11th District Cost of Funds Index: Understanding Its Mechanism and Impact

A comprehensive guide to the 11th District Cost of Funds Index (COFI), including its definition, calculation, historical context, applicability, and impact on financial markets in Arizona, California, and Nevada.

The 11th District Cost of Funds Index, commonly referred to as COFI, is a monthly weighted average interest rate calculated based on the interest expenses of savings institutions operating within the states of Arizona, California, and Nevada. This index is widely recognized in financial markets, particularly for its use in adjustable-rate mortgages (ARMs).

How COFI is Calculated

COFI is computed by the Federal Home Loan Bank of San Francisco (FHLBSF) and reflects the cost of funds for savings institutions within its 11th District. The calculation involves a weighted average of the interest rates paid by these institutions on various types of deposits, including:

• Savings accounts
• Time deposits (such as certificates of deposit)
• Borrowings

The formula can be expressed as:

$$ \text{COFI} = \frac{\sum_{i=1}^{N} (\text{Interest Expense}_i \times \text{Weight}_i)}{\sum_{i=1}^{N} \text{Weight}_i} $$

where:

• \( N \) represents the number of savings institutions,
• \(\text{Interest Expense}_i\) is the interest paid by the \(i\)-th institution, and
• \(\text{Weight}_i\) is the corresponding weight (amount of funds).

Historical Context of COFI

COFI originated in the 1980s during a period of significant interest rate volatility. It was developed to provide a more stable and predictable benchmark for adjustable-rate mortgages (ARMs). This helped align the cost of funds for lenders with the interest rates charged to borrowers.

Applicability and Impact

Adjustable-Rate Mortgages (ARMs)

COFI is notably used as an index for ARMs, especially in the western United States. Lenders use COFI to determine interest rate adjustments for these loans. Because COFI represents a weighted average of interest rates, it tends to be less volatile than other indices like the London Interbank Offered Rate (LIBOR), providing more stability for borrowers.

Financial Markets and Institutions

Financial markets closely monitor COFI as it reflects the cost of borrowing for savings institutions. Changes in COFI can influence lending rates, the profitability of financial institutions, and broader economic conditions in the states of Arizona, California, and Nevada.

Comparison to Other Indices

COFI is one of several indices used in mortgage lending. Key comparisons include:

• LIBOR (London Interbank Offered Rate): A global benchmark interest rate often used in ARMs, but generally more volatile than COFI.
• Treasury Indices: Reflects U.S. government bond yields and is another common benchmark for ARMs.

The main distinction of COFI lies in its regional specificity and its relatively stable nature.

FAQs

What makes COFI different from other indices?

COFI is region-specific, reflecting the cost of funds for institutions in the 11th District (Arizona, California, and Nevada). It tends to be more stable due to its weighted averaging of interest rates, which can be beneficial for ARM borrowers seeking predictability.

How often is COFI updated?

COFI is updated monthly by the Federal Home Loan Bank of San Francisco.

How does a change in COFI affect mortgage rates?

An increase in COFI generally leads to higher interest rates for ARMs tied to the index, while a decrease can lower ARM interest rates. This impacts monthly payments for borrowers.

References

1. Federal Home Loan Bank of San Francisco. “11th District Cost of Funds Index.” Available at: FHLBSF Official Website
2. U.S. Department of Housing and Urban Development. “Adjustable Rate Mortgages: How COFI Works.” Available at: HUD Official Website

Conclusion

The 11th District Cost of Funds Index (COFI) serves as a crucial benchmark in the financial and mortgage sectors across Arizona, California, and Nevada. Understanding COFI’s mechanism, historical development, and its impact on adjustable-rate mortgages provides valuable insight for stakeholders in the real estate and banking industries.