How a Government Shutdown Would Hurt Banks

WASHINGTON — The banking regulators will remain open in the event of a government shutdown, but the ongoing fiscal battle in Congress could still have significant implications for the financial services industry.

The shutdown will go into effect after midnight on Monday, the end of the fiscal year, unless lawmakers in the House and Senate are able to strike a last minute deal to at least temporarily fund the government for several more weeks.

The two chambers remained at an impasse Monday over House Republicans' efforts to use the fight as an opportunity to defund or delay President Obama's healthcare law. Analysts predicted that the government will likely have to shutter its doors, though for how long is unclear. Such an event raises questions about pending regulations, certain mortgage and small business loans and the broader impact on the economy. Following is our guide to how a shutdown will affect banks.

FHA, SBA, Farm Loans Will Grind to a Halt

Banks that make government-guaranteed small-business, mortgage or farm loans — and customers seeking those loans — will feel the impact of the shutdown immediately.

The U.S. Small Business Administration, the Federal Housing Administration, and the Farm Service Agency, an arm of the Department of Agriculture, will largely stop processing loan applications if the government is closed, resulting in potentially large backlogs at banks that originate the loans.

The SBA said in its 36-page shutdown plan that it will shutter all of its loan programs except one that makes direct loans to home and business owners affected by natural or man-made disasters. In its two main programs, 7(a) and 504, the SBA provided guarantees on more than 55,000 loans last year totaling more than $30 billion in fiscal year 2012 and was on pace to approve similar volumes in fiscal year 2013. The SBA said that nearly 2,200 of its employees, or 62% of its workforce, will be furloughed.

With a shutdown looming, lenders have been feverishly completing loan applications and SBA employees have been working overtime to process them before their offices go dark. Tony Wilkinson, the chief executive at the National Association of Government Guaranteed Lenders, said that the SBA has approved $1.2 billion of 7(a) loan requests in the last two weeks — roughly double the normal level of activity — and was on pace to approve $400 million on Monday alone.

"I'm hearing that they plan to process loans up until 11:30 tonight," Wilkinson said Monday afternoon.

Craig Street, the head of SBA lending at the $56 billion-asset Huntington Bancshares (HBAN) in Columbus, Ohio, said that the impact of the shutdown on the bank and its customers will be directly related to how long it lasts.

"If it's only a few days then the impact would be fairly benign," Street said. "If it were to last longer than a week then it could become problematic."

Complicating matters is that several new SBA rules take effect Tuesday, the start of the new fiscal year, including one that will eliminate fees on all SBA loans of less than $150,000. Business owners that waited to apply for the loans to avoid the guarantee fee will have their applications put on hold until the shutdown ends.

The FHA, meanwhile, will be unable to underwrite and approve new loans, according to a report from the Department of Housing and Urban Development, which oversees the agency. However, Ginnie Mae, which guarantees timely payments to investors in government-insured mortgage-backed securities, will continue operating. Fannie Mae and Freddie Mac also will also be largely unaffected.

For the most part, HUD will maintain minimum operations during a shutdown. As a result, FHA lenders cannot be assigned case numbers for new loans and they take some risk in closing loans since they do not know when the government will reopen. A loan has to be submitted to FHA within 60 days of closing to receive insurance.

"An interruption in operations would create immediate and significant market disruption that would lead to financial losses for investors and increased mortgage rates for government-insured mortgage loans," HUD said in a 67-page report detailing the impact of a shutdown.

Only 350 of HUD's 8,700 employees will be working full-time during a hiatus, HUD said. But the agency anticipated another 400 employees will be able to work on an intermittent basis during the first few days of an appropriations lapse.

The Farm Service Agency, which offers loan guarantees on bank loans to farmers and ranchers, is already dealing with a large backlog of loans that could be made substantially worse by an extended shutdown, said John Blanchfield, the senior vice president at the American Bankers Association's Center for Rural and Agricultural Banking.

The agency, which guarantees roughly $2.5 billion of farm loans each year, has said that it will close all of its field and district offices during a shutdown, and though it will still accept applications online, no one will be around to read them.

Blanchfield said that because the Department of Agriculture has been operating under a continuing resolution all year, roughly 1,000 farm real estate loans — totaling $430 million — have gone unprocessed because the Farm Service Agency is awaiting funding.

Even if the budget crisis is resolved, there might not be much money left over to fund new loans, Blanchfield said.

