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2018 Financial and Social Report

Capital Adequacy

Capital management and planning

Capital management relates to two areas: capital adequacy management and capital allocation. For both areas, management goals were set.

The goal of capital adequacy management is: (a) ensuring the solvency in normal and stressed conditions (economic capital adequacy/internal capital) and (b) meeting the requirements specified in external regulations (regulatory capital adequacy). Completing that goal, Bank strives to achieve internal long-term capital limits (targets), defined in Risk Strategy.

Capital allocation purpose is to create value for shareholders by maximizing the return on risk in business activity, taking into account established risk tolerance.

In a scope of capital management process, there is also a capital planning process. The goal of capital planning is to designate the own funds (capital base that is risk-taking capacity) and capital usage (regulatory capital requirements and economic capital) in a way to ensure that capital targets/limits shall be met, given forecasted business strategy and risk profile – in normal and stressed macroeconomic conditions.

Regulatory capital adequacy

Group is obliged by law to meet minimum own funds requirements, set in CRR art. 92. At the same time, the following levels, reccomendations and buffers were included in capital limits/targets setting:

  • Pillar II RRE FX buffer – KNF recommendation to maintain additional own funds for the coverage of additional capital requirements in order to secure the risk resulting from FX mortgage loans granted to households, in line with art. 138.1.2a of Banking Act. A value of that buffer is defined for particular banks by KNF every year as a result of Supervisory review and Evaluation process (SREP) and relates to risk that is in KNF’s opinion – inadequately covered by minimum own funds requirements, set in CRR art. 92. At present, the buffer was set by KNF in reccomendations issued in October and November 2018 in the level of 6.41 p.p. (Bank) and 6.27 p.p. (Group) as for Total Capital Ratio (TCR), which corresponds to capital requirements over Tier 1 ratio of 4.81 p.p. in Bank and of 4.70 p.p. in Group, and which corresponds to capital requirements over CET 1 ratio of 3.59 p.p. in Bank and 3.51 p.p. in Group*;

 

  • Combined buffer – defined in Act on macroprudential supervision over the financial system and crisis management – that consists of:
    • Capital conservation buffer at the level of 1.875%, and from the beginning of 2019 increased to target value of 2.5%;
    • Other systemically important institution buffer (OSII) – at the level of 0%, and the value is set by KNF every year**;
    • Systemic risk buffer at the level of 3% in force from the beginning of 2018;
    • Countercyclical buffer at the 0% level.

* That reccomendation replaces the previous one from 2017, to maintain own funds for the coverage of additional capital requirements at the level of 5.53 p.p. (Bank) and 5.41 p.p. (Group) as for TCR, which should have consisted of at least 4.15 p.p. (Bank) and 4.06 p.p. (Group) as for Tier 1 capital and which should have consisted of at least 3.10 p.p. (Bank) and 3.06 p.p. (Group) as for CET1 capital
** In August 2018 Bank informed about the decision of KNF on the rescinding the decision on identification of the Bank as other systemically important institution (O-SII) and on imposing on the Bank an O-SII buffer

In accordance to binding legal requirements and recommendations of Polish Financial Supervisory Authority (KNF), Bank defined minimum levels of capital ratios. being at the same time capital targets/limits. These are OCR (overall capital requirements) as for particular capital ratios

The below table presents these levels as at 31 December, 2018 and in 2019.

Capital ratio 31.12.2018 2019
CET1 ratio Bank Group Bank Group
Minimum 4,50% 4,50% 4,50% 4,50%
Pillar II RRE FX 3,59% 3,51% 3,59% 3,51%
TSCR CET1 (Total SREP Capital Requirements) 8,09% 8,01% 8,09% 8,01%
Capital Conservation Buffer 1,88% 1,88% 2,50% 2,50%
OSII Buffer 0,00% 0,00% 0,00% 0,00%
Systemic risk buffer 3,00% 3,00% 3,00% 3,00%
Countercyclical capital buffer 0,00% 0,00% 0,00% 0,00%
Combined buffer 4,88% 4,88% 5,50% 5,50%
OCR CET1 (Overall Capital Requirements CET1) 12,97% 12,89% 13,59% 13,51%
T1 ratio Bank Group Bank Group
Minimum 6,00% 6,00% 6,00% 6,00%
Pillar II RRE FX 4,81% 4,70% 4,81% 4,70%
TSCR T1 (Total SREP Capital Requirements) 10,81% 10,70% 10,81% 10,70%
Capital Conservation Buffer 1,88% 1,88% 2,50% 2,50%
OSII Buffer 0,00% 0,00% 0,00% 0,00%
Systemic risk buffer 3,00% 3,00% 3,00% 3,00%
Countercyclical capital buffer 0,00% 0,00% 0,00% 0,00%
Combined buffer 4,88% 4,88% 5,50% 5,50%
OCR T1 (Overall Capital Requirements T1) 15,69% 15,58% 16,31% 16,20%
TCR ratio Bank Group Bank Group
Minimum 8,00% 8,00% 8,00% 8,00%
Pillar II RRE FX 6,41% 6,27% 6,41% 6,27%
TSCR TCR (Total SREP Capital Requirements) 14,41% 14,27% 14,41% 14,27%
Capital Conservation Buffer 1,88% 1,88% 2,50% 2,50%
OSII Buffer 0,00% 0,00% 0,00% 0,00%
Systemic risk buffer 3,00% 3,00% 3,00% 3,00%
Countercyclical capital buffer 0,00% 0,00% 0,00% 0,00%
Combined buffer 4,88% 4,88% 5,50% 5,50%
OCR TCR (Overall Capital Requirements TCR) 19,29% 19,15% 19,91% 19,77%

