Capital adequacy

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.

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:

*That recomendation replaces the previous one from 2018, to maintain own funds for the coverage of additional capital requirements at the level of 6.41 p.p. (Bank) and 6.27 p.p. (Group) as for TCR, which should have consisted of at least 4.81 p.p. (Bank) and 4.70 p.p. (Group) as for Tier 1 capital and which should have consisted of at least 3.57 p.p. (Bank) and 3.51 p.p. (Group) as for CET1 capital

** In August 2019 KNF informed the Bank was not identified as other systemically important institution in 2019

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 2019. The Bank will inform on each change of required capital levels in accordance with regulations.

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.

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.

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”.

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 2019, 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 evolution of Bank Millennium Group and Bank Millennium SA over the last three years was as follows:

The Group uses transitional arrangements for IFRS 9. As at 31.12.2019, if IFRS 9 transitional arrangements had not been applied, capital ratios were as follows:

• TCR: 19.89%
• T1: 16.70%
• CET1: 16.70
• Leverage ratio: 8.00%

The Bank uses transitional arrangements for IFRS 9. As at 31.12.2019, if IFRS 9 transitional arrangements had not been applied, capital ratios were as follows:

• TCR: 19,80%
• T1: 16,55%%
• CET1: 16,55%%
• Leverage ratio: 7.83%

As at 2019 end, capital adequacy in Bank Millennium Group remained on very high and safe level. Total Capital Ratio stayed at year end at 20.09% level for the Group (20.00% for the Bank) and Common Equity Tier 1 Capital ratio (equals T1 ratio) was at 16.91% for the Group (16.77% for the Bank). Therefore, minimum capital levels required by KNF for Bank and Group were achieved with a surplus.

In December 2019 KNF sent the individual dividend policy recommendation, in which it set the following additional buffers for dividend distribution (above the minimum required as at 2019 end for TCR): + 1.5% to pay 75%; + additional Stress test add-on to pay 100%. That add-on was measured as the Bank’s sensitivity to an adverse macroeconomic scenario and was set at 3.01% on the top of TCR, including regulatory adjustments. KNF kept also 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).

Capital ratios at the end of 2019 would allow to pay 75% if not additional K1 and K2 criteria for banks with FX mortgage loan portfolio.

Taking above into account and to provide a reliable capital support for growth a business activity, the Management Board of the Bank will submit to AGM a proposal of full retention of 2019 net profit in Bank’s own funds. Assuming acceptance of this proposal by AGM, positive impact on T1 and TCR ratio will be approximately 0.4-0.5 p.p. (to levels 17.38% and 20.56% for Group, respectively). It should be reminded that the capital ratios as of end 2019 already incorporated the 1^st half 2019 net profit, according to positive decision of KNF upon the Bank’s request.

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 adequacy ratios of the Group decreased during one year period by ca 1.6 p.p. for the Group (by 1.5 p.p. for the Bank). It was caused by a faster risk-weighted assets than own funds growth. In 2019, risk-weighted assets of the Group went up by ca PLN 11.5 billion (i.e. by 31%), mainly as a result of Eurobank takeover. The Group’s Own Funds raised by ca PLN 1.7 billion in 2019, mainly as a result of retention of net earnings (total net earnings for 2018 and net earnings for first half of 2019), and subordinated debt issue.

Bank Millennium has a dividend policy of distributing between 35% to 50% of net profit, subject to regulatory recommendations.

In December 2019 KNF sent the individual dividend policy recommendation, in which it set the following additional buffers for dividend distribution (above the minimum required as at 2019 end for TCR): + 1.5% to pay 75%; + additional Stress test add-on to pay 100%. That add-on was measured as the Bank’s sensitivity to an adverse macroeconomic scenario and was set at 3.01% on the top of TCR, including regulatory adjustments. KNF kept also 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).

Capital ratios at the end of 2019 would allow to pay 75% if not additional K1 and K2 criteria for banks with FX mortgage loan portfolio.

Taking above into account and to provide a reliable capital support for growth a business activity, the Management Board of the Bank will submit to AGM a proposal of full retention of 2019 net profit in Bank’s own funds. Assuming acceptance of this proposal by AGM, positive impact on T1 and TCR ratio will be approximately 0.4-0.5 p.p. (to levels 17.38% and 20.56% for Group, respectively). It should be reminded that the capital ratios as of end 2019 already incorporated the 1^st half 2019 net profit, according to positive decision of KNF upon the Bank’s request.

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.