46.3. Legal risk regarding foreign currency mortgage loans in CHF

Adopted accounting principles

The Group recognizes that the legal risk related to the outstanding portfolio of foreign currency mortgage loans in CHF as at 31 December 2022 affects the expected cash flows from this portfolio and the level of expected credit loss within the meaning of IFRS 9 that can be incurred by the Group.

In connection with the above, the credit risk of the portfolio of foreign currency mortgage loans in CHF is assessed by the Group, taking into account the legal risk associated with this portfolio. Due to unfavorable judgments, resulting in a higher expected number of lawsuits in the portfolio and a significant probability of losing the case, as at 31 December 2022, the Group assumed that loans for which the probability of litigation with the customer is higher than 60% are classified as Stage 3 Other loans (not meeting the above criterion) were classified to Stage 2.

However, with regard to the repaid portfolio of foreign currency mortgage loans in CHF, the Group applies IAS 37 and recognizes provisions allocated to this part of the portfolio under ‘Provisions’ and ‘Other operating expenses’, which were presented in Note 36 and Note 13, respectively.

Portfolio characteristics

Bank Pekao S.A. has not granted loans in CHF to the public since 2003. Almost the entire current portfolio of loans in CHF for individuals was taken over by Bank Pekao S.A. in the process of partial division of Bank BPH S.A. (loans granted before August 2006).

As at 31 December 2022, the Group had a portfolio of foreign currency mortgage loans in CHF with a total gross carrying amount of PLN 2 566 million (i.e. CHF 538.2 million) compared to PLN 2 716.5 million (i.e. CHF 610.7 million) as at 31 December 2021.

The tables below present the structure and quality of the CHF loan portfolio for individuals:

As of 31 December 2022 the average LTV for CHF loans to individuals granted by the Group amounted to 33.3% (35.3% as at 31 December 2021), with an average LTV for the whole portfolio of mortgage loans of 48.3% (52.3% as at 31 December 2021).

Court proceedings related to foreign currency mortgage loans in CHF

In 2019, the Court of Justice of the European Union (hereinafter the ‘CJEU’) issued a ruling on a CHF-indexed loan granted by another bank, in which it interpreted the provisions of Council Directive 93/13 / EEC of 5 April 1993 on unfair terms in consumer loans based on the CHF indexed loan agreement. The CJEU indicated the consequences of recognizing the possible abusiveness of conversion clauses by the domestic court, without examining the possible abusiveness of contractual provisions at all. The CJEU did not prejudge that in the event that a domestic court finds possible abusiveness, the court should automatically declare the entire contract invalid. The assessment in this respect remains to be decided by the national court, but the CJEU has not ruled out the possibility of filling the gap resulting from the abusive nature of conversion clauses by means of domestic regulations.

The ruling of the CJEU constitutes general guidelines for Polish courts. Final decisions made by Polish courts are made on the basis of EU regulations interpreted in accordance with the CJEU judgment, taking into account the provisions of domestic law and the analysis of the individual circumstances of each case. At the same time, it is difficult to talk about that the jurisprudence developed in an unfavorable way, which results in the issuance of judgments by the courts declaring the invalidity of loan agreements and ordering borrowers to return the benefits they have provided.

To date, no resolution has been adopted by the full composition of the Civil Chamber of the Supreme Court regarding the issues covered by the request of the First President of the Supreme Court, namely the answers to the following questions:

1. whether the abusive provisions relating to the method of determining the currency rate in an indexed or denominated loan agreement can be replaced by provisions of civil or customary law,
2. if it is impossible to establish a binding exchange rate for a foreign currency in a denominated loan agreement, the agreement may bind the parties in the remaining scope,
3. if it is impossible to establish a binding exchange rate for a foreign currency in the loan agreement, the agreement may bind the parties in the remaining scope,
4. whether the balance theory or the theory of two conditions will apply in the event of cancellation of the loan agreement,
5. which is the moment to start the limitation period in the event that the bank makes a claim against the borrower for the repayment of the loan,
6. whether it is possible for banks and borrowers to receive remuneration for using the

In the Group’s opinion, the Supreme Court’s ruling may be significant as regards the questions re. 4)-6), as the remaining issues have already been resolved in preliminary rulings issued by the CJEU. In addition, it should be noted that it is not certain whether and when the Civil Chamber will adopt a resolution on the above-mentioned legal questions.

