Polish banking sector, Bank’s position and risk factors

In consequence liquidity of the banking sector in Poland, measured with the Loans/Deposits ratio, improved to 93% from 96% at end of the previous year.

Banking sector’s profit was 2% y/y up after 11 months (according to KNF data), however bearing in mind the significant size of provisions for FX mortgages, created by banks in December, 2019 annual profit will probably be below the previous year’s result. Operating trends of the sector deteriorated materially. The pace of income growth remained solid (+9% y/y) thanks to 11% growth of net interest income and almost 7% increase of net commission income. However the rate of growth of costs also accelerated (almost 9% y/y). The growing level of provisions (+16% y/y) as well as higher effective tax rate (27% vs 25% in the comparable period of the previous year) also adversely affected the sector’s profitability. However when analysing sector data it must be remembered that they have limited comparability y/y due to consolidation processes.

The Polish banking sector maintained a very strong capital position. At end of November 2019 the equity of Polish banks reached PLN 210 billion and solvency ratio was 18.9% (Total Capital Ratio – TCR) and 17.0% (Tier 1 ratio). In November KNF somewhat changed dividend criteria (payment of 100% of profit), however most criteria remained unchanged. Likewise, capital buffers and minimum capital ratios resulting from them remained relatively high. Maintaining by Polish Banks of high buffers and capital ratios is good from the point of view of risk, although it does adversely affect return on the equity committed by banks’ shareholders (lower ROE and limited dividend).

2019 brought continuation of consolidation processes. In November BNP Paribas Poland finalised the merger with Raiffeisen Polska and Bank Millennium with Euro Bank. In result the number of commercial banks fell to 30 from 32 at the end of 2018. At end of September the share of top 5 banks in the total assets of the entire sector was 53% vs. 51% in the same time of the previous year.

According to the Bank’s projections, 2020 should bring a further deceleration of economic growth (GDP: +3.2%), mainly due to decrease of the rate of growth of investments (2020: +2.1% y/y following 7.8% estimated in 2019). The expected stable growth of household income should involve a continued high rate of growth of retail deposits, while the expected maintaining of high private consumption and demand for real estate should support the balance of loans in the personal customers segment.

At end of 2019 Bank Millennium Group was 7th among top commercial banks in Poland by total assets and deposits. The Bank’s market share in deposits was 6.0% (5.3% at end of 2018) and 5.7% (4.6%) in loans. Bank Millennium Group kept a relatively stronger position in the segment of household deposits (7.2% vs 6.2% at end of 2018), mortgages (8.3% vs 6.8% at end of the previous year) and transactions made with credit cards (8.6% vs 8.0%). In the companies’ segment, where the Group has a lower share than in the retail segment (4.0% in deposits and in loans), the Group maintains a traditionally above-average position in lease and factoring products. The Group continues to distribute its products and services via a network of 830 branches, as well as through electronic channels, including cash machines, the Internet, phone and mobile apps.

Despite the fact that there are no major threats to the Polish economy and the banking sector in 2020 there are, however, potential risks, which, if materialised, might have significant impact, in the coming year, upon operations and results generated by the Polish banking sector (including Bank Millennium):

