Government shutdown increases mortgage lender credit risk: Moody's

The government shutdown could affect mortgage origination credit quality as lenders miss some red flags normally found using data that is not currently available, according to a report from Moody's.

"To replace origination processes that are out of commission or at reduced capacity during the shutdown, lenders will need to create more cumbersome or manual workarounds that may result in errors or, in the extreme case, instances of fraud," which makes the shutdown a negative for all mortgage originators, the Moody's report said.

Lenders would need to develop workarounds to verify Social Security numbers. Even though the Internal Revenue Service said it would process requests for tax transcripts as of Jan. 7, there is an initial backlog to get through, which could be exacerbated if staffing to fulfill requests is reduced. That could lead lenders to ask the borrower directly for this information to underwrite the loan, increasing fraud risk, Moody's said.

"Additionally, in the event that the shutdown becomes prolonged, this and other government systems that are currently working, such as federal flood insurance, are at risk of shutting down. In such an event, lenders may need to obtain flood insurance from alternative private lenders, a switch that could result in higher costs or, in some cases, the lack of insurance," the report said.

In particular, the shutdown is a negative for nonbank lenders because they could end up not being able to sell a small percentage of their loans to the secondary market. For example, mortgages made to federal workers would be unsalable because of the inability to verify their employment, Moody's said.

As a result, nonbanks could see some "modest balance sheet strain," the report continued.

"To mitigate some of the increased risk and processing costs from the shutdown, we believe that originators will curtail, if not eliminate, originating certain loan products, such as loans to government employees, during the shutdown," Moody's said.