Moody’s cut Banco Popolare to sub-investment grade yesterday (Monday), from Baa3 to Ba3, and analysts expect a downgrade of a similar magnitude to follow for the Italian issuer’s covered bonds.

A worse than expected evolution of the bank’s asset quality was the main driver for the downgrade, said Moody’s.

Asset quality has deteriorated considerably since the banks’ ratings were placed on review for downgrade in November, according to Moody’s, which pointed out that gross problem loans, as adjusted by the rating agency, reached 12.7% of loans in 2012 (above the system average of 10.6%), compared with 10.7% at the end of 2011. Coverage with loan loss reserves is below the Italian average.

“The significant levels of loan loss provisions, which were triggered by a Bank of Italy review of Italian banks’ reserve coverage levels of their problem loans, indicate the weakness of the bank’s asset quality and the inadequacy of the provisions the bank had previously taken,” said Moody’s. “But despite the sharp increase in provisions – loan loss provisions in 2012 amounted to Eu1.3bn, 69% higher than in 2011 – Banco Popolare’s coverage of 39% didn’t improve notably and remains significantly below the 49% Italian average.”

Other reasons for the downgrade, said Moody’s, are the bank’s weak internal capital generation capacity and the rating agency’s concern regarding the bank’s ability to maintain sufficiently high capital levels above regulatory requirements.

The outlook on Banco Popolare’s ratings is negative, in line with the Italian sovereign and the Italian banking system.

Banco Popolare obbligazioni bancarie garantite (OBGs) are rated A2 by Moody’s, which has assigned them a Timely Payment Indicator (TPI) of “improbable”. In combination with Banco Popolare’s previous Baa3 rating this allowed for zero TPI leeway, and analysts expect the issuer’s covered bonds to be downgraded, to Baa2-Baa3, given the new Ba3 issuer rating and “improbable” TPI.