Mortgage bond index raises costs The cost of insuring against losses on commercial mortgage-backed securities has soared, in a development that risks raising the cost of financing for office developments, shopping centres and apartment blocks in the US. An industry index launched in January, which allows investors to hedge their exposure to commercial mortgages, was hailed at the time as a means of boosting issuance of CMBS. IN Capital Markets However, while CMBS issuance has jumped to its best level since the financial crisis, the launch of the index also coincided with a rise in the interest rates that investors demanded on new CMBS. Some analysts attribute that rise to an unexpectedly sharp tumble in the value of the new index, and worry that its persistent weakness could pose a challenge to a slew of new CMBS deals that are being marketed this month. The cost of using the index as insurance against CMBS losses rises as its value declines. CMBS are securities backed by mortgages on commercial properties, and the CMBX index reflects the credit performance of 25 so-called "conduit CMBS," which are backed by particularly large pools of loans. Investors can hedge their exposure to the 25 CMBS deals by taking a short position in the CMBX. The tactic also works as a partial hedge against the risk of holding other CMBS, or holding commercial mortgages that are yet to be pooled together and packaged into securities - allowing CMBS issuers to take on more loans and speed up their creation of securities. Speculators who take the other side of the trade would be betting on an improvement in the credit quality of the underlying mortgages. "There is a natural short for this index," said Keerthi Raghavan, CMBS strategist at Barclays. There may not be a natural long. Total returns fell an average 3.2 per cent in the first two months of the index, according to RBS Securities. According to Barclays data, interest rates on existing CMBS deals - measured by their spread over rates on US Treasuries - bottomed in mid-January, 10 days before the CMBX launch. New-issue CMBS in February and March were priced with yields more than 80 basis points over swaps, compared to 72 in January. Richard Hill, CMBS strategist at RBS, said the CMBX provides a benchmark for pricing of new issues and may have contributed to the rise in financing costs. "CMBX weakness begets cash market weakness begets CMBX weakness," he said. No one wants to get in the way of a one-way market. CMBS issuance in the first quarter of 2013 jumped to $21.3bn, the biggest total since the final three months of 2007, before the credit crisis. At its current pace, issuance would hit $85bn for the full-year, almost twice the 2012 total. Mr Hill said RBS expected five conduit CMBS deals to be completed this month, in what will be a test of how far the weakness in the CMBX is affecting investor sentiment. Delinquency rates on commercial mortgages remain low and property prices have recovered strongly, but other factors weighing on sentiment include weakness at some shopping centres in the teeth of competition from internet sales.