June 4 (Bloomberg) -- The Federal Reserve may not start lending against residential mortgage-backed securities under its Term Asset-Backed Securities Loan Facility, Federal Reserve Bank of New York President William Dudley indicated.

“We’re still in the process of assessing whether a legacy RMBS program is feasible, and if it were feasible, whether it would be significant enough to make a major impact,” Dudley said at a conference today in New York hosted by the Securities and Financial Markets Association and Pension Real Estate Association.

His comments add to signs that Treasury Secretary Timothy Geithner’s Public-Private Investment Program to boost debt prices and rid banks of devalued assets to expand lending is stalling, after helping to spark a rally in stocks and bonds. The Federal Deposit Insurance Corp. yesterday delayed a test sale of bad loans held by U.S. banks that had been billed as a tryout for its role.

Responding to questions after a speech at the conference, Dudley said each home-loan security is different and must be separately evaluated for the size of the haircut that should be applied, so “there’s a huge administrative hurdle” to expanding the TALF to the bonds.

Last month, the Fed’s program to finance commercial- mortgage bonds was potentially hampered by Standard & Poor’s saying it may downgrade many AAA securities, rendering them ineligible under the central bank’s rules. As much as 90 percent of so-called super senior commercial-mortgage bonds sold in 2007 may be affected as the ratings firm changes how it assesses the debt, New York-based S&P said.

PPIP Mechanism

Under the PPIP, which was announced in March, funds run by private managers buying so-called legacy securities may be able to supplement Treasury co-investments and loans with additional TALF financing. Under a “Legacy Loans Program,” FDIC- guaranteed debt would provide the leverage.

TALF loans may also be available to other investors as the government seeks to boost prices for the more than $2.5 trillion of U.S. residential and commercial mortgage bonds without government backing to free banks and funds to create new credit.

Since the PPIP was announced, U.S. banks have raised capital through stock sales and by converting preferred shares, and as of yesterday the total reached almost $100 billion, according to data compiled by Bloomberg.

‘Complex’ Assets

“Banks have been able to raise capital without having to sell bad assets through the LLP, which reflects renewed investor confidence in our banking system,” FDIC Chairman Sheila Bair said yesterday in a statement in Washington. She added pushing back the pilot sale will give regulators time to assess details of the troubled asset programs.

For the Fed, lending against older home-loan bonds “is difficult,” David Miller, director of investments for the Treasury’s office of financial stability, said in an interview at the conference. “It’s a much more complex asset class” than older commercial-mortgage securities, which the central bank last month agreed to finance, he said.

“It just takes longer to evaluate not only ‘if,’ but how to do it,” Miller said. “And that’s a challenge in terms of timing, which is maybe not as quickly as people would like. But we’re optimistic. And we’re also optimistic about the actual PPIPs getting up and running.”

Managers of the public-private securities funds will likely be named in one to two weeks, after which they will have as long as 12 weeks to raise money, he said. The Treasury has narrowed the list of potential managers to less than 20, and plans to initially select five to 10, he said.

For ‘Fools’

“We still need more” than the capital that banks have raised to revive commercial-mortgage lending, Russ Appel, a managing director at Praedium Group LLC, a New York-based real- estate-investment firm, said during the conference. “Until they start clearing the old loans, they probably won’t be making a lot of new loans.”

After the apparent demise of the PPIP-FDIC program for loans, banks will probably try to mainly off-load commercial mortgages that investors would be “fools” to take on, because the debt would be more troubled than it seems, said Barry Sternlicht, chief executive officer of Starwood Capital Group Global, LLC, a real-estate investor in Greenwich, Connecticut.

“The only things they’re going to try to sell is stuff you probably shouldn’t buy,” Sternlicht said, speaking on the same panel as Appel.

Legacy Impact

The TALF and PPIP plans contributed to a rally among many types of home-loan bonds. Typical prices for the most-senior prime-jumbo securities jumped to about 83 cents on the dollar on May 14, from about 63 cents March 19, before steadying, according to Barclays Capital. Similar bonds backed by Alt-A loans with a few years of fixed rates rose to 45 cents, from 35 cents, according to the bank’s reports. Alt-A mortgages fall between prime and subprime in terms of expected defaults.

“Just the announcement of legacy RMBS being included in TALF has already had a major impact,” Roger Lavan, a portfolio manager in New York at Stone Harbor Investment Partners LLP, a fixed-income asset manager, said in an e-mail today. “Not including legacy RMBS in TALF would be a big mistake.”

Commercial-mortgage “legacy securities are the alternative” to making new loans, David Twardock, president of Prudential Mortgage Capital Company, a unit of Newark, New Jersey-based insurer Prudential Financial Inc., said during the conference panel. After S&P’s downgrade announcement, “it’s unclear now what that picture would look like” because yields on older bonds rose making them more attractive investments, he added.

PPIP ‘Summit’

Sifma billed the conference today as a PPIP “Summit.” Less than 48 hours after a Sifma event last November on U.S. purchases of assets under the Troubled Asset Relief Program where former TARP head Neel Kashkari spoke, the Treasury Department abandoned those plans, Tim Ryan, the New York-based group’s president, noted in his opening remarks.

“This time, though, the FDIC did us a favor and announced they may not need the legacy-loan piece of PPIP before our summit,” he said.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net

Last Updated: June 4, 2009 15:07 EDT