On 7 May 2021, a resolution was adopted by the Supreme Court composed of seven judges, after the resolution of the legal issue in the case III CZP 6/21 in the Civil Chamber, indicating that:

• a prohibited contractual provision (Art.385 (1) § 1 of the Civil Code) is from the outset, by operation of law, ineffective in favor of the consumer, who may subsequently give informed and free consent to this provision and thus restore its effectiveness retroactively;
• if the loan agreement cannot be binding without an ineffective provision, the consumer and the lender are entitled to separate claims for the reimbursement of cash benefits provided in the performance of the agreement (Art. 410 § 1 in conjunction with Art. 405 of the Civil Code). The lender may request the return of the benefit from the moment the loan agreement becomes permanently ineffective.

The resolution in question was given the force of a legal principle, therefore in the scope of resolved issues, it is binding in other cases examined by common courts as well as by the Supreme Court.

Currently, a line of jurisprudence unfavorable for the Group has been developed, consisting in invalidating agreements and adjudicating repayment of installments repaid by borrowers.

In addition, there is a trend on the market related to the referral by common courts of inquiries regarding various types of doubts arising to the Supreme Court, as well as to the CJEU, which may also affect the future directions of judicial decisions. An example of such an important ruling is the judgment of the CJEU of 8 September 2022 issued in joined cases C-80/21 to C-82/21, in which the CJEU replied to the questions referred for a preliminary ruling by the District Court for Warszawa Srodmiescie in Warsaw in the CHF case. The CJEU stated:

1. The national court may not find that the entire contract term is unfair, but only its element which renders it unfair, if such removal would amount to changing the content of the term which would affect its essence. This means that, in principle, the national court is confined to finding that a whole contract term is unfair.
2. If a national court finds that a contract term is unfair, with the result that the entire contract may continue in force despite the exclusion of the unfair terms, the national court cannot replace these terms with a national provision of an optional nature. This means that in such a case the national court may not apply the provisions of the Civil Code concerning the conversion of installments with the average exchange rate of the National Bank of Poland.
3. The national court, after finding that a contract term is unfair, is not entitled to amend the content of that term in order to maintain the validity of the contract, which cannot remain in force after removal of the term, if the relevant consumer has been informed of the consequences of nullity of the contract and has agreed to the consequences of this This means that if the consumer has agreed to the consequences of the nullity of the contract (being informed of them), the national court may not, by ruling, change the content of such a condition, but must declare nullity.
4. The run of the 10-year limitation period for the consumer’s claim for reimbursement of the paid installments may not start from the moment of performance of each service in the performance of the contract (repayment of each installment), even if the consumer was not able to independently assess the unfairness of a contract term or did not become aware of unfair nature of this condition and without taking into account that the loan agreement provided for a much longer (30-year) repayment period. This means that the 10-year limitation period for the consumer’s claim for repayment of installments does not start from the date of repayment of each installment. In practice, it should be assumed that no consumer claims for reimbursement of installments paid have expired.

On the other hand, the CJEU has still not commented on the preliminary ruling concerning the limitation of the bank’s claim against the consumer (for the return of the capital paid out or, possibly, the remuneration for using the capital), as well as the bank’s entitlement to remuneration for the use of the capital. The CJEU will most likely rule on these issues in the middle of 2023 at the earliest.

On 16 February 2023, the Advocate General of the CJEU issued an opinion on the basis of Article 252 of the Treaty on the Functioning of the European Union in case C-520/21 in the proceedings in which the District Court for Warsaw – Srodmiescie in Warsaw, 1st Civil Division requested the CJEU to issuance of a preliminary ruling in which the CJEU will take a position on whether, in the event that a loan agreement concluded between a bank and a consumer is invalid from the beginning due to the inclusion of unfair contractual terms, the parties, in addition to refunding the money paid in performance of this agreement (bank – the loan capital, the consumer – installments, fees, commissions and insurance premiums) and statutory interest for delay from the time of request for payment, may also demand any other benefits.

