Stung by lower-than-expected volume and higher long-term interest rates, Redwood Empire Bancorp of Santa Rosa, Calif., said it is quitting the residential mortgage business.

Redwood Empire, with $432 million of assets, said the three-year-old division has lost $600,000 this year. The company said it plans to spin off the unit by the fourth quarter.

"The business is not meeting our expectations," said Patrick W. Kilkenny, president and chief executive officer at Redwood Empire. "We no longer want to have the risks associated with mortgage banking."

Though Redwood Empire's commercial banking and merchant bank card operations are doing well, the company said losses in its mortgage unit have hurt earnings.

For the first six months, Redwood Empire earned $2.2 million, or 64 cents per share, compared with $2.3 million, or 67 cents per share, a year earlier.

The mortgage unit's losses can be traced directly to the rise in interest rates, which has slowed both originations and refinancings.

From the end of the first quarter through the end of the second, new- home spending grew only 5.1%, according to the Commerce Department. New- home spending had been up 15.4% in the first quarter from the preceding one.

And the Mortgage Bankers Association of America has forecast that single-family housing starts would drop 2.4% at a seasonally adjusted annual rate this quarter and 4.5% in the fourth quarter.

Meanwhile, applications to refinance mortgages fell by 48% in the second quarter.

"The refi market has collapsed," said Brian Carey, an economist at the Mortgage Bankers Association.

Mr. Carey added that fierce rate competition is also starting to drive out smaller players.

Until the recent downturn, Mr. Kilkenny said, Redwood Empire's mortgage division accounted for 20% of the company's revenues. The company aims to recover this revenue by reducing unspecified costs and increasing the bank's core business.

Redwood Empire is not the only California commercial bank company struggling to make money in mortgage lending.

Laguna Hills, Calif.-based Eldorado Bancshares said last month that it is debating whether to stay in the business because its loan volume has fallen 50% below projections.

That dropped second-quarter earnings below expectations. The company earned $1.5 million, or eights cents per share, in the quarter, compared with $1.8 million, or 15 cents per share, a year earlier.

Eldorado, with $1.3 billion of assets, said it plans to lay off loan officers and cut overhead in its residential mortgage unit. The company has slashed its residential division payroll by 9% since May.

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