Financial and
ESG report 2020

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.

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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.

Loss given default is estimated on transaction level.

  • Exposure at Default (EAD) models / CCF models

The EAD model was built for retail portfolio exposure. When estimating EAD, the exposure at default was compared to the limit value and the balance sheet exposure observed one year before the default event. The calculation of balance sheet equivalent (CCF) parameters was carried out for product groups for which there was a possibility of off-balance sheet exposure and the Bank had a significant number of observations allowing for statistical inference, i.e. for overdraft limits and credit cards (QRRE portfolio). The Bank also developed the EAD model for the RRE portfolio, which will be subject to the supervisory validation process in the coming period. Until consent is obtained, in the process of estimating capital requirements, however, prior to its approval, a conservative CCF value of 100% is assumed for this portfolio. A similar approach has been used in the case of the guarantee portfolio. Due to the fact that the limited number of empirical observations, which prevented the observation from being carried out, was too small for statistical analyzes, the conservative CCF value equal to 100% was adopted, analogically to the RRE portfolio.

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.)

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 <0,15 364 187 770 1 934 850 957 63,58% 1 594 374 932 0,08% 300 793 62,06% 55 010 810 3,45% 791 581 1 813 114
QRRE 0,15 do <0,25 164 005 068 296 786 989 71,51% 376 229 789 0,19% 59 861 63,29% 27 242 877 7,24% 457 196 1 702 104
QRRE 0,25 to <0,50 168 381 779 197 513 045 74,72% 315 970 467 0,39% 45 028 64,07% 41 260 044 13,06% 789 542 2 176 594
QRRE 0,50 to <0,75 184 595 499 153 676 594 77,00% 302 925 377 0,71% 38 524 64,72% 64 123 261 21,17% 1 392 069 2 959 681
QRRE 0,75 to <2,50 379 959 402 205 543 899 80,52% 545 471 491 1,72% 62 901 65,40% 226 010 386 41,43% 6 127 827 8 446 786
QRRE 2,50 to <10,00 380 123 502 127 868 510 75,35% 476 476 476 5,99% 55 470 65,72% 464 427 811 97,47% 18 739 605 14 000 346
QRRE 10,00 to <100,00 158 008 867 17 889 053 77,04% 171 791 180 22,84% 19 494 66,50% 309 664 133 180,26% 26 120 481 10 043 735
QRRE 100,00 (default) 117 961 979 8 534 402 0,00% 117 961 979 100,00% 17 217 91,64% 76 265 634 64,65% 108 100 571 52 186 548
QRRE Total 1 917 223 868 2 942 663 448 67,42% 3 901 201 691 5,14% 599 288 64,55% 1 264 004 955 32,40% 162 518 872 93 328 909
Residential Retail 0,00 do <0,15 22 431 405 222 831 599 178 100,00% 23 263 004 399 0,08% 108 046 33,66% 1 742 627 442 7,49% 6 264 268 17 254 145
Residential Retail 0,15 do <0,25 3 876 923 606 77 074 558 100,00% 3 953 998 164 0,19% 15 255 34,42% 574 446 019 14,53% 2 541 938 5 205 477
Residential Retail 0,25 to <0,50 2 223 456 313 42 070 482 100,00% 2 265 526 795 0,39% 8 705 34,50% 568 091 529 25,08% 3 047 916 6 723 253
Residential Retail 0,50 to <0,75 1 677 860 491 29 327 756 100,00% 1 707 188 247 0,71% 6 445 34,87% 658 748 517 38,59% 4 226 936 9 351 090
Residential Retail 0,75 to <2,50 2 576 591 744 58 652 455 100,00% 2 635 244 199 1,67% 9 013 35,39% 1 794 707 686 68,10% 15 640 148 26 438 641
Residential Retail 2,50 to <10,00 1 436 391 667 25 287 875 100,00% 1 461 679 542 5,61% 4 576 35,54% 1 959 978 154 134,09% 29 109 019 29 503 090
Residential Retail 10,00 to <100,00 381 626 218 5 911 404 100,00% 387 537 622 22,44% 1 190 35,50% 813 668 041 209,96% 31 047 445 29 699 314
Residential Retail 100,00 (default) 922 872 188 153 667 100,00% 923 025 855 100,00% 3 059 79,12% 1 681 469 011 182,17% 730 304 675 324 110 676
Residential Retail Total 35 527 127 449 1 070 077 375 100,00% 36 597 204 824 3,23% 156 289 35,22% 9 793 736 400 26,76% 822 182 345 448 285 686
Total Total 37 444 351 316 4 012 740 823 76,11% 40 498 406 514 3,42% 697 904 38,04% 10 531 182 243 26,00% 984 701 217 541 614 595