• Stronger than expected global economic growth slowdown resulting from increasing protectionist policy in global trade and worsening global economic sentiment. In view of links within global production chains, incidents of this type in external environment could have negative impact upon Polish exports and, thereby, upon incomes of domestic enterprises and households
• Increasing inflation expectations of households could significantly increase wage demands and wind the wage-inflation spiral. High inflation would decrease consumer purchasing power thereby limiting economic activity; this effect would be additionally strengthened by interest rates’ increases by monetary authorities.
• Uncertainty connected with impact of spreading corona-virus upon global economy, protectionist actions in global trade and perspectives for trade agreements between the European Union and the United Kingdom might trigger financial market volatility.
• FX mortgage loans legal risk. On 3 October 2019, the Court of Justice of the European Union (‚the CJEU’) issued the judgment in Case C-260/18 in connection with the preliminary questions formulated by the District Court of Warsaw in the case against Raiffeisen Bank International AG. The judgment of the CJEU, in connection with the interpretation of European Union law made therein, is binding on domestic courts. The judgment in question interpreted Article 6 of Directive 93/13 in its answers to the preliminary questions. In the light of the subject matter judgment, Article 6 of Directive 93/13: must be interpreted as meaning that (i) the national court may, on the basis of national law, conclude that a credit agreement cannot continue to exist without unfair terms on the ground that the removal of those unfair terms would alter the nature of the main subject-matter of the contract; (ii) the effects for the consumer’s situation resulting from the cancellation of the contract as a whole must be assessed in the light of the circumstances existing or foreseeable at the time when the dispute arose and that the will of the consumer is decisive as to whether he wishes to maintain the contract and avoid those effects; (iii ) Article 6 of the Directive precludes the filling in of gaps in the contract caused by the removal of unfair terms from the contract (even if the non-filling of those gaps would result in detrimental for consumer falling of the contract), solely on the basis of national legislation of a general nature which provides that the effects expressed in the content of a legal act are to be supplemented, in particular, by principles arising from equity rules or established customs; (iv) Article 6 of the Directive precludes the maintenance of unfair terms in the contract (even if their removal would result in the contract being annulled to the detriment of the consumer) if the consumer has not consented to the maintenance of such terms.
  The CJEU judgment concerns only the situation where the national court has previously found the contract term to be abusive. It is the exclusive competence of the national courts to assess, in the course of judicial proceedings, whether a particular contract term can be regarded as abusive in the circumstances of the case. It can reasonably be assumed that the legal issues relating to foreign currency mortgage loans will be further examined by the national courts within the framework of disputes considered which would possibly result in the emergence of further interpretations, which are relevant for the assessment of the risks associated with subject matter proceedings. This circumstance indicates the need for constant analysis of these matters. Further request for clarification and ruling addressed to the European Court of Justice and Polish Supreme Court may also be filed with potential impact on the outcome of the court cases.As at the end of 2019, the Bank had 2010 loan agreements under individual litigations concerning indexation clauses of FX mortgage loans submitted to the courts with the total value of claims filed by the plaintiffs amounting to PLN 203 million. Until 31.12.2019 only 19 cases were finally resolved and the vast majority of such judgments were in accordance with the Bank’s interest. The claims formulated by the Clients in individual proceedings primarily concern the declaration of invalidity of the contract or payment for reimbursement of allegedly undue performance, due to the abusive nature of indexation clauses. The pushy advertising campaign observed in the public domain to encourage claims against banks may lead to an increase of the number of future court disputes. In addition, the Bank is a party to the group proceedings (class action) subject matter of which is to determine the Bank’s liability towards the group members based on unjust enrichment (undue benefit) ground in connection with the foreign currency mortgage loans concluded. It is not a payment dispute. The judgment in these proceedings will not grant any amounts to the group members. The number of credit agreements covered by these proceedings is 3281. The case is still before its first hearing, which is scheduled for March 2020.Based on ZBP (the Polish Banking Association) data gathered from all banks having FX mortgage loans, vast majority of disputes were finally resolved in favour of banks until 2019 year. However, after the Court of Justice of the European Union (CJEU) judgment issued on 3 October 2019 (Case C-260/18) there is a risk, that so far mostly positive for banks line of verdict in courts may change.

  Taking into consideration the increased legal risk related to FX mortgages, Bank Millennium created PLN 223 million provisions for legal risk. The methodology developed by the Bank is based on the following main parameters: (1) the number of current (including class action) and potential future court cases that will appear within a specified (three-year) time horizon, (2) the amount of the Bank’s potential loss in the event of a specific court judgment (three negative judgment scenarios were taken into account), (3) the probability of obtaining a specific court verdict calculated on the basis of statistics of judgments of the banking sector in Poland and legal opinions obtained. Variation in the level of provisions or concrete losses will depend on the final court decisions about each case and on the number of court cases.

