July 16 (Bloomberg) -- Standard & Poor's is seeking comment on a proposal that may make it impossible for some structured finance products to receive top credit ratings, reining in part of a market that has led to bank losses and writedowns of $421 billion since the middle of 2007.

S&P would add ``ratings stability'' as a consideration in determining credit rankings, addressing what Chief Credit Officer Mark Adelson called ``cliff risk'' when ratings fall several levels under stress conditions. The biggest ratings company said it would enact the change within six months from the end of the comment period.

Adelson, in a telephone interview from his New York office, said the change will affect mainly structured finance and make little difference for corporate or government debt. If enacted, the new consideration may render top ratings impossible for some exotic structured products such as bonds backed by derivatives known as constant proportion debt obligations, or CPDOs, which were among the worst-performing securities in the past year.

``Some of these products had very steep credit cliffs,'' Adelson said. ``This would make it much harder to get a AAA rating. In some cases, it may be impossible.''

S&P's new proposal comes as the U.S. Securities and Exchange Commission is recommending that ratings companies include new designations for structured finance to the letter-based scale created by John Moody in 1909. S&P is a unit of New York-based McGraw-Hill Cos.

The changes may force investors to reassess the way they gauge the risk of securities backed by mortgages, student and auto loans and credit cards, as well as force banks to add capital to guard against losses or curb lending.

`Hypermathematical'

S&P analysts would be asked to assess how far a rating might fall under a ``moderate stress'' scenario, such as a mild recession, over the next two years, Adelson said.

``The majority of people in the capital markets thought this is what we thought was happening,'' he said. ``A few had embraced the hypermathematical view of the rating and really aggressively tried to exploit it. This will make it harder to exploit. The rating is not to going to get gamed again.''

Ratings companies' grades of AAA through C underpin global financial accords dictating how much capital lenders and insurers must set aside to protect against losses. Changes may lead to revisions of rules, including the Basel banking accords, and investment guidelines for mutual and pension funds.

Credit-rating companies came under criticism from investors and Congress after the collapse of the subprime market last year proved that their AAA rankings for thousands of asset-backed bonds were flawed. Banks have been forced to raise $325 billion in capital.

Losses

The number of collateralized debt obligations failing since October has reached 204, with $214 billion of assets, data compiled by S&P and Bloomberg show. Most of that amount was rated AAA by S&P.

Asset-backed securities have lost 7 percent this year and are on their way to their worst performance since the $1.03 trillion Merrill Lynch & Co. Asset-Backed Fixed & Floating-Rate Index was created in November 1994.

To contact the reporter on this story: Mark Pittman in New York at mpittman@bloomberg.net;

Last Updated: July 16, 2008 12:19 EDT