Monthly Median Cost of Funds Index

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

[No. 94-221]

Monthly Median Cost of Funds Index

AGENCY: Office of Thrift Supervision, Treasury.

ACTION: Notice; request for comment.

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SUMMARY: Since 1982, the Office of Thrift Supervision (OTS) or its

predecessor, the Federal Home Loan Bank Board (FHLBB), has collected

data from savings associations for, and published, the Monthly Median

Cost of Funds (MMCOF) index. This index is available for adjusting the

interest rate on adjustable rate mortgages (ARMs).

The MMCOF has become less important to the mortgage lending

industry since development of the Eleventh District Cost of Funds Index

and the One Year Treasury Bill Rate Index. At the same time, as the

OTS-regulated portion of the thrift industry has contracted, the MMCOF

has been based on data from a significantly smaller number of

institutions, representing a smaller portion of mortgage loans.

The OTS is currently evaluating the direct cost to the industry of

supplying data for use in calculating the MMCOF and the indirect cost

to the industry of OTS committing resources used to calculate the

MMCOF. The OTS is considering whether it should: cease publishing the

MMCOF; or modify the scope of the MMCOF to increase its usefulness or

reduce the cost to savings associations.

Potential modifications include expanding the number of reporting

institutions to include all OTS-regulated savings associations or

decreasing the reporting universe to a statistically valid sample of

OTS-regulated institutions.

If the OTS were to cease publishing the MMCOF, section 402(e)(3) of

the Financial Institutions Reform, Recovery and Enforcement Act of 1989

(FIRREA), requires the agency to designate acceptable substitute

indices that could be used for adjusting ARMs currently based on the

MMCOF. After reviewing available indices, OTS found that the Quarterly

Average Cost of Funds Index (QCOFI) and the Eleventh District Cost of

Funds Index appear to be acceptable substitute indices. Both of these

indices are readily available for adjusting ARMs and have demonstrated

a strong correlation over time to the MMCOF. If the agency determines

to stop publishing the MMCOF, it anticipates providing a transition

period of one or two quarters before releasing the last MMCOF.

DATES: Comments must be received on or before November 16, 1994.

ADDRESSES: Comments should be directed to Director, Information

Services Division, Public Affairs, Office of Thrift Supervision, 1700 G

Street NW., Washington, DC 20552, Attention Docket No. 94-221. These

submissions may be hand delivered to 1700 G Street NW., from 9 a.m. to

5 p.m. on business days; they may be sent by facsimile transmission to

FAX number (202) 906-7755. Comments will be available for inspection

from 1 p.m. until 4 p.m. on business days. Visitors will be escorted to

and from the Public Reference Room at established intervals.

FOR FURTHER INFORMATION CONTACT: Stephen A. Whatley, Financial Analyst,

(202) 906-7228, William Shively, Acting Deputy Assistant Director (202)

906-5701, Supervisory Operations; Catherine A. Shepard, Senior

Attorney, (202) 906-7275, Regulations and Legislation Division, Office

of Chief Counsel, Office of Thrift Supervision, 1700 G Street NW.,

Washington, DC 20552.

SUPPLEMENTARY INFORMATION:

I. Background

A. Purpose of the MMCOF

The MMCOF is a monthly index published by the OTS that can be used

to adjust the interest rate on ARMs. The FHLBB first published the

MMCOF in December, 1982. Before the MMCOF, the only national COF index

available to savings associations to adjust interest rates on ARMs was

the semiannual cost of funds index the FHLBB introduced in 1979, when

ARMs first began to be used by the thrift industry to help manage

interest-rate risks. Because this COF was only published semiannually,

many mortgagors would wait until the rate was published to make their

refinancing decisions. The result was a semiannual surge in the number

of refinancings.

The FHLBB and the savings and loan industry believed that creating

a monthly cost of funds index, the MMCOF, would help disperse

throughout the calendar year the number of refinancings associated with

both fixed rate mortgages and ARMs that use COF indices. Since that

time, other monthly indices have been developed and have become far

more widely used than the MMCOF.

B. Current Usage of the MMCOF

The Federal Housing Finance Board's (FHFB) Conventional Mortgage

Interest Rate Survey (MIRS), indicates that the MMCOF is currently of

minor importance to the mortgage lending industry. This survey showed

that instruments used to adjust the interest rate on ARMs included:

1. Treasury bills with maturities of less than one year;

2. One-year Treasury bills;

3. Treasury notes/bonds with maturities greater than one year;

4. Eleventh District Cost of Funds;

5. Federal Housing Finance Board contract rate series on previously

occupied homes; and

6. Other cost of funds indices, including the MMCOF.

According to the March 1994 MIRS, of ARMs closed in March 1994,

57.7 percent were adjusted by the one-year Treasury constant maturity

index, while 21.3 percent of the ARMs were tied to the Eleventh

District COFI. Combined, these two indices controlled 79.0% of the new

ARM business. Only 1.8% of ARMs closed in March 1994 were adjusted with

indices included in the ``Other Cost of Funds Indexes,'' which includes

mortgages adjusted with the MMCOF. When both fixed rate mortgages and

ARMs were considered, the ``Other Cost of Funds'' mortgages were less

than one percent of all loans closed.