  Bank Millennium undertakes number of actions at different levels towards different stakeholders in order to mitigate legal and litigation risk as regard FX mortgage loans portfolio. The Bank is open to negotiate case by case favourable conditions for early repayment (partial or total) or conversion of loans to PLN. On the other hand, the Bank will continue to take all possible actions to protect its interests in courts while at the same time being open to find settlement with customers in the court under reasonable conditions.

  Finally, it should be mentioned, that the Bank has to maintain additional own funds for the coverage of additional capital requirements related to FX mortgage portfolio risks (Pillar II FX buffer) in the amount of 4.96 pp (4.87 pp at the Group level), which corresponds to PLN 1.85 billion, part of which is allocated to operational/legal risk.

• Risk connected with cash loans fees return in case of early repayment. On 11 September 2019 The Court of Justice of the European Union ruled in the case of Lexitor against SKOK Stefczyka, Santander Consumer Bank and mBank (case C 383/18) in which it stated that consumer has rights to demand the reduction of the total loan cost corresponding to interest and costs for the remaining term of the agreement in case of early repayment of loan. Taking into consideration this verdict, Bank Millennium Group created in 2019 a provision in the amount of PLN 66.4 million (split between Net Interest Income and Other Operating Costs), for potential returns to the clients. The provision was estimated based on the maximum amount of potential returns and the probability of payment being made. The adequateness of such reserve will be checked through time and will depend on the clarification of the implications of the verdict and on the number of agreements and values to be returned.
• Potential increase of fees paid to Banking Guarantee Fund (BFG). Following the nearly 27% y/y increase of fees paid by Polish banks to BFG in 2019, 2020 may bring a further increase of the charge. According to available information, BFG may increase the total fee by 12% in 2020. The bulk of the increase is to be driven by higher contributions to deposit guarantee scheme (28% of fees in 2019, 56% in 2018). Given the Bank Millennium’s relatively higher share in contributions to the deposit guarantee scheme than to the resolution scheme, this may lead to an above average increase of overall BFG fees paid by the Bank in 2020. Furthermore, given the targeted size of the funds to be achieved in the long term and the potential use of such funds, a risk of ad-hoc additional intra-year contributions to either deposit or resolution schemes cannot be entirely ruled out.
• Risk of financing costs increase due to a need of MREL eligible instruments issue. The Bank received a letter from BFG regarding the minimum level of own funds and liabilities subject to write down or conversion (MREL). In accordance with the regulation, the MREL requirement should be achieved by January 1, 2023 and maintained at all times from that date. BFG has determined a linear path to reach the required target. The MREL limit for the Bank was set on the basis of data as at December 31, 2018 and the value of required buffers valid as at January 1, 2019. As at December 31, 2019, the Bank fulfils the MREL limits set up by BFG. In order to fulfil and maintain required MREL limits, the Group may issue MREL eligible instruments that could cause increase of financing costs for the Group.
• Cyber-risk is among the highest ranked risks that banks are facing globally and the Polish banking market is no exception. The rapid development of new technologies, digitalisation of the economy and increasingly sophisticated cyber-attacks make cyber-risk a likely constant risk factor that banks going forward will need to put increasing resources to mitigate.
• Regulatory environment remains a big challenge for the banking sector and further tightening of rules and introduction of new ones by either European or local regulators cannot be ruled out.
• Competition is becoming increasingly intense in the financial services sector. While historically banks had to mostly combat threats from their peers, the relaxation of access to customer data that results from the recent introduction of PDS2 directive accelerates the potential entry of bigtechs and fintechs onto the market. Furthermore, the ongoing consolidation of the domestic banking market is likely to further increase competitive pressures further out. As a result larger players are likely to benefit from the economies of scale to the detriment of smaller banks. The increasing share of State owned/controlled banks in the sector is another risk factor worth highlighting.

There is also the likelihood of a more favourable macroeconomic scenario that the assumed one, which may lead to better results of the banking sector and Bank Millennium Group, in particular:

• Faster than expected domestic economic growth due to strong household consumption would support increase of the Bank’s lending activity.
• Rebounding investments of enterprises into production capital would directly support demand for investment lending.
• Favourable situation of households and enterprises would contribute to improvement of the bank’s credit portfolio quality and increase inflows of deposits to this portfolio.