Capital risk, expressed in the above capital targets/limits, is measured and monitored in a regular manner. As for all capital targets, there are determined some minimum ranges for those values. A capital ratios in a given range causes a need to take an appropriate management decision or action. Regular monitoring of capital risk relies on classification of capital ratios to the right ranges and then performing the evaluation of trends and drivers influencing capital adequacy.

Own funds capital requirements

The Group is completing a project of an implementation of internal ratings based method (IRB) for calculation of own funds requirements for credit risk and calculates its own funds minimum requirements using the IRB and standardise method for credit risk and standardise methods for other risk types.

In the end of 2012, Banco de Portugal (consolidating Regulator) with cooperation of Polish Financial Supervision Authority (PFSA) granted an approval to the use of IRB approach as to following loan portfolios: (i) Retail exposures to individual persons secured by residential real estate collateral (RRE), (ii) Qualifying revolving retail exposures (QRRE). According to the mentioned approval, minimum own funds requirements calculated using the IRB approach should be temporarily maintained at no less than 80% (“Regulatory floor”) of the respective capital requirements calculated using the Standardized approach.

During 2014 the Bank submitted to Regulatory Authorities an IRB approval pack regarding the remaining loan portfolios under the IRB roll-out plan – “other retail” and “corporate” portfolios.

In the end of 2014, the Bank received another decision by Regulatory Authorities regarding the IRB process. According to its content, for the RRE and QRRE loan portfolios, the minimum own funds requirements calculated using the IRB approach had to be temporarily maintained at no less than 70% (“Regulatory floor”) of the respective capital requirements calculated using the Standardized approach until the Bank fulfils further defined conditions.

The Bank received the decision of Competent Authorities (ECB cooperating with KNF) in July 2017 on approval the material changes to IRB LGD models and revoking the “Regulatory floor”.

Internal capital

Group defines internal capital according to Polish Banking Act, as the estimated amount needed to cover all identified, material risks found in Group’s activity and changes in economic environment, taking into account the anticipated level of risk in the future.

Internal capital is used in capital management in following processes: economic capital adequacy management and capital allocation. The Group defined an internal (economic) capital estimation process. To this end, as for measurable risk types, mathematic and statistic models and methods are used.

Maintaining economic capital adequacy means a coverage (provision) of internal capital (that is an aggregated risk measure) by available financial resources (own funds). An obligation to banks to have in place that sort of risk coverage stems from Banking Act. It was mirrored in the Group’s capital targets/limits: economic capital buffer and economic capital buffer in stressed conditions.

In 2018, both above capital targets were met with a surplus. A surplus of own funds over internal capital supports a further increase of banking activity, in particular in areas with a higher risk-adjusted return.

At the same time internal capital is utilised in capital allocation process, to assign an internal capital to products/business lines, calculating risk-adjusted performance measures, setting risk limits and internal capital reallocation.

Capital adequacy results

Capital adequacy evolution of Bank Millennium Group and Bank Millennium SA over the last three years was as follows:

Capital adequacy 31.12.2018 31.12.2017 31.12.20162
Risk-weighted assets 36 635.50 32 693.60 36 730.60
Own Funds requirements, including: 2 930.80 2 615.50 2 938.40
Credit risk and counterparty credit risk 2 593.90 2 297.70 2 621.80
– Market risk 20.3 18.3 23.4
– Operational risk 313.1 293.4 279
– Credit Valuation Adjustment CVA 3.5 6.1 14.3
Own Funds, including: 7 943.00 7 190.60 6 390.70
Common Equity Tier 1 Capital 7 243.00 6 548.80 6 356.80
Tier 2 Capital 700 641.8 33.9
Total Capital Ratio (TCR) 21.68% 21.99% 17.40%
Minimum required level 19.15% 18.91% 16.55%
Surplus(+) / Deficit(-) of TCR capital adequacy (p.p.) 2.53 3.08 0.85
Tier 1 Capital ratio (T1) 19.77% 20.03% 17.31%
Minimum required level 15.58% 14.56% 12.79%
Surplus(+) / Deficit(-) of T1 capital adequacy (p.p.) 4.19 5.47 4.52
Common Equity Tier 1 Capital ratio (CET1) 19.77% 20.03% 17.31%
Minimum required level 12.89% 13.53% 12.21%
Surplus(+) / Deficit(-) of CET1 capital adequacy (p.p.) 6.88 6.5 5.1
Leverage ratio 2 8.78% 8.88% 8.85%