In the above opinion, the Advocate General of the CJEU came to the conclusion that Art. 6 sec. 1 and art. 7 sec. 1 of Council Directive 93/13/EEC of 5 April 1993 on unfair terms in consumer contracts should be interpreted as follows:

• the above provisions do not preclude a judicial interpretation of national law according to which, where a loan agreement concluded between a consumer and a bank is held to be invalid from the outset because of the inclusion of unfair contractual terms, the consumer, in addition to reimbursement of the money paid under that agreement and payment statutory interest for delay from the time of request for payment, may, as a result of such recognition, also demand additional benefits from the bank. It is for the national court to determine, in the light of national law, whether consumers are entitled to pursue such claims and, if so, to decide on their merits,
• the above provisions preclude a judicial interpretation of national law according to which, if a loan agreement concluded between a consumer and a bank is held to be invalid from the outset on account of the inclusion of unfair contractual terms, the bank, in addition to refunding the money paid under that contract and paying interest for delay from the time of the request for payment, may, as a result of such acknowledgment, also demand additional benefits from the consumer.

Until 31 December 2022, 2 922 individual court cases have been filed against the Group regarding foreign currency mortgage loans in CHF (including 2 485 cases concerning contracts active at the time of filing the lawsuit), which were granted in previous years, with the total value of the claim in the amount of PLN 915.6 million (as at 31 December 2021, the number of cases was 1 596, and the corresponding value of the dispute is PLN 459.2 million). The main cause of the dispute, as indicated by the plaintiffs, concerns the questioning of the provisions of the loan agreement with regard to the Group’s application of conversion rates and results in claims regarding the partial or complete invalidity of the loan agreements. In 2022, the Group received 578 unfavorable court judgments in cases brought by borrowers, including 95 final judgments and 24 favorable court judgments, including 5 final judgments (in 2021: 124 unfavorable court judgments, including19 final judgments stating the invalidity of the loan agreement and 11 favorable court judgments, including 4 final judgments dismissing the claim for declaring the invalidity of the loan agreement and a claim for payment in connection with the invalidity of the loan agreement).

The total number of claims (broken down into active and paid as at the date of filing the claim) in particular years is presented in the table below:

Provision related to foreign currency mortgage loans in CHF – assumptions and calculation methodology

The calculation of the provision performed by the Group as at 31 December 2022 was based on estimating the expected loss of the Group resulting from the possible materialization of the legal risk of mortgage loans in CHF. The estimate made by the Group includes the following key elements:

1.total number of disputes

The Group updated the forecast of the expected number of future lawsuits using statistical methods and taking into account the observed upward trend, both in the number of incoming lawsuits, as well as issued certificates on the history of loan repayments (which are a leading indicator in relation to future lawsuits). The Group has estimated that in total, i.e. counting the lawsuits that have been and will be filed by borrowers against the Group, approximately 12 thousand loan agreements out of approximately 41 thousand loan agreements active or fully repaid in the last 10 years may be subject to litigation (of which approximately 10 thousand cases will relate to active agreements out of approximately 19 thousand loan agreements active as at 31 December 2022), and the phenomenon of an influx of lawsuits may remain significant until the end of 2028. According to the opinion of an external law firm, for index-linked loans originally granted by Bank Pekao S.A., the Group assesses the probability of the contractual provisions being deemed abusive as negligible, as the indexation clause used was based on the average NBP exchange rate and not the Group’s exchange rate table. As a result, the Group does not expect an influx of lawsuits for such agreements in the future, and for existing lawsuits (5 pieces) it does not create an individual provision, At the same time, for agreements repaid 10 years ago or earlier (i.e. inactive at the end of 2012), the Group assumes the possibility of successfully raising objections resulting in the dismissal of the claim and also does not expect an influx of lawsuits for such agreements in the future. This is confirmed by past practice: the scale of litigation for the remainder of the loan population is negligible.

As a result, the entire forecast of future lawsuits relates to denominated loans of active loans or loans that have been fully repaid within the last 10 years.

The Group estimates that approximately 47% (including approximately 71% for active contracts and 16% for repaid contracts) of the total CHF 2.3 billion of such loans granted is or may be in dispute (relative to 15% at the end of 2021).

2.the likelihood of losing a court case

According to the opinion of an external law firm, for the denominated loans acquired by the Group as a result of the acquisition (demerger) of Bank BPH, the Group estimates the probability that the contractual provisions will be considered abusive at a minimum of 95% (against a minimum of 90% at the end of 2021).

