No notes
Empty basket
Print version
Delete
2018 Financial and Social Report

Internal rating systems and processes

The Group defines a rating system as all of the methods, processes, controls, data collection and IT systems that are used for the assessment of credit risk and for classification of exposures to a pool with a specified risk level, including the rules on the priority of rating models, if applicable, and the rules for overriding rating grades. Elements of the rating system include PD, LGD, CCF-EAD models (hereinafter: models) and methodologies for evaluating specialized lending.

Evaluation of the client’s credit risk in respect to its probability of default (PD) is based on a uniform rating scale, referred to as the Master Scale.

The Master Scale (MS) consists of 15 rating grades, where the given ratings are as follows:

  1. Maximum security – only for sovereigns
  2. Superior quality
  3. Very high quality
  4. High quality
  5. Very good quality
  6. Good quality
  7. Average high quality
  8. Average quality
  9. Average low quality
  10. Low quality
  11. Very low quality
  12. Restricted crediting
  13. Soft signs of impairment
  14. Strong signs of impairment
  15. Default.

Ratings 13 – 15 are procedural ones, reserved to exposures with deteriorated quality.

All the clients with available lending, whether or not they actually use the approved credit limits and all other participants of credit transactions should have a previously awarded rating and should be assigned to an appropriate pool.

An adequate credit or rating policy should specify the model to be used for rating purposes or a homogenous pool for a given client segment.

Each PD model used must be calibrated to MS based on the observed or estimated probability of default.

 

The rating for governments, central banks, international organizations, multilateral development banks and Institutions may be assigned based on a rating awarded by recognized rating agencies, mapped to the Master Scale.

Should the above-mentioned entities have more than one classification awarded by recognized rating agencies (split rating) the rating corresponding to the second best risk shall be taken into account at all times.

The table showing relationships between internal and external risk grades is presented in chapter 6.4 of the Disclosures. The Bank recognizes the following external rating agencies for comparison purposes: Fitch, Moody’s, Standard & Poor’s.

 

In case of retail customers, rating awarded through a behavioral model (behavioral rating) by default takes precedence over a rating awarded through an application model (application rating) if behavioral rating only is awarded. In case of corporate customers, awarded rating comes from 3 components: quantitative module based on an analysis of data from financial statements, module of qualitative evaluation of customers based on non-financial information and behavioral module assessing existing nature of co-operation between customer and Millennium Bank Group (including Bank Millennium).

 

Procedural ratings (13, 14 and 15 according to the Master Scale) are awarded to clients showing signs of deteriorating borrowing capacity and creditworthiness or with overdue debt.

Procedural ratings by default take precedence over application ratings.

After the pre-conditions necessary to award any of the procedural ratings are no longer satisfied, ratings 13 and 14 expire immediately, while rating 15 either expires or is maintained for a “quarantine period”.

Description of the internal ratings process

This exposure class is excluded permanently from the IRB approach.

This exposure class is excluded permanently from the IRB approach.

Exposure classes subject to the plan of gradual implementation of the IRB approach.

  • PD models

The rating process in Bank Millennium is based on the following principles:

  1. Awarding risk grades to all customers and credit exposures;
  2. All credit decisions should be preceded by awarding a risk grade to the client;
  3. In the retail segment. the rating process is based on PD scoring/rating models;
  4. The rating process is separated and independent from the credit decision process.

 

The presented rating principles apply to all categories of retail exposures: retail exposures to individuals secured by residential real estate, qualifying revolving retail exposures and other retail exposures.

The class of retail exposures to individuals secured by residential real estate include exposures which are mortgage loans or home equity loans granted to retail clients (small businesses and private individuals) and secured by mortgage.

The class of qualifying revolving retail exposures includes exposures to natural persons which are unsecured, renewable, with total exposure not exceeding EUR 100.000 and which meet the requirement of low volatility of loss rates.

All the retail exposures that do not qualify to the above categories are treated as other retail exposures.

 

In the rating process, the powers are allocated as follows:

  1. Data input;
  2. Verification of data;
  3. Awarding of the final risk grade (automated decision).

Model-based risk grades and procedural ratings are awarded automatically and are not subject to expert adjustments.

In the rating process, the Bank uses data from various available sources:

  • internal sources (Bank’s IT systems);
  • external sources (Biuro Informacji Kredytowej S.A.);
  • data received from customers.

With respect to probability of default (PD) models for retail exposures, there is a rating system in place for microbusinesses and a rating system for private individuals. Both systems use behavioral scoring models and application scoring models designed for specific client and/or product groups. Procedural ratings are awarded to clients showing signs of deteriorating borrowing capacity and creditworthiness or with past due debt.