1 The Group uses transitional arrangements for IFRS 9. As at 31.12.2018, if IFRS 9 transitional arrangements had not been applied, capital ratios were as follows:

  •  TCR: 21,39%
  •  T1: 19,47%
  •  CET1: 19,47%
  • Leverage ratio: 8,62%

2 ) Risk-weighted assets and own funds requirements are calculated with 70% „Regulatory floor”

Capital adequacy 31.12.2018 31.12.2017 31.12.20162
Risk-weighted assets 36 012.80 31 927.7 36 198.70
Own Funds requirements, including: 2 880.90 2 554.2 2 895.90
Credit risk and counterparty credit risk 2 570.60 2 260.4 2 601.20
– Market risk 20.3 18.3 23.4
– Operational risk 286.4 269.4 257
– Credit Valuation Adjustment CVA 3.6 6.2 14.3
Own Funds, including: 7 738.50 7 002.3 6 252.40
Common Equity Tier 1 Capital 7 038.50 6 360.5 6 218.50
Tier 2 Capital 700 641.8 33.9
Total Capital Ratio (TCR) 21.49% 21.93% 17.27%
Minimum required level 19.29% 19.03% 16.59%
Surplus(+) / Deficit(-) of TCR capital adequacy (p.p.) 2.2 2.9 0.68
Tier 1 Capital ratio (T1) 19.54% 19.92% 17.18%
Minimum required level 15.69% 14.65% 12.82%
Surplus(+) / Deficit(-) of T1 capital adequacy (p.p.) 3.85 5.27 4.36
Common Equity Tier 1 Capital ratio (CET1) 19.54% 19.92% 17.18%
Minimum required level 12.97% 13.60% 12.23%
Surplus(+) / Deficit(-) of CET1 capital adequacy (p.p.) 6.57 6.32 4.95
Leverage ratio 2 8.57% 8.68% 8.74%

1 The Group uses transitional arrangements for IFRS 9. As at 31.12.2018, if IFRS 9 transitional arrangements had not been applied, capital ratios were as follows:

  • TCR: 21,20%
  • T1: 19,25%
  • CET1: 19,25%
  • Leverage ratio: 8,41%

2 Risk-weighted assets and own funds requirements are calculated with 70% „Regulatory floor”

As at 2018 end, capital adequacy in Bank Millennium Group remained on very high and safe level. Total Capital Ratio stayed at year end at 21.68% level for the Group (21.49% for the Bank) and Common Equity Tier 1 Capital ratio (equals T1 ratio) was at 19.77% for the Group (19.54% for the Bank). Therefore, minimum capital levels required by KNF for Bank and Group were achieved with a surplus.

As at 2018 end, capital adequacy in Group, measured by Common Equity Tier 1 Capital ratio and Total Capital Ratio, decreased in one year period by ca 0.3 p.p.

In 2018, risk-weighted assets grew by ca PLN 3.9 billion (by 12%), as result of the growth of loan portfolio. Own Funds raised by ca PLN 753 million in 2018, mainly as a result of 100% retention of 2017 net earnings.

Minimum capital levels required by KNF for Bank and Group were achieved with a surplus.

In January 2019 KNF sent to Bank the individual dividend policy recommendation, in which it set the following additional buffers for dividend distribution above minimum required as at 2018 end for TCR:  +1.5% and full conservation buffer 2.5% to pay 75%; + additional Stress test add-on (3.14% for the Bank/Group) to pay 100%. KNF kept additional criteria for banks with FX mortgage portfolio (K1 based on FX mortgage share in total portfolio and K2 based on share of 2007-2008 vintages in total FX mortgage portfolio).

Bank Millennium has a dividend policy of distributing between 35% to 50% of net profit, subject to regulatory recommendations. The high capital ratios (as at 2018 year-end) would allow to pay 75% if not additional K1/K2 criteria. Taking above into account and considering the planned acquisition of Eurobank SA, the Management Board of the Bank will submit to AGM a proposal of full retention of 2018 net profit in Bank’s own funds. Assuming acceptance of this proposal by AGM, positive impact on T1 and TCR ratio will be approximately 2.1 p.p. (to levels 21.85% and 23.76% for Group, respectively).

After the reporting period, i.e. on 17 January 2019 the Bank had taken decision on the issue of PLN 830 million of subordinated bonds which were fully paid and subscribed as on 30 January 2019. The Bonds, after approval of KNF will constitute Bank’s Tier II instruments and will result in further increase of Group’s TCR ratio by ca 2.3 p.p. to the level of 26.02% (based on 31.12.2018 data, including retention of full 2018 net profits).

Leverage ratio stood at the safe level of 8%-9%, with a small quarterly changes and exceeds almost three times a value deemed as safe (3%).

In a long perspective, capital adequacy level of Bank and Group is evaluated as satisfactory. Capital ratios are in long-term increasing trend, and their levels significantly exceed values defined in regulations.