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

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% 256 497 300 773 245 14 0,05%
QRRE <0,12% – 0,18%) 0,15% 0,15% 31 455 28 979 74 1 0,14%
QRRE <0,18% – 0,28%) 0,23% 0,23% 32 783 30 868 112 15 0,19%
QRRE <0,28% – 0,53%) 0,39% 0,39% 47 324 45 016 273 15 0,36%
QRRE <0,53% – 0,95%) 0,71% 0,71% 39 649 38 511 307 21 0,61%
QRRE <0,95% – 1,73%) 1,28% 1,28% 35 372 35 160 491 29 1,05%
QRRE <1,73% – 2,94%) 2,25% 2,25% 26 057 27 668 512 43 1,63%
QRRE <2,94% – 4,90%) 3,80% 3,80% 21 483 22 998 717 43 2,58%
QRRE <4,90% – 7,60%) 6,10% 6,10% 15 201 15 066 808 30 3,79%
QRRE <7,60% – 12%) 9,55% 9,55% 11 598 11 358 891 31 5,46%
QRRE <12% – 20%) 15,49% 15,49% 15 354 13 130 1591 32 8,99%
QRRE <20% – 100%) 42,92% 42,92% 6 797 6 250 2 843 47 32,19%
Residential Retail <0,06% – 0,12%) 0,08% 0,08% 96 055 108 046 101 1 0,03%
Residential Retail <0,12% – 0,18%) 0,15% 0,15% 7 267 8 176 33 1 0,09%
Residential Retail <0,18% – 0,28%) 0,23% 0,23% 6 519 7 079 23 0 0,14%
Residential Retail <0,28% – 0,53%) 0,39% 0,39% 8 053 8 705 54 1 0,21%
Residential Retail <0,53% – 0,95%) 0,71% 0,71% 6 148 6 445 75 0 0,37%
Residential Retail <0,95% – 1,73%) 1,28% 1,28% 4 963 5 471 105 1 0,60%
Residential Retail <1,73% – 2,94%) 2,25% 2,25% 3 159 3 542 132 0 1,15%
Residential Retail <2,94% – 4,90%) 3,80% 3,80% 2 189 2 392 125 0 1,64%
Residential Retail <4,90% – 7,60%) 6,10% 6,10% 1 178 1 300 79 0 2,21%
Residential Retail <7,60% – 12%) 9,55% 9,55% 814 880 78 0 4,22%
Residential Retail <12% – 20%) 15,49% 15,49% 578 772 70 0 7,68%
Residential Retail <20% – 100%) 36,28% 36,28% 665 418 267 0 45,42%

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.

Term Estimated default rate Actual default rate
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%
2020 1,85% 1,64%

Term Estimated default rate Actual default rate
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%
2020 0,64% 0,83%

In the case of both QRRE and RRE portfolios one can observe the increase of realized default rates in the most recent year however in the case of QRRE portfolio the realized default rate is lower than the estimated one. Observed increase might be connected with the beginning of the crisis resulted from the pandemic situation as well as purchase of the portfolio of Eurobank which was characterized by higher level of risk than the portoflio of Bank Millennium. The biggest impact however for the observed increase for RRE portfolio and the fact that the realized default rate is higher than estimated was introducing of new default definition. Had the old definition been applied, then the default rate for this portfolio for the most recent year would amount to 0.39.

In the case of QRRE portolio the realized default rate, even with the new default definition applied, remained at the lower level than the estimated one. It resulted mostly from applying within the estimation of long-term PD, an additional conservative buffer (higher than in the case of RRE portfolio) connected with the estimation error which increases estimated values of PD parameter.

Comparison of actual and modeled CCF

The analysis of actual CCF has been conducted for QRRE portfolio cases defaulted during the calendar year 2020 (reporting period) as well as defaults from 2018 and 2019 (comparative periods) which at the end of the preceding year (31 December 2019 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.

CCF 2020 2019 2018 2017
Modeled CCF 75,12% 96,30% 89,00% 91,30%
Actual CCF 50,71% 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 2018. 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.

LGD Portfolio
RRE QRRE
Actual LGD 33,14% 54,07%
Modelled LGD 38,06% 67,44%

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),

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

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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