 

A procedural rating has the priority in use. If the client has no procedural rating then the behavioral rating should be used, provided that it has been awarded.

Behavioral rating is awarded for the first time after three months of the client’s cooperation with the Bank and then monthly, provided that the client’s accounts meet the requirements of the behavioral model.

If the client has no behavioral or procedural rating then the application rating should be used.


  • LGD models

Loss Given Default (LGD) models have been built for the following two portfolios:

  1.  unsecured portfolio for retail clients.
  2. portfolio secured by residential real estate for retail clients.

Pursuant to CRR, and its subsequent amendments, banks must estimate LGD parameters using data on defaulted exposures from all the available sources, taking into account all information that is significant for the estimation of economic loss levels.

Accordingly, the Bank has estimated LGD parameters using a database that contains all the defaults resulting from quantitative and qualitative premises included in default definitions.

According to the LGD calculation methodology, the main factors in the calculation include: probability of cure or completion of the client recovery process, value of recoveries, costs and discount rate.

The Bank has taken the following approach to building LGD models:

  1. Establish homogenous risk pools of transactions;
  2. Estimate the probability of different paths from the default status (cure, incomplete, liquidated);
  3. Estimate loss parameters for each path of cure from default.

  • Exposure at Default (EAD) models / CCF models

An EAD model has been built for retail portfolio exposures. When estimating EAD, exposure at default was compared to the value of the limit and the book value of the exposure observed one year before the default event. Credit Conversion Factor (CCF) parameters have been calculated for product groups for which an off-balance sheet exposure could occur and where the Bank had a significant number of observations that enabled statistical conclusions to be drawn. i.e. for overdraft limits and for credit cards. In case of guarantees, where the number of observations was too low to carry out statistical analyses, a conservative CCF value was used. No EAD model was developed for the RRE portfolio due to immaterial number of observations.

In equity exposures, the Millennium Group classifies shares and equity instruments held by any of the Bank’s units. On the consolidated basis, however, the shares representing investments in subsidiaries are excluded, since those are classified as intragroup transactions. However, due to the fact that the total value of the Group’s equity portfolio is insignificant, it has been decided that these exposures should be excluded from the IRB approach permanently and the capital requirement for these exposures should be calculated based on the standardized approach.

The below table presents the basic aggregates and parameters used in calculation of own funds requirements in IRB method. As for exposure classes under IRB method, exposure amounts, CCF’s, average PD’s, debtors amount, average LGD’s, risk-weighted assets, risk density, expected loss and specific credit risk adjustments, break downed by probability of default (PD) brackets are showed.

