11th District Cost of Funds Mortgages: ‘I’m kind of stuck’

While interest rates moved lower and lower in 1995, Richard Norman’s adjustable-rate mortgage seemed to be defying the market--if not gravity.

Month after month, the 47-year-old Marina del Rey resident saw his mortgage rate barely move during most of the year and, in fact, it actually rose a couple of times. Says Norman, who owns a mail service business in Santa Monica: “I’m kind of stuck.”

Norman is among the California homeowners whose adjustable-rate mortgage is tied to a mysterious financial measurement formally known as the 11th District cost of funds index (COFI).

Even though the index may not get the same attention as other key financial barometers, its movements are keenly felt by the thousands of California homeowners whose mortgage rates move in tandem with the index.

While other mortgage indexes gyrate up and down like dancers at a disco, the 11th District index is slow-moving and lethargic, appearing to ignore the vicissitudes of the marketplace. That stability can be attractive--except when rates are falling, as they generally have been since early 1995.

“Most people feel they . . . never come down,” said Santa Monica mortgage broker Steve Abo. The message from many of his clients currently in 11th District mortgages is loud and clear: “Get me out.”

The 11th District’s torpor in an era of falling mortgage rates has opened the door to different varieties of adjustable-rate home mortgages, many of which are faster to respond to financial trends.

Last year, for example, Great Western Bank, one of the state’s leading mortgage lenders and an advocate of the 11th District index, introduced a loan tied to a European interest rate index know as London Interbank Offered Rates, or Libor.

A few mortgage brokers even see the day when 11th District loans fade from the financial scene entirely. Particularly at a time when rates are declining, “it does not make a lot of sense for a borrower to go into COFI,” said Rick Cossano, executive vice president at Pasadena-based Countrywide Financial.

Nevertheless, 11th District loans remain the undisputed king of adjustable home loans in California, with 77% of all adjustable loans made last year tied to that index, according to the Federal Housing Finance Board.

Many of those borrowers, however, are perplexed as to why their rates move at such a glacial pace. “The customer has not a clue as to why the index is moving slower,” said Ginny Ferguson, president of the California Assn. of Mortgage Brokers. “They just know it does.”

The index has tended to lag behind changes in interest rates by three to six months. Even then, the index responds to swings in interest rates in muted fashion. Last year, for example, the 11th District index moved in a narrow band that measured less than half a percentage point wide.

More importantly to homeowners, the index actually rose in 1995, climbing from 4.589% in December 1994 to 5.059% in December 1995, at a time when rates on 30-year mortgages fell by more than 2 percentage points and adjustable-rate loans tied to one-year Treasury Bills fell by more than one percentage point.

However, the 11th District has finally begun to ease slightly in recent months and it has generally remained below the Treasury bill index in the past two years.

A form of the 11th District index has been used in California since the mid-1970s, when state-chartered savings and loans in California were permitted to offer variable-rate mortgages, a precursor to today’s adjustable-rate mortgages. The law that permitted variable-rate mortgages, however, required that the home loans be tied to the then-semiannual 11th District Cost of Funds Index.

When federally chartered savings institutions were allowed to enter the adjustable-mortgage market in 1981, the Federal Home Loan Bank of San Francisco began to issue the monthly 11th District Cost of Funds Index. The index is released on the last business day of the month.

The San Francisco branch of the Home Loan Bank System, which regulates savings and loans, compiles the index with information provided by savings institutions headquartered in the 11th District, a region that includes Arizona and and Nevada as well as California.

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The “cost of funds” reflects what 11th District institutions--there are currently 81--pay on deposits and other sources of funds on a monthly basis. The figure includes the interest paid on everything from passbook and money market accounts and certificates of deposits to loans from the Home Loan Bank and other financial institutions. The costs are averaged, weighted and annualized and expressed as a percentage.

On March 29, the Federal Home Loan Bank released a monthly weighted average cost of funds index (its full name) of 4.975, falling from 5.033 during the previous month.

After the index is issued, most lenders add two or three percentage points to set the rates on their adjustable-rate mortgages.

The different types of interest rates paid by savings and loans helps explain the index’s slow-moving nature.

For example, even if an S&L; lowers rates on short-term money market accounts, it may continue to pay the same, higher rates on certificates of deposit for months, if not years. As a result, it’s the core of stable, long-term deposits that tends to keep the index from swinging dramatically, as the T-bill index does, for example.

“The slowness of the index is exactly why we picked it,” said Sam Lyons, head of mortgage lending at Great Western. “The borrowers like the [11th District’s] slowness when rates are moving up,” adding, however, that they are not “quite enthralled when rates are coming down.”

While California S&Ls; remain strong supporters of 11th District mortgages, the concept never traveled well east of the Rockies.

Nationwide, 11th District loans comprised less than 20% of the adjustable-rate market last year, according to Federal Housing Finance Board. In contrast, mortgages linked to one-year Treasury bills accounted for 62% of the market.

“When we expanded around the country, we found it a little harder to explain the 11th District index to folks on the East Coast,” said Lyons at Great Western. “We decided we needed several different [adjustable-rate mortgages]. Borrowers today want a much wider choice.”

The failures that decimated the S&L; industry in the late 1980s and early 1990s have also raised doubts about the longevity of the 11th District index. The number of savings banks in California, Nevada and Arizona has dwindled from 231 in 1985 to 81.

Most mortgage experts don’t expect the 11th District index to fade away any time soon, however, and these kinds of loans may eventually regain their popularity with consumers if interest rates begin a sustained rise. Indeed, the recent run-up in rates is already changing some minds.

“It’s not going to look so bad since rates have spiked,” said Ted Grose of Santa Monica-based Brodon Mortgage. “It’s going to start looking like a pretty good deal.”

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Slowpoke

Adjustable-rate home mortages tied to the 11th District cost of funds index move much more slowly than those linked to one-year Treasury bills or other indexes.

What is the 11th District cost of funds index?

The index reflects the monthly interest costs by all savings and loans headquartered in the three Western states--Arizona, California and Nevada--that make up the 11th District of the Federal Home Loan Bank System.

What is it used for?

Monthly interest rates on the vast majority of adjustable mortgages in California are based on the index. So, when the index goes up (or down), so do rates on adjustable home loans.

Why does it move so slowly?

Rates on the core of stable, long-term deposits tend to moderate any sharp movements in the more volatile rates on short-term deposits.

When is the monthly index released?

The Federal Home Loan Bank of San Francisco releases an updated index on the last business day of every month.

How do I find out what the most recent index is?

From within California, call (415) 616-2600.