11th district cost of funds index cofi

What Is 11th District Cost of Funds Index (COFI)?

The 11th District Cost of Funds Index (COFI) was a monthly financial benchmark that reflected the average interest expense incurred by savings institutions located in the 11th Federal Home Loan Bank District, which encompassed Arizona, California, and Nevada. As a key component within the broader category of interest rate benchmarks, COFI served primarily as an index for adjusting the interest rates on many adjustable-rate mortgages (ARMs) and certain other variable-rate loans, particularly in the western United States. It measured the actual cost of funds for these financial institutions, including interest paid on customer deposits and other borrowed money. The 11th District COFI was known for its relatively stable and slower-moving nature compared to other indices, often lagging general market interest rates.

History and Origin

The 11th District Cost of Funds Index was first introduced in December 1982, though its roots can be traced back to a semiannual weighted average cost of funds. The Federal Home Loan Bank of San Francisco (FHLBSF) pioneered the concept, becoming the first Federal Home Loan Bank to publish a monthly cost of funds index in August 1981²⁴. This innovation provided a new transparent mechanism for mortgage lenders in the region to tie their adjustable-rate loans to their actual cost of attracting and holding funds. For decades, the 11th District COFI became a prevalent index for adjustable-rate mortgage products, especially in California, where more than half of savings institutions' loans were once tied to it²², ²³. However, due to significant changes in the banking industry, including consolidation and mergers that diminished the number of reporting firms, the Federal Home Loan Bank of San Francisco ceased publishing the COFI on January 31, 2022, with its last reported value being for December 2021²¹.

Key Takeaways

• The 11th District Cost of Funds Index (COFI) was a regional interest rate benchmark based on the average cost of funds for savings institutions in Arizona, California, and Nevada.
• It was primarily used to determine the interest rate adjustments on adjustable-rate mortgages (ARMs) and other variable-rate loans, particularly in the western U.S.
• COFI was known for being a "lagging indicator," meaning it reacted more slowly to changes in overall market interest rates compared to other indices.
• The Federal Home Loan Bank of San Francisco (FHLBSF) discontinued publishing the 11th District COFI on January 31, 2022, due to a decline in the number of contributing financial institutions.
• For existing loans tied to COFI, Freddie Mac introduced a replacement index called the Enterprise 11th District COFI Replacement Index.

Formula and Calculation

The 11th District Cost of Funds Index was calculated as a weighted average of the interest expenses incurred by participating financial institutions on their various sources of funds. These sources primarily included interest paid on customer deposits, such as checking and savings accounts, as well as interest paid on other borrowings²⁰.

While a precise, universally published algebraic formula for the 11th District COFI was not provided, its methodology involved calculating a ratio of the total dollar amount of interest paid during a month to the average dollar amount of funds held by the institutions for that month¹⁹. This approach ensured that larger sources of funding, like customer deposits, had a greater impact on the index value, contributing to its stability and delayed response to rapid market interest rates fluctuations¹⁸.

Interpreting the 11th District Cost of Funds Index (COFI)

Interpreting the 11th District Cost of Funds Index primarily revolved around its application in adjustable-rate mortgages. For an ARM, the interest rate is typically determined by adding a fixed margin set by the mortgage lenders to a fluctuating index rate¹⁶, ¹⁷. A higher COFI value would lead to higher monthly payments for borrowers whose loans were tied to this index, subject to any rate caps¹⁵. Conversely, a decrease in the COFI would result in lower payments.

A key characteristic of the 11th District COFI was its lagging nature; it generally reflected market interest rates from one to two months prior¹⁴. This meant that during periods of rapidly changing interest rates, a COFI-indexed loan's payments would adjust more slowly than those tied to more volatile indices. This characteristic was often seen as a benefit by borrowers seeking payment stability, as it provided a more gradual adjustment to their loan adjustments¹³.

Hypothetical Example

Consider a hypothetical adjustable-rate mortgage (ARM) originated in 2010, tied to the 11th District Cost of Funds Index (COFI) plus a margin. Let's assume the loan has a margin of 2.50%.

• Scenario 1: Stable COFI

  • In January 2015, the 11th District COFI is 0.65%.
  • The borrower's interest rate for the upcoming adjustment period would be: $$\text{Interest Rate} = \text{COFI} + \text{Margin}$$ $$\text{Interest Rate} = 0.65\% + 2.50\% = 3.15\%$$
  • Based on this rate, the monthly principal and interest payment would be calculated.

• Scenario 2: Rising COFI

  • A year later, in January 2016, economic conditions have shifted, and the 11th District COFI has slowly risen to 0.80%.
  • The borrower's new interest rate would become: $$\text{Interest Rate} = 0.80\% + 2.50\% = 3.30\%$$
  • This slight increase in the index would lead to a modest rise in the borrower's monthly mortgage payment, reflecting the increased borrowing costs for the financial institutions that comprise the index.

