

DBRS Morningstar 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 Morningstar private rating.
-- Cash flow analysis to assess the returns due to the noteholders, as the returns are reliant on the swap counterparty.

The transactions can terminate early on the occurrence of an event of default, mandatory cancellation, or cancellation for taxation and other reasons.

Events of default occur under, but are not limited to, the following scenarios:

-- Failure to pay any amount due on the Notes beyond the grace period.
-- The Issuer’s failure to perform its obligations under the series instrument.
-- Any competent court ordering the dissolution of the Issuer for whatever reason that includes, but is not limited to, bankruptcy, fraudulent conveyance, or a 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 the hedging counterparty.

It should be noted that the DBRS Morningstar ratings assigned to the securities do 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 transactions, and the noteholders could be subjected to a loss on the Notes.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Given that each transaction is a credit-linked note of one sovereign inflation-linked bond issued by the Republic of Italy, DBRS Morningstar considers as significant rating factors for these rating actions some of the key drivers behind the latest rating action on the Republic of Italy, namely Institutional Strength, Governance & Transparency (G), and Human Capital and Human Rights (S).

Environmental (E) Factors
There were no Environmental factors that had a significant or relevant effect on the credit analysis.

Social (S) Factors
Human Capital and Human Rights
According to the International Monetary Fund World Economic Outlook, Italy’s GDP per capita of USD 35,473 in 2021 was low compared with its euro area peers. This factor is considered as significant and has been taken into account primarily in the “Economic Structure and Performance” building block.

Governance (G) Factors
Institutional Strength, Governance & Transparency
This reflects particularly Italy’s institutional arrangements that affect government effectiveness and the government’s capacity to address economic challenges and implement forward-looking policies. According to the World Bank, Italy ranked for Governance Effectiveness at 64.9th percentile in 2021. This factor is considered as significant and has been taken into account primarily in the “Fiscal Management and Policy” and “Political environment” building blocks. At the same time, DBRS Morningstar views the Bribery, Corruption, and Political Risks factor as relevant reflecting also weak scores in the rule of law and in the perception of corruption.

Credit rating actions on the Republic of Italy are likely to have an impact on this credit rating. ESG factors that have a significant or relevant effect on the credit analysis of the Republic of Italy are discussed separately at https://www.dbrsmorningstar.com/research/404515/dbrs-morningstar-confirms-republic-of-italy-at-bbb-high-stable-trend.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the “DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings” at: https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable to the ratings is: “Rating CLOs and CDOs of Large Corporate Credit” (26 January 2022).

DBRS Morningstar has applied the principal methodology consistently and conducted a review of the transactions in accordance with the principal methodology.

A review of the transactions’ legal documents was not conducted as the legal documents have remained unchanged since the most recent rating actions.

Other methodologies referenced in these transactions are listed at the end of this press release. These may be found at: https://www.dbrsmorningstar.com/about/methodologies

For a more detailed discussion of the sovereign risk impact on Structured Finance ratings, please refer to “Appendix C: The Impact of Sovereign Ratings on Other DBRS Morningstar Credit Ratings” of the “Global Methodology for Rating Sovereign Governments” at: https://www.dbrsmorningstar.com/research/401817/global-methodology-for-rating-sovereign-governments.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

The sources of data and information used for these ratings include Palladium Securities 1 S.A. and other public sources.

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

At the time of the initial ratings, DBRS Morningstar was not supplied with third-party assessments. However, this did not impact the rating analysis.

DBRS Morningstar considers the data and information available to it for the purposes of providing these ratings to be of satisfactory quality.

DBRS Morningstar does not audit or independently verify the data or information it receives in connection with the rating process.

The last rating actions on the transactions took place on 14 January 2022, when DBRS Morningstar confirmed the ratings of these five series of notes each at BBB (high) (sf).

Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com.

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

-- A one-notch downgrade to the Collateral rating.
-- A one-notch downgrade to the hedging counterparty rating.

DBRS Morningstar concludes that a hypothetical downgrade to the Collateral rating by one notch, ceteris paribus, would lead to a downgrade of all five Series of Notes to BBB (sf). A hypothetical one-notch downgrade of the Hedging Counterparty rating, ceteris paribus, would not have an impact on the current ratings. A scenario combining both the downgrade of the Collateral rating and the hedging counterparty rating would lead to a downgrade of all five series of Notes to BBB (sf).

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

These ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Alfonso Candelas, Senior Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
PALLADIUM SECURITIES 1 S.A. ACTING IN RELATION TO COMPARTMENT 124-2013-24
Initial Rating Date: 15 January 2014
PALLADIUM SECURITIES 1 S.A. ACTING IN RELATION TO COMPARTMENT 141-2014-16
Initial Rating Date: 10 October 2014
PALLADIUM SECURITIES 1 S.A. ACTING IN RELATION TO COMPARTMENT 142-2014-17
Initial Rating Date: 10 October 2014
PALLADIUM SECURITIES 1 S.A. ACTING IN RELATION TO COMPARTMENT 145-2014-20
Initial Rating Date: 19 January 2015
PALLADIUM SECURITIES 1 S.A. ACTING IN RELATION TO COMPARTMENT 148-2014-23
Initial Rating Date: 25 February 2015

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The rating methodologies used in the analysis of these transactions can be found at: https://www.dbrsmorningstar.com/about/methodologies

-- Derivative Criteria for European Structured Finance Transactions (20 September 2021),
https://www.dbrsmorningstar.com/research/384624/derivative-criteria-for-european-structured-finance-transactions
-- Legal Criteria for European Structured Finance Transactions (22 July 2022),
https://www.dbrsmorningstar.com/research/400166/legal-criteria-for-european-structured-finance-transactions.
-- Rating CLOs and CDOs of Large Corporate Credit (26 January 2022),
https://www.dbrsmorningstar.com/research/391226/rating-clos-and-cdos-of-large-corporate-credit.
-- DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (17 May 2022),
https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].