Financial and
ESG report 2020

Fair Value

The best reflection of fair value of financial instruments is the price which can be obtained for the sale of assets or paid for the transfer of liability in case of market transactions (an exit price).

For many products and transactions for which market value to be taken directly from the quotations in an active market (marking-to-market) is not available, the fair value must be estimated using internal models based on discounted cash flows (marking-to-model). Financial cash flows for the various instruments are determined according to their individual characteristics, and discounting factors include changes in time both in market interest rates and margins.

According to IFRS 13 “Fair value measurement” in order to determinate fair value the Group applies models that are appropriate under existing circumstances and for which sufficient input data is available, based to the maximum extent on observable input whereas minimizing use of unobservable input, namely:

Level 1

valuation based on the data fully observable (active market quotations);

Level 2

valuation models using the information not constituting the data from level 1, but observable, either directly or indirectly;

Level 3

valuation models using unobservable data (not derived from an active market).

Valuation techniques used to determine fair value are applied consistently. Change in valuation techniques resulting in a transfer between these methods occurs when:

  • transfer from Level 1 to 2 takes place when for the financial instruments measured according to Level 1 quoted market prices from an active market are not available at the balance sheet day (previously used to be);
  • transfer from Level 2 to 3 takes place when for the financial instruments measured according to the Level 2 value of parameters not derived from the market has become significant at the balance sheet day (and previously used to be irrelevant).

All estimation models are arbitrary to some extent and this is why they reflect only the value of those instruments for which they were built. In these circumstances the presented differences between fair values and balance-sheet values cannot be understood to mean adjustments of the economic value of the Group. Fair value of these instruments is determined solely in order to meet the disclosure requirements of IFRS 13 and IFRS 7.

The main assumptions and methods applied in estimating fair value of assets and liabilities of the Group are as follows:

Receivables and liabilities with respect to banks

The fair value of these instruments was determined by discounting the future principal and interest flows with current rates, assuming that the flows arise on contractual dates.

Loans and advances granted to customers valued at amortised cost

The fair value of such instruments without specified repayment schedule, given their short-term nature and the time-stable policy of the Group with respect to this portfolio, is close to balance-sheet value.

With respect to floating rate leasing products fair value was assessed by adjusting balance-sheet value with discounted cash flows resulting from difference of spreads.

The fair value of instruments with defined maturity is estimated by discounting related cash flows on contractual dates and under contractual conditions with the use of current zero-coupon rates and credit risk margins.

In case of mortgage loans due to their long-term nature estimation of the future cash flows also includes: the effect of early repayment and liquidity risk in foreign currencies.

Liabilities to customers

The fair value of such instruments without maturity or with maturity under 30 days is considered by the Group to be close to balance-sheet value.

Fair value of instruments due and payable in 30 days or more is determined by discounting future cash flows from principal and interest (including the current average margins by major currencies and time periods) using current interest (including the original average margins by major currencies and time periods) in contractual terms.

Liabilities from the issuance of structured debt securities

Liabilities from the issuance of structured debt securities – bank’s securities (BPW) are stated/priced at fair value in accordance with Bank’s model. In this model, zero coupon bond price is calculated, which afterwards is increased by the option price, which was basis for a strategy built in a given structured bond.

The fair value of other liabilities arising from debt securities issued by the Bank (bonds (BKMO)) was estimated based on the expected cash flows using current interest rates taking into account the margin for credit risk. The current level of margins was appointed on the basis of recent transactions of similar credit risk.

Subordinated liabilities and medium term loans

The fair value of these financial instruments is estimated on the basis of a model used for determining the market value of floating-rate bonds with the current level of market rates and historical margin for credit risk. Similar as in loan portfolio the Bank includes the level of the original margin as a part of mid-term cost of financing obtained in the past in relation to the current margin level for the comparable instruments, as long as reliable assessment is possible. Due to lack of the mid-term loans liquid market as a reference to estimate current level of margins, the Bank used the original margin.

The table below presents results of the above-described analyses as at 31.12.2020 (data in PLN thousand):

Note Balance sheet value Fair value
ASSETS MEASURED AT AMORTISED COST
Debt securities 22 38 818 39 559
Deposits, loans and advances to banks and other monetary institutions 22 625 430 625 430
Loans and advances to customers* 21 72 472 589 70 992 415
Liabilities measured at Amortised Cost
Liabilities to banks and other monetary institutions 31 1 057 652 1 057 991
Liabilities to customers 32 81 510 540 81 545 397
Debt securities issued 34 558 560 560 714
Subordinated debt 35 1 540 209 1 540 491
* The negative impact of fair value valuation of the loans portfolio is largely attributable to growth of loan spreads. The methodology, which the Bank uses for valuation of the loans portfolio, assumes that current spreads best reflect existing market conditions and economic situation. A corresponding rule is widely applied for valuation of debt securities, which are not quoted on active markets. In result, paradoxically whenever the spreads of new loans increase, fair value of the “old” loans portfolio falls.

Models used for determination of the fair value of financial instruments presented in the above table and not recognized at fair value in Group’s balance sheet, use techniques based on parameters not derived from the market. Therefore, they are considered as the third level of valuation.