Table 41 EU CR6 - IRB approach - Credit risk exposures by exposure class and PD range (in %, in PLN thous.)
Segmento PD scale Original on-balance-sheet gross exposures Off-balance-sheet exposures pre-CCF Average CCF EAD post CRM and post CCF Average PD Number of obligors Average LGD RWAs RWA density EL Value adjustments and provisions
QRRE 0,00 do <0,15 214 611 825 1 235 376 299 77,01% 1 165 942 712 0,08% 168 351 63,84% 39 414 440 3,38% 595 514 1 040 874
QRRE 0,15 do <0,25 126 209 852 319 510 944 81,46% 386 484 229 0,19% 70 855 62,10% 26 205 270 6,78% 461 960 1 041 818
QRRE 0,25 to <0,50 156 342 002 239 173 027 82,82% 354 432 162 0,39% 59 909 62,55% 43 030 398 12,14% 864 589 1 782 873
QRRE 0,50 to <0,75 230 383 272 187 005 754 84,33% 388 090 417 0,71% 58 991 63,33% 76 555 598 19,73% 1 745 065 3 008 771
QRRE 0,75 to <2,50 420 291 060 205 267 669 84,53% 593 812 863 1,63% 79 468 64,47% 222 829 004 37,53% 6 262 502 7 856 703
QRRE 2,50 to <10,00 253 082 585 67 304 849 84,32% 309 833 175 5,67% 39 269 65,36% 276 711 392 89,31% 11 483 648 9 333 450
QRRE 10,00 to <100,00 127 077 244 15 670 235 82,32% 139 976 207 27,87% 17 673 66,47% 257 327 098 183,84% 25 902 310 10 327 465
QRRE 100,00 (default) 97 178 168 4 690 718 0,00% 97 178 168 100,00% 14 794 93,90% 50 190 192 51,65% 91 247 429 39 519 398
QRRE Total 2 273 999 496 79,62% 3 435 749 933 4,93% 509 310 64,66% 992 263 393 28,88% 138 563 017 73 911 352
Residential Retail 0,00 do <0,15 16 244 614 435 274 996 555 0,00% 16 244 614 435 0,08% 80 704 32,66% 1 124 446 140 6,92% 4 243 909 7 752 632
Residential Retail 0,15 do <0,25 3 623 718 881 28 474 626 0,00% 3 623 718 881 0,18% 16 268 34,25% 484 664 824 13,37% 2 228 454 5 456 990
Residential Retail 0,25 to <0,50 1 876 278 166 16 210 599 0,00% 1 876 278 166 0,39% 8 468 34,15% 443 839 325 23,66% 2 498 949 4 857 773
Residential Retail 0,50 to <0,75 1 705 095 558 12 015 947 0,00% 1 705 095 558 0,71% 7 410 34,47% 619 424 304 36,33% 4 172 989 10 374 819
Residential Retail 0,75 to <2,50 1 944 689 504 18 771 447 0,00% 1 944 689 504 1,66% 8 367 34,58% 1 222 618 469 62,87% 11 149 038 21 121 430
Residential Retail 2,50 to <10,00 1 334 851 896 90 417 988 0,00% 1 334 851 896 6,32% 5 691 35,31% 1 802 939 044 135,07% 30 290 477 31 093 494
Residential Retail 10,00 to <100,00 670 193 773 2 115 764 0,00% 670 193 773 19,01% 2 623 34,93% 1 319 415 091 196,87% 44 420 178 31 281 731
Residential Retail 100,00 (default) 901 466 534 12 970 0,00% 901 466 534 100,00% 2 857 81,26% 1 550 331 531 171,98% 732 499 482 327 338 227
Residential Retail Total 28 300 908 746 443 015 895 0,00% 28 300 908 746 4,18% 132 388 34,93% 8 567 678 727 30,27% 831 503 475 439 277 095
Total Total 29 926 084 755 2 717 015 391 66,64% 31 736 658 679 4,27% 588 404 38,15% 9 559 942 120 30,12% 970 066 492 513 188 446

The following table presents a historical backtesting of PD as for exposures’ classes.

Table 42 EU CR9 - IRB approach - Backtesting of PD per exposure class
Exposure class PD range Weighted average PD Arithmetic average PD by obligors Number of obligors Defaulted obligors in the year Of which new obligors Average historical annual default rate

End of previous year

End of the year
QRRE <0,06% – 0,12%) 0,08% 0,08% 152 383 168 026 66 11 0,04%
QRRE <0,12% – 0,18%) 0,15% 0,15% 29 809 31 797 37 2 0,09%
QRRE <0,18% – 0,28%) 0,23% 0,23% 35 727 38 924 62 5 0,14%
QRRE <0,28% – 0,53%) 0,39% 0,39% 54 442 59 770 194 7 0,29%
QRRE <0,53% – 0,95%) 0,71% 0,71% 54 102 58 781 360 8 0,55%
QRRE <0,95% – 1,73%) 1,28% 1,28% 48 623 51 900 504 8 0,90%
QRRE <1,73% – 2,94%) 2,25% 2,25% 25 897 27 437 452 15 1,54%
QRRE <2,94% – 4,90%) 3,80% 3,80% 17 491 18 437 418 24 2,28%
QRRE <4,90% – 7,60%) 6,10% 6,10% 11 993 12 707 445 38 3,41%
QRRE <7,60% – 12%) 9,55% 9,55% 7 288 6 669 356 29 4,70%
QRRE <12% – 20%) 15,63% 15,68% 7 492 7 581 724 8 8,83%
QRRE <20% – 100%) 76,74% 40,88% 9 437 10 069 2 880 126 33,73%
Residential Retail <0,06% – 0,12%) 0,08% 0,08% 77 389 80 704 2 210 0 0,05%
Residential Retail <0,12% – 0,18%) 0,15% 0,15% 10 437 10 152 54 0 0,12%
Residential Retail <0,18% – 0,28%) 0,23% 0,23% 5 979 6 116 616 0 0,19%
Residential Retail <0,28% – 0,53%) 0,39% 0,39% 8 202 8 468 26 0 0,29%
Residential Retail <0,53% – 0,95%) 0,71% 0,71% 7 278 7 410 26 0 0,49%
Residential Retail <0,95% – 1,73%) 1,28% 1,28% 4 747 5 088 10 0 0,78%
Residential Retail <1,73% – 2,94%) 2,25% 2,25% 2 944 3 279 7 0 1,27%
Residential Retail <2,94% – 4,90%) 3,80% 3,80% 2 097 2 331 15 0 1,73%
Residential Retail <4,90% – 7,60%) 6,10% 6,10% 1 348 1 386 23 0 2,70%
Residential Retail <7,60% – 12%) 9,55% 9,55% 664 737 31 0 4,07%
Residential Retail <12% – 20%) 16,49% 16,50% 2 401 2 471 35 0 9,87%
Residential Retail <20% – 100%) 59,01% 59,01% 163 163 25 0 50,82%

