46.3. Legal risk regarding foreign currency mortgage loans in CHF

The Group recognizes that the legal risk related to the outstanding portfolio of foreign currency mortgage loans in CHF as at 31 December 2023 affects the expected cash flows from loan agreements of 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 Bank, taking into account the legal risk associated with this portfolio, which materializes in the form of court disputes and out-of-court settlements concluded with borrowers.

Due to unfavorable judgments, resulting in a significant probability of losing the case, as at 31 December 2023 the Bank assumed that loans subject to legal dispute and loans for which the probability that the client will file a lawsuit or reach a settlement with the Bank is estimated at higher level than 60% are classified as Stage 3. Other loans (not meeting the above criterion) were classified to Stage 2.

As a result of the above, in the case of the part of the provision relating to (allocated to) an active loan agreement, it is recognized first as an element of the impairment allowance on the loan exposure. However, any surplus of this provision over the net value of the loan exposure is presented as an element of provisions in the ‘Provisions’ line in accordance with IAS 37.

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.

At the same time, part of the provision concerns additional costs related to the possible loss of a court dispute (i.e. interest for delay and costs of legal representation) due to the fact that they do not result from the loan agreement are recognized in accordance with IAS 37 as an element of the ‘Provisions’ (regardless of whether this estimate concerns an active loan agreement or a repaid loan).

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 2023, the Group had a portfolio of foreign currency mortgage loans in CHF with a total gross carrying amount of PLN 2 086 million (i.e. CHF 445 million) compared to PLN 2 566 million (i.e. CHF 538.2 million) as at 31 December 2022.

As of 31 December 2023 the average LTV for CHF loans to individuals granted by the Group amounted to 28.7% (33.3% as at 31 December 2022), with an average LTV for the whole portfolio of mortgage loans of 47.8% (48.3% as at 31 December 2022).

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.

However, subsequent rulings of the CJEU exclude the admissibility of filling the gap after eliminating the prohibited provision under national law, as a result of which the courts of the countries recognize loan agreements as unenforceable after the removal of the abusive provision (conversion clause) and consider that the agreement cannot be enforced, as a result of which the courts declare the loan agreement invalid.

The rulings of the CJEU constitutes interpretative guidelines for above-mentioned Directive for Polish courts. At the same time, it can be rightly said that the unfavorable position has become permanent, which results in the issuance of judgments by the courts declaring the invalidity of loan agreements and ordering borrowers to return the loan installments paid to the Bank as an undue benefit.

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 funds.

In the Group’s opinion, the Supreme Court’s ruling is valid only up to question number 6), insofar as it concerns not so much the remuneration but the indexation of the amount corresponding to the amount of the loan capital paid. 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 the Civil Chamber will adopt a resolution on this questions at all.

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 nullity. 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 15 June 2023, the CJEU introduced a judgment in case C-520/21, in which it settled the question referred for a preliminary ruling by the District Court for Warsaw – Srodmiescie in Warsaw, stated that in the context of recognizing a mortgage loan agreement as invalid in its entirety due to the fact that it cannot continue to apply after removing the unfair terms from it, 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:

• they do not preclude a judicial interpretation of national law according to which the consumer is entitled to claim compensation from the credit institution beyond the reimbursement of the monthly installments and costs paid for the performance of that contract and the payment of statutory interest for late payment from the date of the request for payment, provided respect the objectives of Directive 93/13 and the principle of proportionality, and
• they preclude a judicial interpretation of national law according to which a credit institution is entitled to demand compensation from the consumer beyond the reimbursement of the capital paid for the performance of that contract and the payment of statutory interest for late payment from the date of the demand for payment

The judgment in question closed the way for the banks to pursue the so-called remuneration for the use of capital, while as regards consumer claims against banks, the CJEU referred to national law and emphasized that it is for the referring court to assess, in the light of all the circumstances of the dispute, whether the inclusion of such consumer claims complies with the principle of proportionality. As of today, we are not aware of such claims by borrowers, and thus their legal basis, scope or nature.

On 7 December 2023, the CJEU issued a judgment in case C-140/22, which states that the possibility of exercising rights by a consumer cannot be made conditional on the consumer’s submission to the court of consent to the maintenance of an unfair contract term, consent to invalidity contract and a statement that the consumer is aware of the consequences of the invalidity of the contract and that when settling the invalidity of the contract, banks cannot retain capital interest accrued in the course of performing the contract, thus stating that banks cannot demand compensation from the consumer that goes beyond the return of the paid capital.

On 11 December 2023, the CJEU issued a decision in case C-756/22, in which it ruled that Art. 6 section 1 and art. 7 section 1 of Directive 93/13 must be interpreted as meaning that in the context of declaring a mortgage loan agreement concluded with a consumer by a banking institution to be invalid in its entirety because that agreement contains unfair terms without which it cannot continue to be in force, precludes a judicial interpretation of the law of a Member State according to which that institution is entitled to demand from that consumer the repayment of sums other than the capital paid for the performance of that contract and statutory interest for delay from the time of the request for payment. The above ruling may in the future result in banks being able to claim from Swiss franc borrowers only the return of the loan capital along with statutory interest for delay from the moment of payment demand, without remuneration for the use of capital or capital indexation.

On 14 December 2023, the CJEU issued a judgment stating that Art. 6 section 1 and art. 7 section 1 of Directive 93/13, in connection with the principle of effectiveness, must be interpreted as precluding a judicial interpretation of national law according to which the limitation period for an entrepreneur’s claims arising from the invalidity of a mortgage loan contract begins to run only from the date on which the contract becomes permanently ineffective and that they preclude a judicial interpretation of national law according to which the submission of an objection by the entrepreneur to the retention will from that moment result in the consumer losing the possibility of claiming interest for the delay. Moreover, the CJEU ruled that a credit institution is not obliged to examine whether a consumer who is a party to a loan agreement is aware of the consequences of the invalidity of the agreement.

