Sweden’s Handelsbanken, Nordea and Landshypotek and Norway’s DNB were cut by Moody’s yesterday (Thursday), but the rating agency said that the banks’ covered bond funding had helped lessen the extent of the downgrades.

Completing the Swedish round of its series of reviews of European banks, Moody’s cut Nordea Bank one notch from Aa2 to Aa3, Handelsbanken one notch from Aa2 to Aa3, and specialised agricultural lender Landshypotek two notches from A3 to Baa2. The ratings of SEB and Swedbank were affirmed, with all five banks now on stable outlook.

Moody’s said that, to varying degrees for each group, the rating actions were driven by: comparatively high reliance on market funding; modest profitability that could make it challenging for them to rebuild capital in the event of unexpected losses; and risks to asset quality despite robust performance to date. The rating agency nevertheless acknowledged that the Swedish economy has performed relatively well versus other EU economies, Swedish banks have been able to attract market funding on economic terms from international investors, and that Swedish banks have strengthened capitalisation since 2008.

The rating agency also said that the banks’ reliance on wholesale funding has two mitigating factors that limit its concerns.

“First, these banks have remained successful in accessing capital markets on economic terms so far,” it said. “Second, Moody’s believes that Swedish covered bonds, an important funding source for Swedish banks, are less volatile than, for example, short term unsecured market funds, due to the market’s long track record and a strong domestic investor base with few asset alternatives.”

The rating agency also said that the maturities of Swedish covered bonds largely match those of the assets they fund, minimising refinancing risk, compared with other markets, notably Denmark

“Moreover, the structure of the Swedish covered bond market has been stable for some time,” it said. “And while Swedish house prices have risen steadily over a long period, Moody’s notes the absence of a significant buy-to-let or speculative investor segment, as seen in other countries.”

Covered bonds also helped mitigate the extent of Moody’s rating action on DNB Bank, which was cut from Aa3 to A1. Regarding DNB’s wholesale funding, Moody’s said that several factors were mitigants in preventing a larger downgrade.

“In addition to the generally strong demand from domestic pension funds and others for securities denominated in Norwegian kroner, Moody’s believes that the rapidly developing Norwegian covered bond market has the potential to provide a funding source that is typically less confidence sensitive than other wholesale market sources,” it said.

“Moody’s also notes that DNB has increased the maturity profile of its funding and maintains adequate liquidity buffers, limiting its funding risk in the short term.”

Giving the reasons for its downgrade, Moody’s had noted that market funding represents around 40% of DNB’s total funding (excluding interbank funds, which are largely deposited with central banks), while the bank has exposure to asset classes such as commercial real estate and shipping. It also said that DNB’s relatively diversified earnings will come under pressure from higher liquidity requirements and weaker revenue raising opportunities.

Moody’s said that the magnitude of the downgrade was limited by several mitigating factors.

“Specifically, Moody’s recognises the banks’ relatively resilient asset quality and profitability metrics, partly reflecting its more stable domestic economic environment, its increased capital and liquidity buffers, as well as our assessment of a very high probability of systemic support.

“As a result, DNB’s A1 rating positions it at the high end of Moody’s European banking ratings.”