By P.J. Huffstutter

CHICAGO (Reuters) - The U.S. government's $2.65 billion operating loan program for farms is close to running out of funds as cash-strapped grain farmers and cautious banks have rushed to shore up capital to survive the industry's worst downturn in more than a decade.

The U.S. Department of Agriculture's Farm Service Agency funding for direct loans or guarantees are expected to be depleted by the end of June, about three months before the next year's program restarts Oct. 1, USDA officials told Reuters on Tuesday.

It is the second year in a row that money has dried up before the end of the fiscal year, the latest sign of a credit crunch as commercial banks and lenders have reined in lending to farmers, already hurt by sinking grains prices.

That has forced farmers to turn to federal help to ride out the global grains downturn.

Commercial banks and lenders have also scrambled to get guaranteed operating loans, which ensure that as much as 95 percent of the farm's operating loan will be backed by the government.

A recent rebound in crop prices, with soybeans up 37 percent since early March and corn up 23 percent, has not cooled demand.

These FSA loan guarantees and direct loans are often considered to be loans of the last resort, say banking experts. Without the financial support, some farmers may struggle to survive until the next cash injection in the fall, say rural economy experts.

In the past, such lending typically focused on smaller or new farmers with fewer resources.

But as grain prices plummeted early this year, and economic erosion continues to squeeze Midwest farmers' capital expenditures and pressure farmland values, a growing number of agricultural lenders turned to the federal government, FSA staff said.

As of the end of May, applications for operating loans to the FSA were up 23 percent, while funding obligation has jumped 19 percent, compared to a year earlier, according to agency data.

The applications continue to roll in even from farmers that have not needed FSA loans in the past, said Edwin Elfmann, vice president of government relations at political affairs at the American Bankers Association.

USDA officials and banking experts estimated that the backlog of applications by October could be as much as $650 million.

Banking and agricultural groups have pleaded for help from House and Senate appropriations committees, but have received no clear response yet, Elfmann said.

(Reporting By P.J. Huffstutter. Additional reporting by Mark Weinraub in Washington D.C.)