The judgments of the CJEU regarding the commencement of the limitation period for banks’ restitution claims do not cause any changes in the Group’s approach to this type of cases, due to the unclear jurisprudence of national courts, the Group assumes the earliest possible date for the commencement of the limitation period, which is the submission by the borrower of a declaration containing a demand related to the allegation that the contract was invalid. The above December rulings may change the approach of courts to awarding interest from banks for delays with a date earlier than the date of submission of the consumer’s declaration of consent to the invalidity of the contract and the effects of this invalidity, and may also unify the approach to the issue of whether filing an allegation of retention by a credit institution causes interruption and charging of interest to the customer, which, if such a practice is established before common courts, may be unfavorable for banks.

Until 31 December 2023, 5.8 thousand individual court cases were pending against the Group regarding foreign currency mortgage loans in CHF (including 1 thousand regarding contracts repaid as at the date of filing the lawsuit), which were granted in previous years, with the total value of the claim in the amount of PLN 1 938 million (as at 31 December 2022, the number of cases was 2.9 thousand, and the corresponding value of the dispute is PLN 916 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 based on the Bank’s exchange rate Table and results in claims regarding the partial or complete invalidity of the loan agreements. During the 12- month period ended on31 December 2023, the Group received 1 303 unfavorable court judgments in cases brought by borrowers, including 197 final judgments and 40 favorable court judgments, including 3 final judgments (in 2022: 578 unfavorable court judgments, including 95 final judgments stating the invalidity of the loan agreement and 24 favorable court judgments, including 5 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).

On 2 October 2023, the Bank started offering out-of-court settlements under the name “2% safe settlement. The program applies to borrowers who as of 31 March 2023 had an active mortgage loan agreement denominated in CHF, including those in legal dispute with the Bank.

As part of the settlement, a new debt balance is determined, expressed in PLN and calculated as the loan amount paid by the Bank, increased by contractual interest calculated at a fixed interest rate of 2% per annum and reduced by all repayments made by the borrower until the settlement is concluded. The amount of debt remaining after the settlement bears interest at a fixed interest rate of 2% per annum for the first 60 months, and thereafter in accordance with the Bank’s current offer. If the new debt balance turns out to be negative (i.e. there is an overpayment), the Bank refunds the overpaid amount to the borrower.

The Bank successively sends settlement offers to subsequent groups of borrowers covered by the program, starting with the oldest loans granted. As of 31 December 2023, approximately half of the borrowers responded to the settlement offer received, of which approximately 70% (1.5 thousand customers) accepted the Bank’s proposal. The program is scheduled to be completed by the end of 2024.

The calculation of the provision performed by the Group as at 31 December 2023 was based on estimating the expected loss of the Bank resulting from the possible materialization of the legal risk of mortgage loans in CHF. The estimate made by the Bank includes the following key elements:

1. forecast of disputes

   The Group updated the forecast of the expected number of future lawsuits using statistical methods and taking into account the observed trends in the scale of incoming lawsuits, as well as issued certificates on the history of loan repayments (which are a leading indicator in relation to future lawsuits).

   According to the opinion of an external law firm, for index-linked loans originally granted by Bank Pekao S.A., the Bank 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 Bank’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 (9 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 2013), 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 in total, i.e. counting the lawsuits that have been and will be brought by borrowers against the Bank, approximately 41% (including approximately 65% for active contracts and 13% for repaid contracts) of the total CHF approximately 2 billion of such loans granted may be in dispute (relative to 47%, including 71% for active contracts and 16% for repaid contracts estimated at the end of 2022), and the phenomenon of the inflow of lawsuits may remain significant until the end of 2028.

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 95% at the end of 2022).

3. financial implications of court disputes

   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 Bank 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 Bank’s exchange rate table with the average NBP rate;
     • dismiss the claim.

   The Group maintained 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 exceeds 95% (no changes compared to 2022).

   Moreover, the calculation takes into account additional costs related to the possible loss of a court dispute, calculated for the entire portfolio covered by the provision calculation: interest for delay and costs of legal representation.

   The Bank also takes into account the time value of money, in accordance with the projected dynamics of the inflow of future lawsuits and the expected duration of the dispute, i.e. the financial consequences of the dispute in an amount not exceeding the net carrying amount of a given contract were discounted using the effective interest rate of the loan, and the remaining part, including the entire interest for delay and costs of legal representation, profitability of Polish treasury bonds.

4. inclusion of a settlement program

   For the population of agreements covered by the program, the Bank assumes that the borrower will accept the settlement offer with a probability of approximately 35%, resulting from empirical observations. If a settlement is reached, the Bank no longer expects a lawsuit under a given contract. Otherwise, the probability and distribution of resolutions of the court dispute are the same as described in point 1)-3).

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 Bank 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 Bank 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.

As at 31 December 2023, the level of the provision for the aforementioned legal risk related to CHF denominated mortgage contracts estimated by the Group amounted to PLN 2 448 million and increased by PLN 250 million relative to the level of such provisions as at 31 December 2022. As a result, the level of the provision at 31 December 2023 represents approximately 44% of the total volume of CHF-denominated loans granted, active or fully repaid over the last 10 years (relative to approximately 35% at 31 December 2022). For active contracts, the allocated provision corresponds to 68% and for repaid contracts to 15% of the amount granted.

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.

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.

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.