Call it the Domino Effect, but when a bank's rating is threatened there is inevitably a securitization that's being threatened as well.

Such is the case with Standard & Poor's announcement at November's debut that it would place Commerzbank AG's A+' long-term counterparty credit ratings on CreditWatch with negative implications; and a week later come the trailing effects to its credit-linked notes, Residence 2000-1.

According to S&P the rating action on the bank results from disappointing third quarter results in which its return on equity declined to 0.9%, which resulted from a 7.6% decline in revenues and a 13.4% increase in operating expenses that led to a reported cost-to-income ration of 84%. S&P believes that the overall operating results might be vulnerable to continuing deterioration going forward into the fourth quarter.

"We would expect a credible strategy to restore our ratings level [for Commerzbank]," said S&P analyst Stefan Best. The bank's move to merge its mortgage bank subsidiary, Rheinhyp, with those of its peers (see ASR 11/15/01) is regarded as possibly a good step in the right direction. "Commerzbank will have to increase Rheinhyp's capital by EURO500 million, however, and is likely to assume guarantees for Rheinhyp's existing mortgage-loan portfolio, which is currently under review," reported S&P.

Enter Residence 2000-1, Commerzbank's EURO1 billion floating-rate amortization credit-linked notes. According to S&P the ratings assigned to the class A1, A2, B and C notes reflect the Pfandbriefe collateral for the class A1 and A2 notes, Commerzbank's senior unsecured double-A-minus debt rating and the ability to service the loans as well as the sound of legal structure of the transaction.

The ratings of the notes rated lower than triple-A depend on Commerzbank's rating, which includes the class B notes, rated A'; and the Class D notes, rated BBB'. S&P writes: "The class B, C and D notes are direct unsecured obligations of Commerzbank as issuer. Commerzbank will be responsible for the final repayment of the principal and for the timely payment of interest on these classes. Therefore, Commerzbank's senior unsecured rating is a supporting rating. A lowering of its long-term rating below A' may lead to a downgrade of the class B notes and similarly a lowering of Commerzbank's long-term rating below BBB' may lead to a downgrade of the C notes."

However, market analysts believe that a one notch downgrade of Commerzbank's long-term rating might not be enough to affect the class B notes - but any further deterioration of the bank's rating would likely have negative ramifications for the bonds. "This is a bank that has had some serious difficulties in strategic direction on where it goes from here, but as to whether it will be two notches, I don't think that is imminent," said Gerry Rawcliffe, head of investment-grade credit research at Dresdner Kleinwort Wasserstein.

"I would afford that at this stage a one-notch downgrade is probably the likely outcome."

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