Moody’s downgraded Swedish issuer SBAB Bank AB’s issuer rating from A1 to A2 today (Wednesday) because of its view that the standalone credit quality of SBAB is exposed to increasing challenges. The rating agency said that covered bonds issued by SCBC, its subsidiary, were unaffected.

The rating agency said the challenges facing SBAB are mainly the result of its low profitability, a concentrated and unseasoned loan book, and almost total reliance on market funding.

Moody’s noted that SBAB’s current strategy of diversifying its product offering, particularly in terms of retail savings products, is broadly credit positive. But, it added, SBAB could find the implementation of this strategy challenging, “in the context of the fierce competition between banks”, with limited upside potential for its profitability.

“This is particularly relevant given the strong competition in the Swedish banking market and SBAB’s relatively limited expertise in these business areas,” said Moody’s. “The rating agency expects that SBAB’s profitability will continue to underperform that of the other rated Swedish institutions, though it recognises that mortgage lending is general a low margin business in Sweden.”

Moody’s added that SBAB’s income may be negatively affected by increasing funding costs, similar to other European financial institutions.

The rating agency said SBAB’s funding profile, which is almost wholly reliant on capital market funding, is a vulnerability in the current economic climate.

Relatively low risk residential mortgages account for about 60% of SBAB’s loan book, said Moody’s, recognising that the exposures are well collateralised with very low levels of problem loans historically. But, it noted, loan growth in the portfolio has been “brisk in recent years, leading to a less seasoned portfolio”. A sustained increase in house prices in Sweden may have contributed to inflated collateral values, said Moody’s.

“Any increase in interest rates,” said the rating agency, “although unlikely to occur in the short term, may negatively affect borrowers’ repayment abilities and weigh on asset quality metrics.”

SBAB was removed from the Swedish government’s “for sale” list in March this year, said Moody’s, adding that it regards this decision as “removing some downwards pressure on support for SBAB”. The rating agency said a willingness to provide support to SBAB has not been clearly expressed, because this decision was a result of the opposition parties blocking a general government privatisation initiative, as opposed to a specific SBAB related decision.

“The stable outlook on SBAB’s ratings reflects Moody’s view that the ratings are well positioned at their current levels,” said the rating agency.

Moody’s said that covered bonds issued by the Swedish Covered Bond Corporation, SBAB’s wholly-owned subsidiary, have not been affected by this action.