DBRS Morningstar Confirms Palladium Securities 1 S.A. Series 147 Instruments – Multiple Collateral at BB (high) (sf)

DBRS Ratings GmbH (DBRS Morningstar) confirmed its BB (high) (sf) rating on the Series 147 Fixed to Floating Rate Instruments due 2024 (the Notes) issued by Palladium Securities 1 S.A. acting in relation to Compartment 147-2014-22 (the Issuer).

The confirmation follows an annual review of the transaction.

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 of two corporate fixed-rate bonds (the Collateral). The Collateral comprises EUR 28.3 million euro-denominated bonds issued by Assicurazioni Generali S.p.A. (5.125% bonds due 16 September 2024; ISIN: XS0452314536) and GBP 22.15 million British pound-denominated bonds issued by ENEL Finance International NV (5.625% bonds due 14 August 2024; ISIN: XS0452188054), which together represent the full issue amount of the Palladium Series 147 Notes, i.e., EUR 56.6 million. The noteholders and other transaction counterparties have recourse only to the assets in Compartment 147-2014-22, 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 of the two bonds that constitute the Collateral or the hedging counterparty defaults. The transaction documents contain no downgrade provisions with respect to the hedging counterparty. As such, DBRS Morningstar considers the Notes to be also exposed to the risk of default of the hedging counterparty. Deutsche Bank AG, London Branch acts as the hedging counterparty.

Under the asset swap:
-- The hedging counterparty sold the par amount of EUR 56.6 million of the Collateral (EUR 28.3 million euro-denominated bonds issued by Assicurazioni Generali S.p.A. and GBP 22.15 million British pounds-denominated bonds issued by ENEL Finance International NV) to the Issuer and received a payment on 10 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 pay interest annually on 10 February, beginning in 2016 and ending in 2024.
-- The hedging counterparty pays a fixed rate of 2.3% per annum for the first two years of the transaction.

The subsequent payments on the Notes are a fixed 0.5% of interest plus a floating bonus interest subject to a bonus threshold. The bonus interest is equal to the five-year EUR constant maturity swap (CMS) less 0.5% as calculated each year, with a maximum rate of 3.75% and a minimum rate of 0.50% per annum. The bonus threshold, in respect of each interest rate period, is determined by the EUR-USD exchange rate being below or equal to EUR 1.40. The fixed-rate and floating bonus interest rate in aggregate are equal to an interest rate of five-year EUR CMS (subject to a minimum of 1.00% and a maximum of 4.25%).
-- At the scheduled maturity, the hedging counterparty will receive the Collateral from the Issuer and will pay EUR 56.6 million.

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 internal assessments on the ratings of the corporate fixed-rate bonds that make up the Collateral to evaluate the credit risk of the Collateral and monitor its credit risk on an ongoing basis. As per DBRS Morningstar criteria, an internal assessment is an opinion regarding its creditworthiness based primarily upon public ratings. Internal assessments are not ratings and DBRS Morningstar does not publish them.

In addition to the credit profiles of the Collateral and the hedging counterparty, the rating on the Notes is based on DBRS Morningstar’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 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 transaction 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 fails to perform its obligations under the series instrument.
-- 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 the hedging counterparty.

It should be noted that the DBRS Morningstar 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.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant impact on the credit analysis.

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 transaction in accordance with the principal methodology.

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

Other methodologies referenced in this transaction 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 this rating 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 rating, 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 this rating 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 action on the transaction took place on 14 January 2022, when DBRS Morningstar confirmed its BB (high) (sf) rating on the Notes.

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

To assess the impact of changing the transaction parameters on the rating, DBRS Morningstar 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 Morningstar concludes that a hypothetical one-notch downgrade of the rating of the lowest rated collateral, ceteris paribus, would lead to a confirmation of the notes at BB (high) (sf). A hypothetical one-notch downgrade of the hedging counterparty rating, ceteris paribus, would not affect the current rating. A scenario combining both a one-notch downgrade of the Collateral rating of the lowest rated collateral and a one-notch downgrade of the hedging counterparty rating would lead to a confirmation of the Series 147 instrument rating at BB (high) (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.

This rating is 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
Initial Rating Date: 10 February 2015

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The rating methodologies used in the analysis of this transaction 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 info@dbrsmorningstar.com.