Sterling covered bond issuance got off to an “exceptional” start in 2012, Moody’s said yesterday (Monday), with domestic developments showing a promising increase in the importance of the market for issuers and investors that will benefit UK covered bonds.

Publicly placed sterling covered bond issuance in the first quarter of 2012 was nearly double aggregate 2011 volumes, according to the rating agency. Julie Ng, analyst at Moody’s, said that confidence in a market gains traction as it achieves greater liquidity and depth and tighter pricing.

“We therefore believe that as this market expands, banks and financial authorities would have greater incentives to support and protect it,” she added. “In addition, we believe that a robust domestic investor base should improve the funding capabilities of covered bonds during times of market stress.”

The rating agency said that the emergence of a nascent domestic sterling investor base does not necessarily signal that the UK covered bond market has become as established as some of the core European covered bond jurisdictions, but that progress to date indicates that the importance of this market for issuers and investors is increasing.

It identified a series of interrelated benefits, such as those stemming from the development of a robust domestic investor base, which will enhance the credit quality of UK covered bonds.

This is because as the investor base for UK covered bonds expands into a deeper and more liquid market, covered bonds become more attractive to issuers as a funding option, and the cost dynamics of covered bonds improve “as increasing costs associated with foreign exchange swaps are saved for sterling issuance”.

A strong domestic market can also help ensure continued funding and relatively tighter pricing of covered bonds during stressed economic periods, added the rating agency.

“A tightly priced domestic covered bond market helps ensure that a bank (bearing in mind it is likely to be a domestic bank) will be confident it can fund itself by issuing covered bonds to purchase the cover pool assets of a failed issuer,” said Moody’s. “A strong bid for such bonds will be further supported by the bank’s ability to issue in local currency and to local investors who are more likely to understand the collateral and the credit strengths underpinning the domestic product.”

An established and growing domestic market for covered bonds also takes on an importance that transcends individual issuers, said the rating agency, creating incentives for the banks and financial authorities in the country to support and protect the market.