This example illustrates how the 11th District COFI directly influenced the interest burden for borrowers with linked loans, demonstrating its role in real estate finance.

Practical Applications

Historically, the 11th District Cost of Funds Index (COFI) had significant practical applications, predominantly within the real estate and lending sectors, especially in the western states of Arizona, California, and Nevada. Its primary use was as a benchmark for adjustable-rate mortgages (ARMs). Mortgage lenders widely adopted the 11th District COFI for these loans, where the interest rate would periodically reset based on the index's movements plus a predetermined margin¹². This provided a transparent, albeit lagging, mechanism for borrowers' interest rates to reflect the underlying cost of money for their lenders.

Beyond residential mortgages, the COFI was also sometimes used for certain business loans and other forms of variable-rate real estate financing, giving businesses and property investors insights into regional borrowing costs¹¹. While the original 11th District COFI has been discontinued, the concept of a cost of funds index reflects how financial institutions price their lending products based on what they pay to attract deposits and other funds. Understanding the historical application of COFI provides context for how adjustable-rate loans are structured and how different indices affect borrower payments¹⁰.

Limitations and Criticisms

The 11th District Cost of Funds Index, while widely used for a period, faced several limitations and criticisms that ultimately contributed to its discontinuation. One primary criticism was its nature as a lagging indicator⁹. Because it reflected the average interest paid on a mix of deposits and borrowings that often had various maturities, the 11th District COFI reacted more slowly to changes in overall market interest rates than other benchmarks like Treasury yields or the prime rate. This slow response meant that borrowers might benefit from lower rates for longer during periods of rising rates, but conversely, they would experience delayed rate decreases when market rates fell. This inherent volatility could create payment uncertainty.

Furthermore, the calculation of the index relied on data from a decreasing number of savings institutions within the 11th District⁸. Over time, consolidation, mergers, and changes in bank charters led to a significant reduction in the number of firms contributing data. This dwindling participation raised concerns about the index's representativeness and robustness, as it became less reflective of the broader cost of funds across a diverse group of financial institutions⁷. These structural changes to the banking industry eventually rendered the 11th District COFI unsustainable as a reliable benchmark, leading the Federal Home Loan Bank of San Francisco to cease its publication in January 2022⁶.

11th District Cost of Funds Index (COFI) vs. Secured Overnight Financing Rate (SOFR)

The 11th District Cost of Funds Index (COFI) and the Secured Overnight Financing Rate (SOFR) are both interest rate benchmarks, but they differ significantly in their scope, underlying methodology, and current relevance in financial markets.

The COFI was a regional benchmark reflecting the cost of funds for specific financial institutions, particularly prevalent in adjustable-rate mortgage markets in the western U.S. In contrast, SOFR is a broad, transaction-based benchmark that emerged as the preferred alternative to the London Interbank Offered Rate (LIBOR) due to its robustness and large underlying volume of transactions³, ⁴. While COFI served its purpose for many years within a niche market, SOFR represents a modern, more resilient standard for pricing a wide array of financial products globally.

FAQs

What was the primary use of the 11th District Cost of Funds Index?

The 11th District Cost of Funds Index (COFI) was primarily used as an index for adjusting the interest rates on adjustable-rate mortgages (ARMs) and other variable-rate loans, especially in Arizona, California, and Nevada. It helped mortgage lenders determine how to adjust loan adjustments based on their own borrowing costs.

Why was the 11th District Cost of Funds Index discontinued?

The 11th District COFI was discontinued in January 2022 because the number of financial institutions contributing data for its calculation significantly decreased over time due to industry consolidation and other factors. This made the index less representative and robust².

How did the 11th District COFI affect adjustable-rate mortgages?

For an adjustable-rate mortgage (ARM) tied to the 11th District COFI, the interest rate would periodically reset based on the current index value plus a fixed margin. If the COFI increased, the borrower's interest rate and monthly payment would typically rise, and vice-versa, subject to any rate caps specified in the loan agreement¹.

Was the 11th District COFI a good indicator of overall market interest rates?

The 11th District COFI was generally considered a lagging indicator of overall market interest rates. This meant it reacted more slowly to changes in the broader financial markets, which could offer stability to borrowers during periods of rising rates but also delay the benefits of falling rates.

What replaced the 11th District Cost of Funds Index for existing loans?

For existing loans that were tied to the discontinued 11th District COFI, the Federal Home Loan Mortgage Corporation (Freddie Mac) created a replacement index called the Enterprise 11th District COFI Replacement Index. This new index is intended to provide a consistent benchmark for those legacy loans.