Moody’s downgraded Finland’s Aktia Bank from A1 to A3 today (Wednesday), reflecting concerns surrounding the bank’s weakening profitability and reliance on market funding, particularly covered bonds.

The rating agency cited the Finnish bank’s high reliance on market funding, particularly on covered bonds issued through Aktia Real Estate Mortgage Bank, as part of the reason for the downgrade. It said market funds adjusted for liquid assets as a share of total assets increased from below 15% at year-end 2008 to 30% at year-end 2011.

“Generally, Moody’s regards market funding as a less stable funding source compared with deposits, and points out that the possible fragility of overall investor confidence in Europe may put pressures on Aktia Bank’s access to long term funding as well as increase its cost, which would put additional pressure on already depressed margins,” said the rating agency.

“However, at the same time Moody’s recognises the importance of access to diversified funding, as demonstrated by Aktia Bank’s long and short term funding programmes and the diversification of its maturity profile.”

The rating agency expects that Aktia’s income will remain under pressure due to the expiry of the positive effects of interest rate hedges as well as the competitive Finnish operating environment for retail mortgages and deposits.

Profitability continued to deteriorate in 2011, said Moody’s, with net interest income specifically weakening (the positive effect from hedging decreased from Eu58.3m in 2010 to Eu34.8m in 2011), and overall net income falling from Eu52.6m to Eu25.7m.

Aktia receives a two notch uplift from the Baa2 standalone credit rating.

“The probability of systemic support is increased by Aktia’s function as a central financial institution for Finland’s independent savings banks and cooperative banks,” said Moody’s.

It said a return to sustainable earnings growth while maintaining strong asset quality could provide upward pressure on the ratings, while if Aktia does not stabilise over the next 12 to 18 months, or in case of a greater than expected deteriorating of asset quality, renewed pressure could arise.