'Shot in the Arm' or Shot in the ARM?
Jump in Cofi, a Mortgage-Rate Benchmark, May Be Good for Banks but It Isn't for Homeowners
By Carrick Mollenkamp
The Wall Street Journal
January 15, 2010
Late in the day on New Year's Eve, holders of adjustable-rate mortgages across the country got a jolt when the rate used to calculate their loans jumped by two-thirds, sending their loan payments up by 9% in many cases.
The surprise increase had nothing to do with the Federal Reserve raising interest rates or the loans themselves. It was triggered by a surprising and unexplained jump in something called Cofi, an index used as a benchmark to set rates on many of these loans.
"Wow, what happened?" was the reaction of Randy C. Bowers, the president and chief executive of Malaga Financial Corp., a bank in the Palos Verdes Peninsula area of California. Mr. Bowers said he thought it might have been a misprint.
Instead, at 3 p.m. on Dec. 31, the Federal Home Loan Bank of San Francisco, which oversees Cofi, announced without explanation that the rate had jumped 0.835 percentage point to 2.094% from 1.259%. The index is called the 11th District Monthly Weighted Average Cost of Funds Index, or Cofi for short. The 11th district covers California, Arizona and Nevada.
For a $250,000 adjustable-rate mortgage, the rise in Cofi could increase a monthly mortgage-loan bill by more than $100, according to two mortgage brokers. It isn't known how many borrowers have been affected by the increase. Cofi in the past served as a benchmark for popular option adjustable-rate mortgage loans that give borrowers a choice of how to pay the monthly mortgage bill, though it isn't known what portion of these loans was tied to Cofi.
"This change is material and impacts already weakened consumers when they can least afford it," said Chris Freemott, president of All American Mortgage Corp. in Naperville, Ill.
Both Cofi and the more popular London interbank offered rate, or Libor, are used in setting borrowing costs for adjustable-rate mortgages. Lenders often will set lending rates at a margin above one of the indexes. But the sudden shift in Cofi and a jump in Libor during the worst of the financial crisis in 2008, show that these rates and the loans tied to them may not be as steady and reliable as people think.
Cofi, first published in 1981, is calculated by tallying up the interest expense that some two-dozen western U.S. savings banks pay to borrow money by their total funds, including deposits and other borrowings. Cofi is then published at 3 p.m. on the last business day of the month following the month where the data are collected. Bigger banks can have a disproportionate impact on the index.
The jump in Cofi is tied to the wave of bank mergers caused by the financial crisis. It has its roots in the 2006 acquisition of California lender Golden West Financial Corp. by Wachovia Corp. The deal left Wachovia with souring mortgages and spurred that bank's sale to Wells Fargo & Co. in 2008. Wachovia was by far the biggest bank included in the Cofi calculation, and as part of its acquisition by Wells Fargo, it was removed from the report data for Cofi.
An FHLB spokeswoman, Amy Stewart, said that the remaining Wells Fargo unit was ineligible to be a Cofi reporting member because it wasn't an Arizona, California, or Nevada savings institution that was a member of the Federal Home Loan Bank of San Francisco.
That expulsion dramatically changed the data collected for Cofi. Average total funds—the denominator for the Cofi calculation—decreased to $38.5 billion for November from $90.2 billion in October. A big reason for that decrease was the fact that a subset known as "average other borrowings," which includes short-term bank IOUs known as commercial paper, plunged from $33.2 billion to just $306.6 million.
People familiar with the change now believe that Wachovia, unlike other savings banks that largely borrow via deposits, was raising cheaper money via the wholesale market. Because it was so large relative to the other banks, its low borrowing rates had a big impact on the index, keeping the number down and effectively keeping mortgages tied to the number lower than they otherwise might have been.
At his home office in Philadelphia, borrower Joel Palmer checked the index on the day of the sudden Dec. 31 change. Mr. Palmer monitors Cofi because it affects the borrowing cost for a $278,000 mortgage loan he took in 1986 for a four-bedroom ranch house with a pool in the West San Fernando Valley area of Los Angeles.
Mr. Palmer said in an email, "I am NOT a sophisticated mathematician, nor do I pretend to understand the nuances of banking at this level but the facts are stark. This index … was seriously misstated, either then or now or both." He figures he'll have to pay $40 more in his monthly payments
Ms. Stewart said that the FHLB Web site makes it clear that the index can shift based on changes in the member institutions.
But even bankers were taken aback. On Jan. 4, the controller at Malaga Bank emailed the FHLB. The controller wrote, "Please send me information on why the COFI rate increased by 84 basis points. I noticed that the Advances and Other borrowings were down quite a bit. Did an institution drop off? Is it possible to get a list of the reporting institutions?" An FHLB staffer explained why Wachovia was removed.
Mr. Bowers, the chief of Malaga, said the sudden change could be a "big shot in the arm" for banks because it lets them lend at higher rates. For example, if Malaga had provided a mortgage loan at Cofi plus 2.25 percentage points before the change in the index, a borrower would pay 3.509%. However, once the Wells Fargo unit was removed, the interest rate on that loan would be 4.344%. Mr. Bowers said actual changes would depend on individual loan terms.
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