"Any new money will be used to fund the backlog, so we could be right back in a backlog situation," he said.

The Volcker Rule (and Other Regs) Will Be Delayed

The primary banking regulators, including the Federal Reserve Board, the Office of the Comptroller of the Currency, the Consumer Financial Protection Bureau and the Federal Deposit Insurance Corporation are all poised to remain open in the event of a shutdown, because none are subject to the federal budget. But two key agencies, the Securities and Exchange Commission and the Commodity Futures Trading Commission, could both be forced to close if lawmakers don't come to a resolution — potentially hamstringing several interagency efforts, including the Volcker rule and a host of derivatives rules that have yet to be finalized.

The SEC said Monday that it has additional funds to remain "open and operational" on Oct. 1 if a government shutdown occurs, but it's uncertain how long that money would last. The agency remained open during the entirety of the last government shutdown, which lasted for 21 days starting in December 1995.

Still, there is "some distraction inevitable" in the event of a possible shutdown, said David Lynn, a partner at Morrison Foerster and former chief counsel at the SEC's Division of Corporation Finance, who was at the agency in the mid-1990s during the last budget battle. "Human nature kicks in and some of the time you're worried about making your mortgage payment" if the agency does have to close, along with the internal meetings and other procedural work that goes into preparing for a possible shutdown.

The CFTC will implement its shutdown plan on Tuesday if the government is not funded, a spokeswoman confirmed on Monday. Only "essential" employees would be permitted to work in the case of a shutdown — just 6% of SEC staff and 4% of CFTC staff, according to shutdown operating plans the two agencies published last week.

Functions that would remain ongoing "include those related to emergencies involving the safety of human life or the protection of property, including law enforcement functions; those for which there is an express authority to continue during an appropriations lapse; and those for which authority to continue during an appropriations lapse arises by necessary implication," the SEC said in its plan, issued Sept. 27.

Such operations would not include day-to-day work like the writing of regulations, such as the long delayed Volcker rule, which would impose a ban on propriety trading at commercial banks. The rule, first proposed in 2010, is still being drafted by five agencies, including the SEC and CFTC.

Comptroller of the Currency Thomas Curry pledged last week at American Banker's Regulatory Symposium that regulators would issue the rule by the end of the year, a deadline that could be difficult to meet if key staff are delayed for several weeks due to a shutdown. The rule is now in its final stages and rests in the hands of several dozen staff economists at the SEC to calculate the costs and benefits of its numerous and complex provisions, Bloomberg reported Monday morning.

The SEC and CFTC have also been working to implement a host of key derivatives rules under the Dodd-Frank law, and the SEC is separately pursuing reforms to money market mutual funds — work that would stop in the wake of a government shutdown, in addition to work on pending enforcement actions.

"People are basically prohibited from working — as an employee, you can't take work home and do it from there," said Lynn.

Brian Gardner, an analyst with Keefe, Bruyette & Woods, said that timing delays would become more apparent the longer a shutdown lasts.

"If it goes on for several weeks, then you start to see an effect on the timing of rules that need to be finalized," he said.

Shutdown May Hurt Broader Economy

Analysts also warned that the ongoing budget fight could have wider implications for the economy beyond the impact on specific agencies and programs.

"We see no upside for financials or housing in a shutdown," said Jaret Seiberg, a policy analyst at Guggenheim Securities, in a note to clients Monday. "Any benefit from delayed rules or fewer enforcement actions is greatly offset by the risk that a shutdown could weaken consumer confidence and slow economic growth."

As is the case with more specific issues, the key question is how long the looming shutdown lasts. Estimates range from a few hours to several weeks — a particular cause for concern because the U.S. is expected to reach its debt limit Oct. 17 unless Congress quickly acts to raise it.

"Our sense is that if the government does shutdown at midnight it will last for either a matter of hours or well into mid-October when the impending debt ceiling deadline will force Congressional action," said Isaac Boltansky, an analyst at Compass Point Research & Trading, in a note to clients Monday. "Congress faces a 'must act' deadline in mid-October which we believe would serve as a catalyst to end a government shutdown if it were to last that long."

Still, Seiberg warned in his note that if the two events merge it could create "an even bigger mess."

"Our view remains that the market is underestimating the overall risk with both the budget and the debt limit," he said.

Kate Berry contributed to this story.