Comparison of actual and modeled PD

The tables below present the calculation of actual default rates and estimated default rates for portfolios covered by the permission to use the IRB approach.

Table 43 Actual and estimated default rates for the QRRE portfolio (in %)
Term Estimated default rate Actual default rate
2014 2.68% 1.99%
2015 2.69% 1.82%
2016 2.47% 1.59%
2017 2.27% 1.45%
2018 2.01% 1.43%
Table 44 Actual and estimated default rates for the portfolio of loans secured by residential property (in %)
Term Estimated default rate Actual default rate
2014 0.78% 0.48%
2015 0.82% 0.55%
2016 0.88% 0.60%
2017 0.91% 0.53%
2018 0.82% 0.43%

 

In case of QRRE portfolio, one may observe a further decrease (although lower than previous years) of actual default rates in last years. They are lower than estimated. The observed decrease in actual default rates in recent years is consistent with the observed market trends and may be explained by the following stable macroeconomic situation.

In case of RRE portfolio, actual default rates are lower than in the last year. They are lower than estimated as well. That decrease stems from good macroeconomic situation, as well as a falling share loans denominated in foreign currencies (mostly CHF). As for the latter, the observed risk is higher than as for PLN loans.

In case of both portfolios, the actual default rates were also lower than the average probability of default (PD) mainly because of consideration in estimation of long-term PD an additional conservative buffer, connected with estimation errors, that increases PD values.

Comparison of actual and modeled CCF

The analysis of actual CCF has been conducted for QRRE portfolio cases defaulted during the calendar year 2018 (reporting period) as well as defaults from 2016 and 2017 (comparative periods) which at the end of the preceding year (31 December 2017 in case of the reporting period) were not defaulted and had a positive off-balance sheet exposure. The analysis involved a comparison of the average actual conversion factors with average modeled levels (weighted by the amount of off-balance sheet exposure). The modeled factors include a number of conservative haircuts and should be higher than the actual figures. The results are presented in the table below.

Table 45 Comparison of actual and modeled CCF (in %)
CCF 2018 2017 2016
Model CCF 89.0% 91.3% 86.1%
Actual CCF 55.8% 57.2% 61.0%

 

In both the reporting period and the comparative periods, actual CCF levels did not exceed the modeled levels. Since the Bank has not recorded higher than expected credit conversion factors, this credit risk element does not lead to the occurrence of higher than expected losses.

Comparison of actual and modeled LGD

The analysis of actual LGD was carried out for cases from RRE and QRRE portfolios. Calculation of actual LGD figures requires a longer time horizon, because recoveries may occur only after the exposure achieves the default status. Accordingly, the calculation of actual LGDs was based on the cases, which defaulted at the latest in December 2016. The average LGD calculated on the basis of these cases (EAD-weighted average) was compared with the average LGD level used for the purpose of IRB capital requirements calculation (EAD weighted). The model values include a number of conservative haircuts (including an additional multiplier imposed by regulators in the IRB decision from July 2017 on approval of changed LGD models for RRE and QRRE portfolios) and should be higher than the actual losses. The results are presented in the table below.

Table 46 Comparison of actual and modeled LGD (in %)
LGD Portfolio
RRE QRRE
Model LGD 38.5% 69.3%
Actual LGD 26.6% 50.8%

 

For both analyzed portfolios, modeled loss amounts were much higher than actual figures. We can therefore state that there were no unexpected losses associated with LGD levels and the parameters used have proven to be sufficiently conservative.

 

The Group does not have companies conducting credit activity abroad (CRR 452.j),

 

Table EU CR10 – IRB (specialised lending and equities)

Considering that the Group does not use IRB method for specialised lending and equities, Table EU CR10 (EBA/GL/2016/11) is not presented.

 

Table EU CR7 – IRB approach – Effect on the RWAs of credit derivatives used as CRM techniques

Considering that the Group does not use credit derivatives as CRM techniques, Table EU CR7 (EBA/GL/2016/11) is not presented.