3.possible financial implications

The Group accepts the following possible litigation settlements:

• invalidation of the entire CHF foreign currency mortgage loan agreement as a result of declaring the valorization clause illegal, which the Group considers to be the most likely outcome (above 95%);
• recognition that the clauses contained in the loan agreement constitute prohibited contractual provisions resulting in the loan balance being set in PLN and the loan interest rate remaining based on the SARON/LIBOR rate (the so- called ‘de-franking’);
• declare the valorization clause abusive and replace in its content the Group’s exchange rate table with the average NBP rate;
• dismiss the

The Group updated expectations including the probability distribution of possible outcomes and the amount of expected financial impact if the court case is lost, taking into account statistics for litigation cases currently pending. In particular, the share of loan cancellation in possible settlement scenarios has exceeded 95% (against 80% at the end of 2021). In addition, the Group assumes the possibility of concluding out-of-court settlements with borrowers, resulting in the conversion of the loan into PLN. According to the approach adopted, the settlement offer will be presented to borrowers with active contracts and in dispute with the Group and may include the option of recalculating the loan as if it had originally been granted in PLN (as proposed by the Chairman of the UKNF). The financial impact estimate takes into account the expected propensity of borrowers to use settlements, depending on the ratio of the benefits of a settlement to the potential benefit of continuing the litigation.

Although the subject of legal risk related to the CHF loan portfolio is one of the key topics in the sector in recent years, the history of data on the scale of lawsuits (in particular in the field of final judgments), is still insufficient. All of the above causes that the process of determining the level of the provision requires each time the Group adopts many expert assumptions based on professional judgment.

Subsequent rulings and possible sectoral solutions that will appear on the Polish market with regard to foreign currency mortgage loans in CHF may affect the amount of the provision determined by the Group and cause the necessity to change individual assumptions adopted in the calculations. In connection with the above-mentioned uncertainty, it is possible that the amount of the provision will change in the future.

Provision related to foreign currency mortgage loans in CHF – results and allocation

As at 31 December 2022, the level of the provision for the aforementioned legal risk related to CHF-denominated mortgage contracts estimated by the Group amounted to PLN 2 198 million and increased by PLN 1 572 million relative to the level of such provisions as at 31 December 2021. As a result, the level of the provision at 31 December 2022 represents approximately 35% of the total volume of CHF-denominated loans granted, active or fully repaid over the last 10 years (relative to approximately 11% at 31 December 2021). For active contracts, the allocated provision corresponds to 55% and for repaid contracts to 10% of the amount granted. Specifically, the total impact on the financial result in the fourth quarter of 2022 from the creation of provisions for CHF loans, taking into account the increase in loan write-downs, the increase in the legal risk provision and the release of hedge accounting, amounted to approximately PLN 1.2 billion

The main reasons for the increase in the provision level as at 31 December 2022 in relation to the previous year are:

• an update of the expected number of litigation cases, rooted in the observed continuation of the increasing trends of incoming litigation cases and loan repayment history certificates issued, and taking into account the possible impact of changes in the legal environment, including the opinion of the CJEU Advocate General, on the propensity of borrowers to enter into litigation with the Group, and
• an increase in the likelihood of possible adverse dispute resolutions, resulting from a line of case law more unfavourable to banks, in which the predominant and increasing share of overall resolutions is the annulment of the loan agreement.

The above amount includes a provision for individual existing litigation to which the Group is a party and a portfolio provision for the remaining CHF foreign currency mortgage loan contracts that are subject to the legal risk of the recognition of abusive conversion clauses. In addition, the Group has allocated the total amount of the provision to the allowance for loan losses element (in correspondence with the item ‘Result from allowance for expected credit losses’) and the litigation provision element (in correspondence with the item ‘Other operating expenses’).

A summary of the recognition of the provision for legal risk related to foreign currency mortgage loans in CHF in the statement of financial position and income statement is presented in the tables below.

Sensitive analysis

The Group performed a sensitivity analysis in relation to the significant assumptions of the provision calculation, where a change in the level of individual parameters would have the following impact on the amount of the provision for the legal risk of foreign currency mortgage loans in CHF.

Impact on the provision level in the event of changes to the assumptions (with other elements of the calculation unchanged):