26. Cost of legal risk of mortgage loans in convertible currencies

In connection with the current legal disputes regarding loans in convertible currencies, the The Group has identified a risk that the cash flows on the portfolio of mortgage loans denominated in and indexed to foreign currencies planned on the basis of schedules may not be fully recoverable and/or a liability resulting in a future outflow of funds may arise. The Group decreases the gross carrying amount of mortgage loans denominated in and indexed to foreign currencies and/or recognizes provisions for legal risk in accordance with the requirements of IFRS 9 Financial instruments and IAS 37 Provisions, Contingent Liabilities and Contingent Assets. The cost of legal risk was estimated taking into account a number of assumptions which have a significant effect on the amount of the estimates recognized in the Group’s financial statements.

The Group recognizes as the decrease of the gross carrying amount of mortgage loans the effect of legal risk related to potential litigation for the portfolio of mortgage loans in convertible currencies and existing legal claims related to loan exposures recognized as at the balance sheet date in the statement of financial position. If the estimated loss due to legal risk exceeds the gross value of the loan and for settled loans, the Group recognizes provisions for legal risk as a liability of the Group, in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

The costs of legal risk related to mortgage loans in convertible currencies were estimated using a statistical method taking into account the effect of customer characteristics as the sum of the products of:

• probabilities of specific outcomes of legal disputes and the amount of loss in the event of various dispute outcome scenarios, taking into account the current and expected number of court cases throughout the period of the Group’s exposure to such risk; and
• probability of acceptance of settlement by the customer and the amount of loss resulting from the settlement.

The Group also estimates the probabilities of adverse outcomes for the actual and potential claims. Such probabilities are different for mortgage loans indexed to foreign currencies and denominated in foreign currencies. In the evaluation of such probabilities, the Group uses the support of third party law firms. In the Group’s opinion, the level of estimated costs of legal risk is also affected by such factors as: duration of legal proceedings (also estimated on the basis of relatively short statistics which do not meet the requirements of quantitative methods) and growing costs which must be incurred to initiate and conduct legal proceedings.

The Group has also taken into account, as an impact on the probability of settlements, the tax preferences of customers falling within the scope of the Regulation of the Minister of Finance of 11 March 2022 on suspending the collection of income tax on certain types of income (revenue) related to a mortgage loan granted for residential purposes, as amended by the Regulation of 20 December 2022, which is in force until 31 December 2024.

Given the short horizon of the historical data available and a significant uncertainty as to the direction in which the legal solutions will evolve, the adopted methodology of assessing losses in respect of the legal risk will be periodically reviewed in the subsequent reporting periods. The uncertainty in the estimates relates both to the number of future lawsuits and court decisions in this regard, including the remuneration to which the Bank is entitled for the customer’s non-contractual use of capital in the event of a cancellation scenario (currently the model takes into account a probability of non-recovery of the cost of capital of 70%, thus the probability of recovery of the cost of capital is 30%) and to the expected number of settlements, which may be influenced in particular by changes in the jurisprudential line on mortgages denominated or indexed to foreign currencies, an increase in underlying interest rates or a change in the PLN/CHF exchange rate.

In 2022 and 2021, the Group regularly, on a quarterly basis, monitored the model’s adequacy by comparing the actual key model parameters with the calculated values. In addition, new empirical data (more accurate or resulting from a longer observation) were gradually modifying or replacing previous assumptions. The model was also adjusted to the new processes launched by the Group in the area of mortgage loans denominated in or indexed to foreign currencies granted in the past. The following major changes were introduced to the model:

• updating the probabilities of specific outcomes of legal proceedings – on the basis of the current information received from the Group’s legal advisors;
• updating the probability of signing a settlement or filing a lawsuit based on empirical data;
• determining the ratio of conversion of lawsuits to settlements over the loan’s lifetime on the basis of empirical data;
• taking into account non-zero probability of a favourable outcome (for the Group), where the customer is obliged to reimburse the fee for using funds without an agreement – in the event of a verdict declaring a loan agreement invalid.

The Group has analysed the model’s sensitivity to changes in key parameters:

From 2022 onwards, the Group has recognized the effects of final judgments declaring the invalidity of loan agreements in convertible currencies. As a consequence of the aforementioned judgments, the Group ceased to recognize receivables from active loan agreements in the Group’s assets (under “Loans and advances to customers”). At the same time, the Bank recognized, under “Other assets”, receivables from principal disbursed to customers and the Bank’s claims for reimbursement for non-contractual use of principal, as well as liabilities, relating to the reimbursement of principal and interest instalments paid by customers (“Other liabilities”).

• „Loans and advances to customers”,
• „Other assets”, „Provisions”, „Legal claims”
• „Management of currency risk associated with mortgage loans for individuals.

Starting from 4 October 2021, following a decision of 23 April 2021 of the Extraordinary General Meeting of PKO Bank Polski S.A., the Group has been concluding settlements with consumers who concluded loan agreements or cash advance agreements with the Bank secured by mortgages and indexed to foreign currencies or denominated in foreign currencies (hereinafter: settlements with consumers).

As at 31 December 2022, nearly 37.5 thousand applications for mediation were recorded (as at 31 December 2021 – more than 19 thousand applications). The total number of settlements concluded as at 31 December 2022 was 20 396, of which 19 786 were concluded in mediation proceedings and 610 in court proceedings. As at 31 December 2021, the total number of settlements concluded was 5 887, of which 5 754 were concluded in mediation proceedings and 133 in court proceedings. Starting from 20 June 2022, the Bank enabled concluding settlement agreements with respect to MIX mortgage loans granted in CHF designated for housing purposes.

Revaluation of the loss in respect of the legal risk is associated with the effect of changes in foreign exchange rates on the part of the loss which is recognized in the convertible currency as adjustment to the gross carrying amount of loans.