Thanks for all the replies. First, the water heater isn't connected to the genny. There has never been excessive cranking of the genny, it starts almost on the first crank, every time. The mechanic was convinced the water in the engine was fresh water. We drained the muffler and he tasted salty water there.
I had an email from one of the fellows here and he had a similiar situation that may be my problem. His flush valve for the watermaker had a slow leak AND he had the seachest thru-hull valve closed. Since the flush valve was slowly leaking it eventually pressurizes the seachest and then the seawater system, which includes the genny. He noted the genny is lower and will fill first.
The Yanmar appears to be fine, the oil level is below the high mark and doesn't appear murky. I'm going to change the oil there anyway to be sure there isn't water in it.
This has the benefit of explaining the freshwater in the engine. I wonder why I don't have water coming out the airconditioning thru-hull though. Maybe it can't get past the pumps impeller?
This makes a lot of sense to me, what do all of you think?
One take-away here, don't leave the seachest valve closed when you haul-out, if you're going to use the freshwater pump. During our last haul-out it was left open.