In a stark sign of the downturn in home lending, Bank of New York Co. is poised to liquidate its sizable mortgage unit.

After failing to find a buyer for its Arcs Mortgage, Bank of New York has decided to shut down the unit's production offices, lay off most of its 500 employees, and sell a $9 billion servicing portfolio, according to sources close to the unit.

A Bank of New York spokesman said the company "is reviewing the entire Arcs operation, and that may result in a reconfiguration." He said, however, that reports of a shutdown were "premature."

Arcs, based in Calabasas, Calif., has been for sale since at least July, but interest has been tepid, with potential buyers scared off by a brutally competitive market. Analysts say that industrywide mortgage originations are running at just 60% of volume seen during the refinance boom two years ago.

Despite the rocky conditions, some players think they can profit by focusing on niches. American Express Co., for example, has just teamed up with Prudential Home Mortgage Co. to offer mortgages to American Express cardholders. (See article, page 8.)

Most lenders, however, are facing decidedly tough times. While the value of mortgage servicing businesses has surged in recent months, originations networks are viewed as drags on earnings. Price competition is as "murderous as at any time in living memory," said a mortgage banker.

The result, evidently, is that many mortgage banks are now worth more dead than alive.

"Bank of New York realized that they will end up with more cash if they shut the place down than take the bids that they received," said a mortgage banker close to the situation.

Observers believe that Bank of New York will continue to originate home loans from its banking branches.

"Mortgages are not a core business for Bank of New York," said James P. Hanbury, an analyst with Wertheim Schroder & Co. "While the bank likes fee income, the business is so volatile. Anybody in it is forever ramping up or ramping down."

Arcs Mortgage has about 45 production offices, most on the East and West Coasts. The unit produced $1.1 billion of loans in the first half of 1994. Arcs, headed by Howard Levine, has been widely cited as a well-run, traditional mortgage bank.

The $9 billion of home-loan servicing rights comprise some 86,000 loans. Based on recent sales, the portfolio could fetch between $90 million and $120 million.

Bank of New York has been scouting for a way out of the mortgage banking business for several years. In 1992 the bank filed a registration statement to sell Arcs stock to the public, but pulled back when the market soured.

An especially striking aspect of the nascent move is the fact that most of Arcs Mortgage's production is retail, a channel that has thus far held its value better than wholesale or correspondent production. According to one banker who lends to the industry, retail has become as unprofitable as wholesale, or even more so.

As the news made the rounds, many mortgage executives were asking themselves if the Arcs scenario could spread to other mortgage banks.

One Wall Street executive compared the situation to that in the late 1980s when, after a downturn in originations, mortgage franchises rapidly lost value. "There just wasn't a bid for originations. People were paying buyers to take it off their hands."

Arcs will not be the first to try such a strategy in the current downturn. In December, Household Finance shut down its loan production offices and fired 200 employees. Some smaller, privately held mortgage businesses are said to be choosing to shut down after failing to find buyers.

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FARMINGTON HILLS, Mich. - Source One Mortgage Services Corp. reported a net loss of $43.5 million for the year ended Dec. 31.

The loss includes the effects of a $68.1 million pretax charge, recorded as a cumulative adjustment as of Jan. 1, 1994, relating to the way the company measures impairment of its purchased mortgage servicing assets.

The new accounting method measures the asset's impairment on a disaggregated basis and discounts the asset's cash flow using a current market rate.

Rising interest rates have generally led to a longer life and thus a higher value for servicing rights. But Source One's writedown is for the period before rates began rising last year and appears related to the high rate of prepayments at the time. The company's servicing portfolio stood at $39.6 billion at yearend.

Excluding the effects of the accounting change and investment transactions, net income was $4.4 million for 1994, compared with $20.8 million for 1993.

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