In a move that puts a once-popular kind of mortgage one step closer to extinction, Washington Mutual Inc. is drastically cutting back production of 11th District cost-of-funds loans.

Washington Mutual Inc., with about $50 billion of loans and securities- or 61% of its portfolio-tied to the cost-of-funds index, said it plans to deemphasize the loans in favor of adjustable rate loans linked to Treasury rates.

Cofi, as it is known, tracks funding costs at thrifts in California, Arizona, and Nevada that belong to the San Francisco Federal Home Loan Bank. And Washington Mutual is thought to have the largest portfolio of the loans.

The index is dominated by the funding costs at California's largest thrifts, two of which-American Savings Bank, Irvine, and Great Western Financial, Chatsworth-are now owned by Seattle-based Washington Mutual.

Since its purchase of American Savings in December, Washington Mutual has aggressively promoted the Treasury-based product.

Already these new loans make up 30% of mortgages at American Savings. By yearend, they will account for half of all mortgages written at American Savings, according to Craig Davis, executive vice president of mortgage lending and financial services at Washington Mutual.

Last year Cofi loans constituted 70% of American's mortgage production.

Explaining the switch, Mr. Davis, a former American Savings executive explained, "There's lots of debate about Cofi and what the long-term outlook would be, so what we want to do is give our sales organization and customers a number of choices."

Though it has been a mainstay of thrift portfolios for many years, the Cofi adjustable rate has been the subject of heated debate in recent years.

Mortgage investors have never liked the index, because it lags behind the actual cost of funds at thrifts by about two months. When rates are rising, this puts a crimp in yields-and thrift earnings.

That is typically also when Cofi adjustables are the most attractive to consumers, enabling the big thrifts to steal market share from big mortgage banks.

Conversely, when rates fall, adjustable rate mortgage yields-and thrift profits-are boosted by the lag. But investors aren't much comforted by that.

Thrifts have also been troubled by the shrinking base of institutions whose funding costs comprise the index. When it was launched in 1981, 200 thrifts figured in the index. Now less than 80 do, and the lion's share of the index is determined by the largest California thrifts.

As they are snapped up by other banks and thrifts, the index is even more narrowly determined-raising questions about its stability. Moreover, as more thrifts offer checking accounts, the average cost-of-funds has fallen, making the index less profitable.

Mr. Davis said thrifts have generally increased the margins they charge above the index, as the index becomes "less predictable."

Through its American Savings subsidiary, Washington Mutual makes adjustables that carry rates 260 basis points above the index. At the beginning of the year, the margin was 240 basis points, Mr. Davis said.

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