While the OTS has no data that explain why the MMCOF has been used

by such a small percentage of the ARM market, it notes that the

universe of reporting institutions providing the data from which the

MMCOF is calculated has declined dramatically since its inception. In

August 1989, the MMCOF was calculated from data reported by

approximately 3,350 FHLBB-regulated, Federal Savings and Loan Insurance

Corporation-insured institutions. The then relatively small universe of

FHLBB-regulated, Federal Deposit Insurance Corporation (FDIC)-insured

federal savings banks was not included in calculating the MMCOF.

Although these institutions were few in number, they then represented,

and continue to represent, approximately 9-10% of the industry's

assets.

The number and aggregate assets of OTS-regulated, Savings

Association Insurance Fund (SAIF)-insured institutions declined rapidly

after FIRREA, with the result that the MMCOF was being prepared from an

increasingly smaller universe. Only 1,614 institutions were reporting

as of March 1994. This reporting universe includes only OTS-regulated,

SAIF members. It no longer includes approximately 221 FDIC-regulated,

private sector SAIF-insured institutions.

C. Current Costs of the MMCOF

The OTS estimates that it costs the industry approximately $400,000

per year to complete and file the MMCOF index data

electronically.1 The total annual cost to the agency to prepare

and distribute the MMCOF, which OTS does not use for any supervisory or

regulatory purpose, is between $50,000 and $100,000. Accordingly, the

OTS believes that the significant resource costs it incurs in

calculating and publishing the MMCOF and the relatively high data

preparation cost to the industry may outweigh the continued usefulness

of the publication, at least in its current form. Therefore, OTS is

reviewing: (1) whether the usefulness of the MMCOF can be increased or

the burden on the industry and OTS can be decreased through modifying

the scope of the MMCOF; or (2) whether OTS should stop publishing the

MMCOF.

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\1\OTS estimates that filing data for the MMCOF cost

approximately $20 per report, per month, per savings association.

Before January, 1993, the MMCOF was calculated based on information

extracted from the monthly Thrift Financial Report (``TFR''). As of

January 1, 1993, OTS abolished the monthly TFR to reduce the

regulatory reporting burden on the industry. Since then, OTS-

regulated SAIF-insured savings associations have been required to

submit information directly to OTS for calculation and publication

of the MMCOF.

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D. Statutory Requirements

Section 402(e)(3) of FIRREA requires the OTS to take such action as

is necessary to assure that the indices prepared by the FHLBB,

including the MMCOF, immediately prior to the enactment of FIRREA and

used to calculate the interest rate on ARMs continue to be published.

Under section 402(e)(4), the OTS may cease publication of an index if

it substitutes an index that is substantially similar to the index that

is being deleted and if the Director of OTS determines, after notice

and opportunity for comment, that:

1. the new index is based on data substantially similar to that of the

original index; and

2. the substitution of the new index will result in an interest rate

substantially similar to the rate in effect at the time the original

index became unavailable.

This statutory protection is designed to mitigate the potential

impact of substantially modifying or stopping publication of an index

on outstanding mortgages. Currently, ARMs purchased by both the Federal

National Mortgage Association and the Federal Home Loan Mortgage

Corporation contain ``adjustable rate note'' language discussing the

index to be used and what must occur if an index is no longer

available. The standard language is: ``If the Index is no longer

available, the Note Holder will choose a new index which is based upon

comparable information. The Note Holder will give me notice of this

choice.'' This means that the mortgage holder does not have to

renegotiate with a borrower so long as the new index selected is based

upon comparable information and the borrower is notified of the change.

In determining whether to modify the MMCOF, OTS must therefore

consider whether such a modified index would be based on comparable

data and provide comparable results. Similarly, in considering stopping

publication of the MMCOF, OTS must determine whether acceptable

substitute indices are available.

II. Potential Modifications to the MMCOF

OTS has considered two potential modifications to the MMCOF and

believes that neither would substantially affect the information

provided in the MMCOF or the results obtained by using it in adjusting

ARMs.

A. Use a Randomly Selected Sample of the Industry

The OTS has considered computing the MMCOF using a randomly

selected sample of OTS-regulated institutions. This might include the

OTS-regulated, BIF-insured institutions discussed above in section

II.A. The OTS estimates that a random sample of 476 institutions would

provide a confidence level of 95% that the MMCOF will be within +(-)

.05% (5 basis points) of the sample value. By rotating the institutions

comprising the statistical sample every twelve to eighteen months, the

regulatory reporting burden on the industry as a whole would be

reduced. The agency resources involved in calculating the MMCOF would

also likely be reduced.

