The COFI explained and the cost of funds index history

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COFI explanation continued:

Cost of Funds Index (COFI)

The COFI is the monthly weighted average cost of funds for savings institutions that are members of the Federal Home Loan Bank System, Eleventh District (the "Bank"). COFI consists of the monthly weighted average cost to members of:


1.	Savings

2.	Borrowings, and

3.	Advances by the Bank

The Bank tabulates and announces COFI on or near the last working day of each month, reflecting the costs for the previous month. For example, the Bank announces the February COFI at the end of March. The new index value will be in effect until announcement of the March COFI at the end of April.

In 1932 the Roosevelt administration created the Federal Reserve Bank. The United States was split up into 12 Lending Districts with 12 Federal Home Loan Banks (FHLB). The 11^th District has 3 states: California, Arizona and Nevada. The 11^th District FHLB is located in San Francisco. The FHLB is to monitor on a monthly basis what each and every Federal Savings & Loan’s expense (cost) is. These costs (expenses) would be what the Savings & Loans are paying back to depositors (people like you and me) on checking accounts, savings and money market accounts, Certificate of Deposits (CDs) and what, if any, the interest rate on any money borrowed from the Federal Reserve Bank itself, i.e. Fed Funds Rate.

This Index only moves in hundredths or thousandths of a percentage point per month. It is the safest and slowest moving index in the country. If you are wondering why the 11^th District is the one being used, it is because its Index moves the slowest out of the 12 districts in the USA. The 11th Districts COF Index has been used for home purchases and refinances since 1981.

Every month Savings & Loans (S&L's) report to the Home Bank what their monthly Cost or Expense will be; or what they are paying back to depositors on their checking, savings, money market accounts and CD's. These S&L's will also borrow money from the Federal Reserve via the Fed. Funds Rate. Hence the interest that they are paying back to the Fed. Bank is also in the monthly Cost Of Funds Index calculation.
It is an expense or a "cost" to a Savings Institutions when they pay "interest" on the monies that are deposited into checking, savings, money market and C/D accounts, and from moneys borrowed.
Every S&L would like to keep their "cost" as LOW as possible. They do this by offering depositors (you and me) as low of an interest rate as they possibly can on our checking, savings and CD's. S&L's & banks display their "cost" on a "Rate Board" (usually located in the lobby.)

Below is an example of how your Bank or S&L calculates its own COF Index:

The first Rate Board #1 is an example of the LOW interest rates (cost) that a typical S&L (bank) would PAY BACK to us on the monies that we've deposited with them.

The second Rate Board #2 is an example of the income the same S&L will make on the money that they LEND OUT. Savings institutions will always lend money to you at a higher interest rate, i.e. credit cards, home equity loans, personal loans, then what they offer to us on our checking, savings, money market accounts and C/D's.

Here is an example of what you might see at your local S&L or bank:

Rate Board #1:
(Cost to the bank or the Rates to entice one to deposit their money - usually located in the lobby entrance)

(Interest rates paid back on deposited funds)

Checking 3.25%

Savings 3.50%

6 month C/D 3.99%

1 year C/D 4.50%

3 year C/D 5.00%

5 year C/D       5.20%
                       _____
                     25.44% divided by 6 = 4.24% or total avg. "cost" or expense on monies deposited.

Rate Board #2
(Revenue on your deposits this bank lends out - located in managers office)

(Interest rates on money borrowed)

Credit cards 15.00%

Personal loans 7.85%

Car loan 6.00%

Home Equity 8.00%

1st mtg.            5.875%
                         ______
                        42.73% divided by 5 = 8.55% or interest income earned on monies lent out from the monies deposited.

As you can see in this example that every S&L (and bank) would like to give you and I the lowest interest rate possible on the money that we've deposited into our checking, savings, money market accounts and C/D's as this keeps their "cost" lower. However they also want to offer us the highest possible interest rates on monies that we borrow from them, e.g., personal loans, credit cards, home equity loans, etc. This is one of the main ways an S&L or bank makes money. Hence, all S&L's want to keep their "cost" as low as possible and their profit as high as possible; the COFI loan is based mainly upon these "cost."

Here is the movement of the four most popular indexes between the years May 1993 to May 1994:

The Federal Reserve increased the Prime Rate (7) seven times between May 93 to May 94.

Q. Why didn't the COFI go up?

A. Banks and S&L's will start to offer higher interest rates on the money that they lend when the PRIME Rate increases, however this increase does not greatly affect the COFI because the majority of the money that is deposited in the 11th district is deposited into checking, savings, money market and C/Ds. And only a small portion of this estimated $250-$300 billion in total funds deposited into the 11^th District on an annual basis is actually borrowed from Federal Government at the Fed. Funds Rate, not the Prime Rate. Most of the money that S&L's borrow is from depositors (people like you and me). This money is deposited into checking and savings accounts, money market accounts and C/D's, and it is not directly affected by a Prime Rate adjustment however if the Prime Rate continues to increase it will eventually have an effect on the COFI.

