11th District Cost of Funds Index (COFI)

The 11th District Cost of Funds Index (COFI) is a regional economic indicator that primarily affects the lending economy, particularly in the western United States. This index represents the weighted average interest rates paid by savings institutions on deposits and advances. It’s issued by the Federal Home Loan Bank of San Francisco (FHLBSF). COFI is used extensively in the calculation of interest rates for adjustable-rate mortgages (ARMs), thereby influencing mortgage payments for a significant number of households.

Background and Definition

What is COFI?

COFI stands for the 11th District Cost of Funds Index. It was developed to provide a standardized measure of the cost of funds for lending institutions within the 11th Federal Home Loan Bank District. This district includes the states of Arizona, California, and Nevada. The index is designed to reflect the interest costs incurred by these institutions on the funds they utilize for lending purposes.

Origin of COFI

The index was initiated by the Federal Home Loan Bank of San Francisco in 1981. It was aimed at providing a regional benchmark that would help in the standardized calculation of adjustable-rate mortgages (ARMs). By offering a consistent and reliable measure, COFI aids financial institutions in the effective pricing of ARMs.

Composition

COFI is calculated based on the weighted average of interest rates paid by member financial institutions on various categories of deposits and borrowings. This includes:

These components reflect the cost of capital for a blend of funds, providing a comprehensive picture of funding costs for the institutions involved.

Methodology

Data Collection

The data used to calculate COFI is derived from monthly reports submitted by savings institutions to the Federal Home Loan Bank of San Francisco. These institutions report the actual interest expenses incurred on their deposits, as well as other interest-bearing liabilities.

Weighting

Each type of deposit or borrowing is weighted according to its percentage share of the total funds. For instance, if savings deposits constitute 50% of the total funds, then the interest paid on savings deposits will account for half of the index calculation.

Calculation

The index is calculated monthly and released approximately 30 days after the end of the reporting period. The formula for calculating COFI can be simplified as:

[ \text{COFI} = \frac{\sum(\text{Interest Expense}_i \times \text{Weight}_i)}{\sum \text{Total Funds}} ]

where:

This calculation ensures that the index accurately reflects the weighted average cost of funds.

Applications

Adjustable-Rate Mortgages (ARMs)

One of the primary applications of COFI is in the adjustment of interest rates for adjustable-rate mortgages. In these mortgage contracts, the interest rate is periodically adjusted based on the value of a specific index, commonly COFI. Mortgage lenders use COFI to adjust the interest rates on loans, which subsequently impacts the monthly mortgage payments of borrowers.

Financial Institutions

Financial institutions use COFI to evaluate their own cost structures and to benchmark against other institutions. By analyzing COFI trends, banks and savings institutions can make informed decisions about their loan pricing, deposit rates, and overall financial strategies.

Economic Indicators

COFI is also a valuable economic indicator that reflects the broader trends in the cost of funds within the 11th District. Market analysts and economists closely watch COFI as it can provide insights into the health of the lending market, and by extension, the real estate market in the region.

Impact and Reliability

Regional Influence

COFI primarily influences financial activities within the 11th Federal Home Loan Bank District. However, due to its role in mortgage pricing, its effects can be seen beyond these borders, especially in cases where lenders operate nationwide but base their mortgage products on COFI.

Reliability and Stability

One of the strengths of COFI is its reliability and stability. It tends to be less volatile compared to other indices like the London Interbank Offered Rate (LIBOR). This stability makes COFI particularly appealing for long-term financial products such as mortgages.

Criticisms

Despite its benefits, COFI is not without criticism. Some argue that it may not fully capture rapid changes in interest rates due to its method of averaging over various types of funds. Consequently, it may lag in reflecting the immediate cost conditions faced by lending institutions.

Historical Performance

COFI has shown various trends over the years, often reflecting broader economic scenarios such as inflation rates, Federal Reserve policies, and regional economic conditions. During periods of rising interest rates, COFI tends to increase, leading to higher mortgage rates for borrowers.

As of recent years, COFI has been influenced by the overall low-interest-rate environment, largely stemming from Federal Reserve policies aimed at stimulating the economy. This has resulted in relatively low COFI values, which has benefited borrowers with adjustable-rate mortgages tied to COFI.

Future Outlook

Looking ahead, the future trajectory of COFI will likely be influenced by macroeconomic policies, particularly those enacted by the Federal Reserve. Changes in inflation expectations, economic growth, and monetary policy will all play a crucial role in determining COFI’s direction.

Conclusion

The 11th District Cost of Funds Index (COFI) is a critical tool in the financial sector, particularly within the mortgage market. By providing a standardized measure of the costs incurred by savings institutions on their deposits and borrowings, COFI plays a vital role in the pricing of adjustable-rate mortgages. Its influence extends to both financial institutions and borrowers, making it a significant economic indicator in the western United States.

For more information, you can visit the official page of the Federal Home Loan Bank of San Francisco here.

Detailed understanding and monitoring of COFI are essential for stakeholders in the real estate and financial markets. As interest rates and economic conditions evolve, COFI will continue to serve as a vital benchmark in assessing and managing financial costs and risks.