B. Expand the Number of Reporting Institutions

One of the past benefits of the MMCOF as an index for adjusting

ARMs was that it represented a broad, national cross-section of the

thrift industry. If the MMCOF is no longer widely used because it is

calculated from a decreasing number of OTS-regulated SAIF-insured

thrifts, one alternative that might increase its utility is to expand

the number of reporting institutions. While OTS does not have the

authority to require depository institutions that it does not regulate,

such as commercial banks to provide information on their cost of funds

to the OTS, it could expand the MMCOF to include OTS-regulated, Bank

Insurance Fund (BIF)-insured institutions. This would add 16

institutions currently not included in the reporting universe. These

institutions control between 9 and 10% of the industry assets.

Expanding the number of reporting institutions to include the OTS-

regulated BIF-insured institutions would only slightly affect the MMCOF

index, however, because it is a median index2 and not a weighted

average.3 The additional burden such an expansion would cause OTS

would also be slight.

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\2\ The median cost of funds is defined as the middle value (the

point that has an equal number of observations above and below it)

of a set of institutions' individual cost of funds ratios.

\3\ The weighted mean cost of funds ratio is defined as the sum

of quarterly interest expense paid or accrued on deposits and

borrowings, excluding escrow accounts, divided by the average

(current and previous cycle) sum of balances in deposits and

borrowings (both Federal Home Loan Bank advances and other

borrowings, excluding escrow accounts).

III. Potential Substitute Indices if OTS Stopped Publishing the

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MMCOF

OTS reviewed three potential substitute indices to determine if any

would be acceptable substitutes under the requirements of section

402(e)(3) of FIRREA. Two of these indices either use a calculation

formula substantially similar to the MMCOF or yield results

substantially similar to the MMCOF: the Eleventh District COFI and the

QCOFI. These indices are based on data either supplied to the OTS or

that the OTS requires thrifts to supply to their Federal Home Loan

Banks on request.

The index most frequently used to adjust ARMs, One Year Treasury

Bills (Constant Maturity), was also reviewed as a possible acceptable

substitute. OTS believes, however, that this index does not satisfy the

statutory requirements for substitute indices because it is neither

technically similar to the MMCOF index, nor is its movement

substantially similar. Exhibit 1 shows the movement of the MMCOF

compared to the One Year Treasury Bill index. The two indices' only

similarity is that both are released monthly.

A. Eleventh District Cost of Funds Index

The Federal Home Loan Bank of San Francisco's ``Eleventh District

Cost of Funds'' index is calculated from data submitted from all OTS-

regulated SAIF-insured savings institutions located in Arizona,

California, and Nevada.4 In March, 1994, these institutions

represented 6.4 percent of the total number and approximately 35

percent of the total assets of OTS-regulated institutions. The Eleventh

District COFI and the MMCOF are substantially similar in that the

formula used in the Eleventh District COFI is based on the same Thrift

Financial Report lines as are used in the MMCOF. While the Eleventh

District COFI is a weighted mean and the MMCOF is a median, the

Eleventh District COFI closely tracks the MMCOF. For example, from mid-

1991 through March 1994, the monthly results were substantially

similar, particularly over the last two years. Exhibit 2 shows the

movement of the Eleventh District COFI as compared to the MMCOF from

1980 through March 1994.

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\4\ 12 CFR 563.180(e) requires savings associations to supply

this data to their respective Federal Home Loan Banks upon request.

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B. OTS Quarterly Average Cost of Funds Index

The QCOFI, published by the OTS, closely tracks the MMCOF. The

QCOFI is published less frequently than the MMCOF. Thus, it would only

be available to savings associations on a quarterly basis. The only

distinction between the two indices is that the MMCOF is a median while

the QCOFI is a mean (weighted average). However, as shown in Exhibit 3,

the trend lines between the MMCOF and the QCOFI are quite close.

Because the QCOFI is a weighted average, the addition of the OTS-

regulated, BIF members to the reporting universe would have a larger

impact on the QCOFI than on a median index such as the MMCOF. The QCOFI

would have declined if BIF-insured institutions had been included in

the calculation (see Exhibit 4). Such a decrease would lower the yield

on mortgages tied to the national index. In addition, indices

calculated for states and/or regions that contain BIF institutions

could be affected. One possible alternative would be for OTS to

calculate and publish a Quarterly Median Cost of Funds index.

IV. Request for Comment

OTS invites comment on all aspects of the proposed modifications

to, or elimination of publication of, the MMCOF. Comments should focus

on the impact of the proposal on lending institutions in adjusting the

interest rate on their ARMs. Specific comments should address any

difficulties savings associations encounter in preparing the monthly

submission of data to the OTS; any potential benefits of continuing

publication of the MMCOF index with modifications; and the suitability

of the two substitute indices proposed by the OTS. Comments from

savings associations might also address the potential savings resulting

from the proposed reduction in the reporting burden.

Dated: October 11, 1994.

By the Office of Thrift Supervision.

Jonathan L. Fiechter,

Acting Director.

BILLING CODE 6720-01-P

TN17OC94.000

TN17OC94.001

TN17OC94.002

TN17OC94.003

[FR Doc. 94-25630 Filed 10-14-94; 8:45 am]

BILLING CODE 6720-01-C