June - 1994 to June - 1996

Digging deeper into the Cost of Funds Index for 11^th District Savings Institutions:

The below actual monthly calculation (for July 2000) explains in detail why the 11^th District’s Cost of Funds Index doesn't dramatically increase (or decrease) when the Fed. Chairman raises (or lowers) the Prime Rate. You'll note in this example that only about 47% of the estimated Average total funds deposited is borrowed (i.e., Average advances & borrowings) from the Federal Bank via the Fed. Funds Rate which has a lower interest rate than the Prime Rate - (moreover, it takes about 9 months for a Fed. Funds increase or decrease to really effect the over-all economy.) The rest of the "deposits" (est. at $162.3 billion or 52.8% - (see Average deposits) are made up of actual deposits from folks like you and me buying CD's, or placing $ into Money Market funds, checking and savings accounts. In this monthly calculation, try to think of these "deposits" as a big bath tub; turning on the spigot represents (hypothetically) people buying 1, 3 and 5 year C/Ds in these est. 50 institutions making up the 11 District at that time. Let's assume on 07/01/2000, folks were receiving a 2% Rate-Of-Return (ROR) on their 1 yr. C/Ds, 2.5% ROR on a 3 yr., and 4% ROR on a 5 yr. when they mature; but because it takes between 1-5 years for these C/Ds to come to maturity (or drain out of the bath tub), the average cost of funds doesn't move that rapidly even when these same S&L's begin to offer higher returns on their new C/Ds (e.g., turning on the spigot.)

Further clarification: Let's assume on July 2001, these same S&Ls are in a good mood, and they decided (out the kindness of their heart) to start offering CDs at a higher ROR and we will assume the 1yr. C/D is now being offered was 2.5%, the 3yr. increased to 3.5%, and the 5 yr. was now at 4.5%. Back to the "bath tub" analogy, let's now assume that when we "turn on the spigot" (a year later) these higher CDs are spilling into this bath tub, or pool of monies borrowed - (this of course means these same S&Ls will have to increase their cost of doing business, or cost of funds, which they do not like to do....) But because the first C/Ds coming to maturity (from our 07/01/2000 example) are the 1 yr. CD and are only paying back a 2% ROR, the actual "cost of funds" to these S&L's are just for the CDs (and other deposits) coming to maturity (or going out of the bath tub drain) which doesn't really affect the entire (average) pool of money because it will take another 1 year for the new 1 yr. CD at 2.5% to affect (or increase) the avg. pool of deposits, and so on. Therefore, it will take even longer for the new and hypothetically higher 3 and 5 yr. CDs to affect this avg. pool of deposits in the 11th District. For this reason, and the fact these savings institutions are borrowing monies from their own Federal Bank at a lower rate than the Prime Rate, and because it is human nature for these S&Ls to keep their "cost down" (by not offering higher paying CDs and Money Market and other savings accounts) is why the 11th District's COF Index moves so slowly.

In July 2000, 50 institutions reported COFI data:

This monthly index is a ratio of monthly interest costs to total funds, expressed as a percentage. Interest costs, the numerator of the cost calculation, include the total amount of interest paid or payable during the month on all checking and savings accounts, all Federal Home Loan Bank advances, and all other borrowings, i.e. C/Ds. Funds, the denominator of the cost calculation, consist of the simple average of the sum of the two most recent month end balances of total deposits, Federal Home Loan Bank advances, and other borrowed money. The resulting quotient is the weighted average cost of funds paid by the 11^th District savings institutions for that month. Because the number of days in each month differs, the quotient is multiplied by an adjustment factor that is calculated by dividing an average month (based on a 12-month, 365-day or 366-day year) by the actual number of days in that month. The adjustment factors are 1.086 for February, 1.014 for 30-day months, and 0.981for 31-day months. In leap years, the adjustment factors are 1.052 for February, 1.017 for 30-day months, and 0.984 for 31-day months. The product is annualized by multiplying by 12:

July 2000 (Dollars in Thousands)

Interest Costs on Deposits, Advances, and other Borrowings (July 2000)	$1,420,689.00
Average Funds (Month end June 2000 plus month end July 2000 divided by 2)
Deposits	$162,258,542
Advances	$94,468,327
Other Borrowings	$50,771,244
Total Funds	$307,498,113
Weighted Average Cost of Funds (July 2000)
Ratio	$1,420,689 / $307,498,113
Expressed as a Percentage	x 100 = 0.4620
Monthly Adjustment Factor	x 0.984 = 0.4546
Annualized	x 12 = 5.4555
Rounded to the third decimal place	5.456%

Comparison to June 2000 Index Value

	July 2000	June 2000
Index value (COFI) ->	5.456%	5.357%
Average total funds	$307.5 billion	$298.7 billion
Average deposits	162.3 billion	161.5 billion
Average advances	94.5 billion	91.6 billion
Average other borrowings	50.8 billion	45.5 billion
Total interest expense *	1398.0 million	1333.2 million
* Adjusted for the number of days in the month. The adjustment factors for 2000 are 1.052 for February, 1.017 for 30-day months, and 0.984 for 31-day months.

One on the keys to understanding about the stability of 11th District Cost Of Funds Index is to understand what happened in 1989, i.e., because of FIRREA, the COFI dramatically dropped; the following two articles First Boston and Salomon Brothers will give more information on what made the COFI drop. The First Boston article (written in 1992) convinced Greg Hughes the owner of AAMI to change his then "fixed" mortgage to a COFI "ARM" mortgage; however he has had an MTA-index on his Primary and Investment homes over the past several years due to its lower Margin.

As of 04/2007 the COFI has averaged 4.016% over the past 15 years, and is currently at 4.376% - (see last 20 yr. mo movement.) If you had a 2.10% Margin you would have averaged a fully-indexed rate of 6.12% for the past 15 yrs.

COFI Rate Sheet