Randy Krenelka, chief financial officer for Regents Bank, says he’s anticipating two quarter point hikes in the funds rate, which would bring it to 4.5 percent. (photo/lambertphoto.com)

When Alan Greenspan was appointed Federal Reserve chairman by President Reagan in 1987, a gallon of gas cost 95 cents. In the financial thriller “Wall Street,” prototype ’80s stock swindler Gordon Gekko tells his protégé, “It’s all about the bucks, kid. Everything else is conversation.” George Bush the elder is vice president. Soon after Greenspan is appointed, the financial system threatens to come down around his ears, as the Dow freely falls 537 points — a bigger drop than the one that triggered the Great Depression. Greenspan issues this statement: “The Federal Reserve, consistent with its responsibilities as the nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.”

The market rallies, Greenspan rides the tech boom of the ’90s to folk hero status, and enters the national vocabulary for daring to ask, “How do we know when irrational exuberance has unduly escalated asset values?”

It’s the same question before San Diego bankers in 2006, although Greenspan is retiring and being replaced by economics professor Ben Bernanke. Has real estate finally priced itself out? Are short-term rate hikes finally going to slow the economy? Where are long-term rates headed?

“That’s the $64,000 question,” says Gary Cady, CEO of Torrey Pines Bank. “What’s going to happen with long-term rates, which affects us more because we are very active in the owner occupied real estate market and many people at this point are trying to lock into fixed rate product.”

Trouble is, the bank is reluctant to lock in when it doesn’t yet know how much higher rates will climb. So what will Chairman Bernanke do?

“I think it’s hard for us to know the answer,” Cady says. “We’re trying to be prepared either way. We see at least another 50 basis points in the rise in short-term rates, but over what period of time is hard to tell.”

Randy Krenelka, chief financial officer with Regents Bank, also says he’s anticipating two quarter point hikes, which would bring the funds rate to 4.5 percent. “Then it’s a little less clear as to whether there would be a quarter of a percent every time they (the Fed) meet, or whether they’ll take a break mid-2006,” Krenelka says.

The Bernanke factor is hard to figure. “What you’re reading about the guy is a lot of opinions about his history in some other spot than the spot he’s in now,” says Ron Kendrick, San Diego-based executive vice president for San Francisco’s Union Bank. “But once he gets into that spot, things change, so it’s too early to tell what effect he will have.”

Bigfoot Competitors

Bob Adkins, chief executive of Neighborhood National Bank, says smaller community banks can find themselves at a competitive pricing disadvantage with bigger banks that can afford to charge borrowers lower or fixed rates. (photo/lambertphoto.com)

Although banks have the opportunity to earn more in a rising interest rate environment, smaller community banks typical of San Diego can find themselves at a competitive pricing disadvantage with mega banks that can afford to charge borrowers lower or fixed rates.

“The larger banks look at it as an opportunity to cherry pick (smaller banks’ customers) if they can by offering more fixed rate type commercial loans,” says Bob Adkins, chief executive of Neighborhood National Bank. “Larger banks have the ability to stretch more without getting into trouble.”

But the Bernanke factor and poaching megabanks aren’t the only bothers for community bankers this year. Business banks could find their customers affected by a consumer spending slump tied to housing.

“A lot of people stretched to get into homes, some with interest only loans, or similarly aggressive loan products,” says Adkins. “There was always the potential in a rising interest rate environment they would come back as problem loans and foreclosures and it’s probably starting to happen now, though it’s not as visible as it will be as we move into 2006.”

Under bankruptcy reform legislation signed by President Bush this fall, minimum payments on credit card balances are expected to rise, and “all of a sudden cash flows get tight and the potential for foreclosures increases,” Adkins explains.

For most San Diego-sized commercial banks not heavy into residential real estate, this is an indirect effect, although Adkins notes that his bank holds second mortgages on homes as collateral for small business loans. “The impact on us from this market is not as great as for institutions that have a bigger part of their portfolio in residential housing,” he says.

Compliance issues are adding to banks’ overhead costs. The biggest item is the Bank Secrecy Act, which is enlisting banks’ cooperation in an effort to cut down on money laundering in cash intensive businesses, such as gas stations, mini marts and check cashing facilities. “The regulations have resulted in many institutions incurring additional costs,” Adkins says. “At Neighborhood, we were able to comply but not without costs. We’ve added a couple of people.”

Adkins says he’s concerned that identity and data theft, counterfeiting, and “taking advantage of electronic systems” leave banks open to more regulation in 2006 and beyond.

Banks also may have to incur additional costs to attract deposits this year. “Despite higher interest rates, loan demand has remained pretty strong,” says Cady. “Where we are finding more of a challenge is in the deposit area. Most banks are seeing loan-to-deposit ratios increasing and that’s true of us, too. There is an industrywide shortage of deposits and that’s a bigger challenge for us than loan demand.”

Rational Exuberance, Anyone?

Ron Kendrick, San Diego-based executive vice president for San Francisco-based Union Bank, says he plans to open six new offices in California this year. (photo/lambertphoto.com)

Gripes aside, San Diego banks are positioning themselves for growth with new branches as San Diego’s overall economy begins 2006 in strong shape. Regents is opening a branch in Carlsbad, a North County complement to its La Jolla and Downtown offices.

Kendrick, who heads up Union Bank’s branch operation from his Downtown office, says he plans to open six new offices in the state this year, part of a five-year plan to bring under-branched Union into the same league with bigger banks. “We’re not of a size where we can rush out and put 25 branches in one community like Washington Mutual,” says Kendrick, “but we have for the last five years opened between seven and 10 offices each year.”

Will business borrowers balk at higher rates? “That will be interesting to see, because we’ve had cheap money for such a long time,” Kendrick says. “There might be some indication of that, because every time there’s a dip in mortgage rates, you see a surge.”

Regent’s Krenelka says he expects “more of the same” from a relatively healthy economy that threw off the effects of Hurricane Katrina in short order. “It’s encouraging to see whatever impact Katrina had seemed to be relatively temporary, which goes to the strength of the economy to weather storms.”

This is hardly what Greenspan would call irrational exuberance but, Adkins says, “as long as we stay with the fundamentals, and maintain loan quality, we should be able to withstand the pluses and minuses of the coming year.”