UPDATE 1-S&P plan may halve TALF-eligible CMBS-Deutsche Bank

(Adds S&P comment)

By Al Yoon

NEW YORK, June 8 (Reuters) - The number commercial mortgage backed securities eligible for a Federal Reserve program to restart lending would be halved if new conservative rating methods are adopted by Standard & Poor's, Deutsche Bank said on Monday.

The S&P proposal to overhaul its rating model to better reflect risks in commercial real estate has provoked an uproar among bondholders and analysts, who say they cannot comprehend the models used to justify drastic changes.

If adopted, the proposal would likely result in downgrades to 95 percent of top-rated bonds issued during the peak of the real estate cycle in 2007, and 85 percent of CMBS from 2006, S&P said.

The Fed's Term Asset-Backed Securities Loan Facility (TALF), a program that allows investors to obtain financing to buy bonds backed by consumer debt, has had success in lowering borrowing costs and countering the financial crisis. But the expansion to CMBS is now in jeopardy following the S&P proposal, since the TALF requires that the bonds hold "AAA" ratings.

S&P's new rating method would cut 2005 to 2007 bonds available to TALF from $122 billion from $252 billion, according to Richard Parkus, an analyst at Deutsche Bank.

"There is an enormous amount at stake here, both for S&P and securitization markets," Parkus said in a report.

Buying of CMBS in anticipation of funding from the Fed's TALF helped reduce yields closer to levels that would spur lending for office, retail and apartment buildings, many of which are defaulting due to a lack of credit. It has also aided the battered portfolios and balance sheets of banks and other investors that hold CMBS.

That rally has been reversed since the first S&P announcement in late May, with risk premiums up as much as 1.4 percentage points. Speculation the Fed will change its guidelines to make eligible bonds that are "super senior," even if they are downgraded, tempered selling, Parkus said.

About $80 billion in value has evaporated from the market since S&P announced its proposal, according to the Commercial Mortgage Securities Association, which asked the rating company to meet with industry representatives and to extend its comment period beyond June 9.

"The significance of these changes cannot be overstated since S&P rated more than 85 percent" of a common type CMBS over the past five years," the CMSA said. "The changes require a clear explanation and understanding of the policy rationale," it added.

An S&P spokesman said it is too soon to determine the impact of market feedback on implementation of its rating model. It has been transparent with the market about how it applies any new criteria, however, he said.

S&P's proposal also puts it at odds with competitor Fitch Ratings, which on Monday said top-rated CMBS are likely to retain their "AAA" designations for the foreseeable future.

The Fitch comment, which also delays likely cuts to junior "AAA" bonds since it said the bulk of actual losses are at loan maturity dates seven to nine years away, signals that S&P "way overshot," said one analyst at a Wall Street primary dealer.

Parkus called the S&P real estate model a "black box," with S&P lacking transparency on its workings.

The missing details and other "critical deficiencies" mean "it would be a serious mistake for S&P to push this new methodology out before these issues are resolved satisfactorily," Parkus wrote.