Dan Yates, president of Regents Bank, says the overall impact of the mortgage crisis on business clients has been more negative than in the last 10 years. (photo/lambertphoto.com)

Like a chain reaction pileup on Interstate 8, the Mortgage Mess of 2007 is gradually impeding the progress of all kinds of traffic. Commercial bankers are sitting behind the wheels of their souped-up, growth-fueled lending machines, wondering how long they’re going to be caught in the slowdown. With the exception of Bank of America, Wells Fargo, Washington Mutual and credit unions (see sidebar), most San Diego lenders have steered clear of the mortgage crisis, mindful of the residential real estate debacle in the 1990s that wrecked high-performance vehicles such as Home Fed.

Commercial lending demand is slowing because much business expansion is dependent on the products and services that flow from the housing industry.

“We’ve been talking to our business clients to see how they have been impacted, and the overall feedback is more negative than it has been in the last 10 years,” says Dan Yates, president of Regents Bank. “Clients connected to residential real estate could range from a distributor of tools used in construction, or architecture, or the trades — business that on the surface doesn’t seem related to home building, but is two or three steps removed. As consumer confidence wanes, it can affect a lot of businesses.”

As clients’ revenues decrease, banks experience a reduction in the use of credit lines for equipment and expansion, though like that slow motion traffic jam, it is a delayed reaction.

“We could see in the future a slowdown in our growth, though this year we expect earnings to be up more than 30 percent,” Yates says.

In the meantime, bankers have been sorting through the uncertainty with an eye on how much the slowdown might affect the value of existing deals and how much underwriting should be tightened on deals under consideration.

“We are slicing and dicing data from different perspectives, looking at our portfolio from a lot of different angles,” says Yates. “We’re reviewing appraisals more frequently for loans already on the books, doing internal testing to ‘stress test’ our loans. We run through various hypotheticals, asking what would happen if rates went up 200 points, or if rents drop, to see the impact on different clients. For loans already on the books it’s more critical. If there are weak areas, we want to see if clients have contingency plans in place, rather than wait for problems to develop after the fact.”

Lenders are generally discounting the effect of the mortgage mess on the value of property in their portfolios; they’re banking on the business cash flow.

“Appraisals and collateral are important,” says Yates, “but if it’s income property, you still have to look at the quality of tenants, vacancy rate and consistency of leases.”

The market turbulence is not stopping San Diego Trust Bank from opening its first branch this month in Encinitas in the original headquarters of Southwest Community Bank. Southwest sold to Wells Fargo last year, and San Diego Trust President Mike Perry says the office’s staff in deposit-rich Encinitas was pursued by eight competitors.

Other lenders are finding opportunity in the downturn from borrowers who once spurned them.

“We’re seeing more opportunities among people that didn’t originally want our deal,” says Robert Horsman, president of San Diego National Bank. “They’d say, ‘I’ve got conduit financing (through a larger lender),’ but that financing has been drying up, and those people are coming back for the deal we talked about.”

That deal is likely to include tighter underwriting criteria, even in the midst of what Yates calls “fierce competition.” Most bankers say they maintain conservative lending criteria in good times and bad, but in bad times avoiding the temptation of lower credit quality is job one.

“We began tightening our lending criteria about 12 months ago,” says Gary Cady, president of Torrey Pines Bank. Lowering loan to value ratios on deals is one way of protecting the bank going in, but Cady says business lenders shouldn’t unduly worry about existing deals going south.

“The repayment is driven by underlying viability of the business, and while collateral is a factor, as long as the cash flow is there, they pay the loan,” he explains. “In an SBA loan, you have government support in a 504 (business property) deal. SBA is a good risk because the property is owner occupied.”

“We haven’t changed, but then we’ve always been tight in our underwriting criteria,” says Paul Rodeno, president of Downtown’s Security Business Bank. “We’re always looking for clients with strong sponsorship, but now industries that are being impacted by the housing market we’re giving a real hard look to.”

Although executives know what steps to take to insulate their banks from problem loans, they’re less sanguine about how long the downturn will last and government efforts to stimulate demand.

“There’s so much uncertainty that everyone’s afraid to make the next move,” says Joseph Benoit, market president of the San Diego region for Union Bank. “The Dow takes a nosedive on a bank run in the U.K. on a bank I’ve never heard of. So the question is how do you project ’08 on a realistic basis?”

San Francisco-based Union is among the commercial lenders in town with exposure to the mortgage mess, but Benoit says the bank’s credit quality remains largely unaffected. “I’m sure we’ve had a handful of foreclosures, but we never did sub-prime,” he explains.

Although there is a lot of of housing-related industry in the region, says Benoit, the weather, Fed cuts and the military are layers of protection from a recession.

Vince Siciliano, president of 1st Pacific Bank, discounts the effect of rate cuts on loan demand.

Vince Siciliano, president of 1st Pacific Bank, discounts the effect of rate cuts on loan demand. “We’re in a very interesting time,” he says. “You have passionate arguments over interest rates as a stimulus, but I can’t imagine it makes any difference. Increasing liquidity in the short term won’t affect jumbo (mortgage) loans. That’s going away because investors seriously doubt the ratings of the securities, and that’s not going to be fixed by rate cuts.”

Already squeezed by years of thin margins, banks face the prospect of lighter loan demand, competitive deal pricing and increased risk to credit quality.

“The current market is going to affect our forecasts going forward,” says Rodeno. “Those 25 percent growth rates are going to be harder to achieve and not reasonable to budget.”

Some of the results bankers will report in early ’08 will be based on decisions made in better times. “We were all smart bankers when the economy was strong,” says Cady. “Now we’ll find out how smart we really were.”