A California bank holding company's decision to collapse its thrift into its bank subsidiary points up a concern that the inherent risks in the thrift business don't jive with the banking industry.

Officials of Santa Rosa-based Redwood Empire Bancorp hope the move to consolidate Allied Bank into National Bank of the Redwoods will reduce the company's interest rate risk and allow it to focus on its more profitable commercial-banking activities.

The $535 million-asset company has already begun to cut back on Allied's wholesale mortgage banking activities to ensure it doesn't have too much capital invested in a business line that can skew earnings significantly. But officials still plan to maintain the thrift's subprime and retail mortgage lending.

The combined bank will be the eighth-largest community bank in northern California, with nine branches and four loan production offices.

Redwood Empire's situation is somewhat unique in that Allied is less of a traditional thrift than it is a wholesale mortgage bank, analysts said. About 85% of Allied's business is in broker-originated "A" mortgages, with additional lending now in construction, retail mortgages, and subprime lending.

"The issue is not so much that it is a thrift, but that it is a mortgage bank that focuses on the wholesale business," said Raymond Cabillot, analyst at Piper Jaffray Inc. in Minneapolis. "That's not a terribly profitable business.

As many of the larger thrifts are venturing into more banklike products and services to boost profits, some of the banks that own separate thrift subsidiaries - a rare breed - are examining steps similar to Redwood's in an effort to cut costs and boost profits.

Homeland Bancshares, Waterloo, Iowa, and Kalispell, Mont.-based Glacier Bancorp, for example, have considered merging their thrift subsidiaries with the banks, Mr. Cabillot said. And Honolulu-based CB Bancshares announced in October that it would merge its bank and thrift subsidiaries.

Glacier officials couldn't be reached for comment. Homeland has been restricted by federal regulations in what it can offer through its thrift, but the $1.2 billion-asset company is holding off because it can use the thrift's branching powers to circumvent restrictive state laws. Homeland is also slated to be acquired by St. Louis-based Magna Group Inc.

Redwood Empire's decision stems from losses the thrift suffered in 1994 on loans linked to the 11th District cost of funds index. Officials had failed to manage the risk properly by covering the loans with offsetting hedges, so when rates suddenly skyrocketed, the thrift lost several million dollars on loans held for sale. Redwood Empire had a net loss that year of $3.3 million.

Realizing that too much of the company's capital was in mortgage banking, which is constantly subject to interest rate risk, officials decided to diversify. They sold off some loans, reintroduced residential construction lending, stressed retail mortgages, and ventured into subprime lending.

But even that wasn't enough, so in late 1995, directors decided to shed Allied. "It was a risk that we didn't want so we attempted to sell it," said Patrick W. Kilkenny, president and chief executive of Redwood Empire Bancorp.

But the $150 million a month in mortgage loan volume the thrift was generating wasn't enough to attract a good price in California, so officials decided to fold it into the bank.

The consolidation, which is still awaiting regulatory approval, is expected to be completed by the end of the second quarter of 1997.

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