Provident Bancshares’ plan to close its mortgage unit by yearend illustrates the difficulty lenders have had in turning a profit during the last 18 months, as well as the industry’s dreadful state.

Citing the cyclical and low-margin nature of the business, Provident officials said Wednesday that the unit could not produce revenue growth in line with its other, more profitable operations, leading to the decision to close it. The company will continue to offer mortgages but through an outsourcing arrangement with another lender.

“We got to the point where we felt we were extremely efficient, we did a great job processing and closing the mortgage, we had great customer satisfaction, and we still couldn’t make money in it,” said Jack Novak, group manager consumer lending at Provident Bank. “We determined that this product is too costly, too cyclical, and too low-margin to be consistently profitable at levels that we want.”

Business is bad, most observers and lenders agree. But Provident’s move, the cyclical nature of mortgages aside, begs the larger question of why any company would want to be in mortgages at all.

Neil Bader, chief executive officer of IPI Skyscraper in New York, one of the country’s largest mortgage brokers, said it seems “as if nobody wants to be in the mortgage business anymore.”

Besides narrowing margins, mortgage brokers, which originate more than 70% of loans, are indirectly biting into some lenders’ profits, Mr. Bader said.

“Mortgage brokers have taken over the industry,” he said. “And brokers inherently churn their portfolio — when rates go down a half a percent, the first thing I do is call my customer and refinance him.”

This has resulted in a diminishing of servicing values, formerly the most profitable piece of mortgage banking, Mr. Bader said. Also, mortgage volume reached $1.4 trillion a year ago but will be lucky to break $1 trillion this year, he said.

“The bottom line is that there’s less business right now. You’ve got more people fighting over the same deals, and inherently, that is going to make for a thinner margin” and more competitive industry, he said.

Yet many banks still feel they must offer mortgages. Despite his sweeping comments about the business, Mr. Novak said mortgages are still an important item to offer retail customers.

Gerald Baker, president of First Horizon Home Loan Corp. of Dallas, the mortgage subsidiary of First Tennessee National Corp. of Memphis, said borrowers consider mortgages one of the most valuable products they can get from a bank.

Banks that can attract customers by offering mortgages can also sell them products such as checking accounts, savings accounts, or annuities, he said. If a bank lets a borrower “go down the street to another bank, you’re giving that bank an opportunity to cross-sell to your customer.”

Michael McMahon, an analyst at Sandler O’Neill & Partners, said banks have to offer mortgages. “The question is, what is the best way to offer” them, he said.

The biggest problem today is that many companies do not maintain a balance between production and servicing capacity, Mr. McMahon said. Many have far too much production, which is why they are losing money, he said.

“It’s a result of the incredible market in 1998, and companies have not fully downsized yet,” he said. “Although they’ve been downsizing, it’s like a dog chasing its tail. They cut, but volume keeps falling.”

Large lenders such as Wells Fargo & Co., Bank of America Corp., and Countrywide Credit Industries are generating decent, if not good, mortgage profits because their servicing portfolios are large in relation to their production capacity, Mr. McMahon said.

“But if you’ve got that turned around, and you’ve got production capacity that’s four times what you’re servicing, you’re in a world of hurt,” he said. “And there’s a lot of guys out there like that.”

Pat Flood, president and CEO of HomeBanc Mortgage Corp., an Atlanta originator, agreed that 1998, the last boom year in the mortgage business, has contributed to today’s suffering.

Many banks overinvested in the refinancing boom that year and are only now reevaluating their strategies, Mr. Flood said. The boom created unrealistic expectations for the size of the industry, he said, and too many players joined in.

When the mortgage market collapsed last year, origination operations started to collapse with it, Mr. Flood said. “If your strategy is heavily weighted in refis, you’re already dead. If your strategy is against purchases and refis, you’re dying a slow death.”

The only originators left standing have focused exclusively on the purchase market, Mr. Flood said, but these companies are now feeling the repercussions as the refinancing lenders try to hold on to their business while losing money.

“They are dropping prices to get loans, even if they lose money,” he said. “It’s crippling margins in the business.”

Mr. Bader said that today’s production volume actually is the national market’s normal level and that the industry should not expect a big increase soon.

“This is the real market now, and there will be a lot of shakeout as a result of that,” he said. “Everybody can make money in a good market, just as in the stock market, but when you lose 30% of your volume nationwide, somebody’s going to lose out.”

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