Aug. 3 (Bloomberg) — Standard & Poor's, frozen out of thecommercial-mortgage bond market since last year, is changing itsmethod for rating the instruments in a way that may produce highergrades for some securities.

The preliminary criteria that S&P released in June wouldresult in higher rankings for the three deals that it has ratedsince then, according to reports distributed to investors by thecompany. For a $340 million offering of mall debt that MorganStanley sold yesterday, S&P said its new methodology would ratethe entire deal investment-grade, while the old criteria resultedin $29.7 million of unrated debt.

Wall Street banks have been bypassing S&P's ratings forcommercial-mortgage bonds since the company derailed a $1.5 billionsale by Goldman Sachs Group Inc. and Citigroup Inc. last year bypulling its grades on the securities. Since then, S&P hasn'trated a so-called conduit deal composed of loans from multipleborrowers, the biggest part of the market, according to datacompiled by Bloomberg. The three deals rated since June are linkedto single property owners.

“The higher loan proceeds deriving from their proposedunderwriting criteria is suggestive of somewhat more lenienttreatment,” according to Christopher Sullivan, who oversees about$2 billion as chief investment officer at United Nations FederalCredit Union in New York.

New Criteria

Credit-rating companies determine the value of the propertiesbacking the loans in CMBS using the rent and a so- calledcapitalization rate — a ratio of estimated net income to value ofthe property. In the new criteria, S&P said it would use lowercapitalization rates, raising the estimated values.

The new criteria would primarily affect the lower-ranking bondsof the recent deals.

S&P is using lower recovery rates in its model for defaultedmortgages, offsetting the effect of higher property values onratings, the New York-based company said in a June 4 reportrequesting comments on its proposal.

Ed Sweeney, a spokesman for S&P, cited the June 4 reportstating “more positive rating movements are expected fortransactions issued in 2009 or later,” and declined to commentfurther

“It's reasonable to assume that cap rates may compress goingforward,” said Richard Hill, a debt strategist at Royal Bank ofScotland Group Plc. “That's what the central banks are attemptingto do – engineer an environment where there are lower yields acrossthe board.”

Fed Targets

The Federal Reserve has kept its target rate for overnight loansbetween banks at zero to 0.25 percent since December 2008, and saidit expects to keep it “exceptionally low” through at least late2014 in an effort to spur economic growth.

Still, rising interest rates are one the biggest risks forcommercial real estate, Hill said. A rise in rates could eat intoproperty values as capitalization rates rise in tandem, meaningproperty owners would demand higher returns on their investment.Additionally, loans would be more difficult to refinance at ahigher interest rate, Hill said.

During the U.S. housing boom, S&P and its competitors pushedto win business by providing inflated ratings for risky mortgagebonds, according to the Financial Crisis Inquiry Commission and aSenate report last year. That allowed pension funds and otherratings-sensitive investors to pack their portfolios with bondsthat later plummeted in value.

Wall Street banks have arranged about $18.5 billion in bondstied to skyscrapers, shopping malls and hotels this year, down froma record $232 billion in 2007, according to data compiled byBloomberg. Credit Suisse Group AG forecasts as much as $45 billionin 2012 issuance.

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