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2019 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.

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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.

All credit decisions should be preceded by awarding a risk grade to the client;

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

  • Data input;
  • Verification of data;
  • 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:

  • unsecured portfolio for retail clients.
  • 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:

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

Loss given default is estimated on transaction level.

  • 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. For RRE segment conservative CCF parameter was also used.

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 45. EU CR6 - IRB approach - Credit risk exposures by exposure class and PD range (in %, in PLN thous.)

XLS
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 <0,15 368 379 1 661 965 64,30% 1 437 005 0,08% 257 096 62,35% 47 442 3,30% 717 2 655
QRRE 0,15 do <0,25 181 026 294 363 72,65% 394 886 0,19% 64 331 63,19% 27 238 6,90% 480 2 482
QRRE 0,25 to <0,50 179 435 193 319 75,63% 325 637 0,39% 47 397 63,97% 40 434 12,42% 812 2 712
QRRE 0,50 to <0,75 183 535 144 243 77,40% 295 178 0,71% 39 853 64,60% 59 391 20,12% 1 354 2 972
QRRE 0,75 to <2,50 338 253 177 991 80,60% 481 721 1,70% 61 529 65,06% 188 133 39,05% 5 346 6 495
QRRE 2,50 to <10,00 320 166 88 382 81,98% 392 619 5,95% 50 638 65,47% 361 943 92,19% 15 293 10 560
QRRE 10,00 to <100,00 162 171 17 335 78,97% 175 861 22,91% 22 177 65,92% 301 139 171,24% 26 532 9 795
QRRE 100,00 (default) 104 507 5 656 0,00% 104 507 100,00% 15 225 90,67% 65 174 62,36% 94 755 56 566
QRRE Razem 1 837 472 2 583 255 68,52% 3 607 414 5,03% 558 246 64,47% 1 090 894 30,24% 145 290 94 238
Residential Retail 0,00 do <0,15 18 692 802 485 205 100,00% 19 178 007 0,08% 96 055 31,67% 1 287 409 6,71% 4 859 9 670
Residential Retail 0,15 do <0,25 3 407 193 58 102 100,00% 3 465 295 0,19% 13 786 32,40% 454 361 13,11% 2 116 4 160
Residential Retail 0,25 to <0,50 2 031 209 30 267 100,00% 2 061 476 0,39% 8 053 32,63% 465 800 22,60% 2 624 4 529
Residential Retail 0,50 to <0,75 1 578 213 18 100 100,00% 1 596 314 0,71% 6 148 32,53% 547 212 34,28% 3 687 5 423
Residential Retail 0,75 to <2,50 2 295 540 31 561 100,00% 2 327 101 1,67% 8 122 32,91% 1 398 088 60,08% 12 777 18 093
Residential Retail 2,50 to <10,00 1 294 589 17 105 100,00% 1 311 694 5,61% 4 192 33,09% 1 556 412 118,66% 24 289 26 619
Residential Retail 10,00 to <100,00 381 306 4 525 100,00% 385 831 25,76% 1 243 33,04% 726 060 188,18% 33 347 16 697
Residential Retail 100,00 (default) 835 198 57 100,00% 835 256 100,00% 2 949 83,46% 1 466 333 175,55% 697 101 394 672
Residential Retail Razem 30 516 051 644 923 100,00% 31 160 974 3,49% 140 548 33,42% 7 901 675 25,36% 780 800 479 864
Total Razem 32 353 522 3 228 178 74,81% 34 768 387 3,65% 643 512 36,64% 8 992 569 25,86% 926 089 574 102

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

Table 46. EU CR9 - IRB approach - Backtesting of PD per exposure class

XLS
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% 168 026 256 497 82 2 0,04%
QRRE <0,12% – 0,18%) 0,15% 0,15% 31 797 31 455 60 2 0,12%
QRRE <0,18% – 0,28%) 0,23% 0,23% 38 924 32 783 73 2 0,16%
QRRE <0,28% – 0,53%) 0,39% 0,39% 59 770 47 324 224 12 0,32%
QRRE <0,53% – 0,95%) 0,71% 0,71% 58 781 39 649 376 17 0,61%
QRRE <0,95% – 1,73%) 1,28% 1,28% 51 900 35 372 591 30 1,01%
QRRE <1,73% – 2,94%) 2,25% 2,25% 27 437 26 057 446 45 1,68%
QRRE <2,94% – 4,90%) 3,80% 3,80% 18 437 21 483 501 80 2,52%
QRRE <4,90% – 7,60%) 6,10% 6,10% 12 707 15 201 450 82 3,56%
QRRE <7,60% – 12%) 9,55% 9,55% 6 669 11 598 342 93 4,92%
QRRE <12% – 20%) 15,63% 15,49% 7 581 15 354 699 51 9,13%
QRRE <20% – 100%) 76,74% 40,48% 10 069 6 797 3 056 48 31,62%
Residential Retail <0,06% – 0,12%) 0,08% 0,08% 80 704 96 055 18 0 0,04%
Residential Retail <0,12% – 0,18%) 0,15% 0,15% 10 152 7 268 8 0 0,09%
Residential Retail <0,18% – 0,28%) 0,23% 0,23% 6 116 6 519 9 0 0,17%
Residential Retail <0,28% – 0,53%) 0,39% 0,39% 8 468 8 053 20 0 0,26%
Residential Retail <0,53% – 0,95%) 0,71% 0,71% 7 410 6 148 25 0 0,38%
Residential Retail <0,95% – 1,73%) 1,28% 1,28% 5 088 4 963 24 0 0,63%
Residential Retail <1,73% – 2,94%) 2,25% 2,25% 3 279 3 160 30 0 1,10%
Residential Retail <2,94% – 4,90%) 3,80% 3,80% 2 331 2 189 28 0 1,46%
Residential Retail <4,90% – 7,60%) 6,10% 6,10% 1 386 1 179 22 0 2,36%
Residential Retail <7,60% – 12%) 9,55% 9,55% 737 815 25 0 4,48%
Residential Retail <12% – 20%) 16,49% 16,49% 2 471 578 201 0 9,13%
Residential Retail <20% – 100%) 59,01% 59,01% 152 665 77 0 51,71%

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 47. Actual and estimated default rates for the QRRE portfolio (in %)

XLS
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%
2019 1,95% 1,40%

Table 48. Actual and estimated default rates for the portfolio of loans secured by residential property (in %)

XLS
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%
2019 0,83% 0,38%

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 2019 (reporting period) as well as defaults from 2017 and 2016 (comparative periods) which at the end of the preceding year (31 December 2018 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 49. Comparison of actual and modeled CCF (in %)

XLS
CCF 2019 2018 2017
Modelled CCF 96,30% 89,00% 91,30%
Actual CCF 53,57% 55,80% 57,20%

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 50. Comparison of actual and modeled LGD (in %)

XLS
LGD Portfolio
RRE QRRE
Actual LGD 28,54% 51,12%
Modelled LGD 38,53% 69,25%

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.

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