The table below presents data as at 31.12.2019 (data in PLN thousand):

Note Balance sheet value Fair value
ASSETS MEASURED AT AMORTISED COST
Debt securities 22 48 153 46 875
Deposits, loans and advances to banks and other monetary institutions 22 784 277 784 120
Loans and advances to customers* 21 68 117 195 65 834 231
Liabilities measured at Amortised Cost
Liabilities to banks and other monetary institutions 31 1 578 848 1 580 741
Liabilities to customers 32 81 454 765 81 463 818
Debt securities issued 34 1 183 232 1 189 016
Subordinated debt 35 1 546 205 1 548 362

The table below presents balance-sheet values of instruments measured at fair value, by applied fair value measurement technique:

Data in PLN‘000, as at 31.12.2020

Note Quoted market prices Valuation techniques – observable inputs Valuation techniques – significant unobservable inputs
Level 1 Level 2 Level 3
ASSETS
Financial assets held for trading 18
Valuation of derivatives 133 815 20 373
Equity instruments 245
Debt securities 269 413
Non-trading financial assets mandatorily at fair value through profit or loss 19
Equity instruments 134 163 66 609
Debt securities 50 335
Loans and advances 1 615 753
Financial assets at fair value through other comprehensive income 20
Equity instruments 320 29 218
Debt securities 18 613 077 0
Derivatives – Hedge accounting 23 21 795
LIABILITIES
Financial liabilities held for trading 30
Valuation of derivatives 83 754 20 021
Short positions 64 778
Derivatives – Hedge accounting 23 738 850

Data in ‘000 PLN, as at 31.12.2019

Note Quoted market prices Valuation techniques – observable inputs Valuation techniques – significant unobservable inputs
Level 1 Level 2 Level 3
ASSETS
Financial assets held for trading 18
Valuation of derivatives 46 143 65 538
Equity instruments 210
Debt securities 874 033
Non-trading financial assets mandatorily at fair value through profit or loss 19
Equity instruments 66 609
Debt securities 103 001
Loans and advances 1 498 195
Financial assets at fair value through other comprehensive income 20
Equity instruments 276 29 367
Debt securities 20 840 604 999 917
Derivatives – Hedge accounting 23 43 159
LIABILITIES
Financial liabilities held for trading 30
Valuation of derivatives 84 772 65 186
Short positions 202 265
Derivatives – Hedge accounting 23 426 847

Using the criterion of valuation techniques as at 31.12.2020 Group classified into the third category following financial instruments:

  • credit exposures with a leverage / multiplier feature inbuilt in the definition of interest rate (these are credit card exposures and overdraft limits for which the interest rate is based on a multiplier: 4 times the lombard rate). To estimate the fair value of loans, due to the lack of availability of the market value, an internal valuation model was used, taking into account the assumption that at the time of granting the loan the fair value is equal to the carrying value. The fair value of loans without recognized impairment is equal to the sum of future expected cash flows discounted at the balance sheet date. The discounting rate is the sum of: the cost of risk, the cost of financing, the value of the expected return. The fair value of impaired loans is equal to the sum of future expected recoveries discounted using the effective interest rate, recognizing that the average expected recoveries fully take into account the element of credit risk. In case of an increase in the discount rate by 1 p.p. valuation of the portfolio would have been reduced by -0.1% (sensitivity analysis: based on the FV model for the portfolio of credit cards);
  • index options, option transactions are measured at fair value with use of option measurement models, the model measurement is supplemented with impact on fair value of the estimated credit risk parameter;
  • VISA Inc. engagement shares in the number of 23,798; the method of fair value calculation of this instrument considers the time value of money, the time line for conversion of preferred stock in common stock of VISA and adjustments resulting from litigations (on-going or potential) against VISA and the Bank.;
  • other equity instruments measured at fair value (unquoted on an active market).

In the reporting period, the Group did not make transfers of financial instruments between the techniques of fair value measurement.

Changes of fair values of instruments measured on the basis of valuation techniques with use of significant parameters not derived from the market are presented in the table below (in ’000 PLN):

Indexes options Options embedded in securities issued and deposits Shares Debt securities Loans and advances
Balance on 31.12.2019 61 294 (60 944) 95 976 103 001 1 498 195
Settlement/sell/purchase (34 996) 34 697 0 0 90 544
Change of valuation recognized in equity 0 0 (175) 0 0
Interest income and other of similar nature 0 0 0 0 69 934
Results on financial assets and liabilities held for trading (6 387) 6 688 0 0 0
Result on non-trading financial assets mandatorily at fair value through profit or loss 0 0 0 (52 666) (42 920)
Result on exchange differences 0 0 26 0 0
Balance on 31.12.2020 19 911 (19 559) 95 827 50 335 1 615 753

For options on indexes concluded on an inactive market, and FX options the Group concludes back-to-back transactions on the interbank market, in result estimated credit risk component has no impact on the financial result.

Accordingly Group’s estimation impact of adjustments for counterparty credit risk was not significant from the point of view of individual derivative transactions concluded by the Bank. Consequently, the Bank does not consider the impact of unobservable inputs used in the valuation of derivative transactions for significant and in accordance with the provisions of IFRS 13.73 does not classify such transactions for level 3 fair value measurements.

Indexes options Options embedded in securities issued and deposits Shares Debt securities Loans and advances
Balance on 31.12.2018 35 430 (35 584) 50 651 43 187 1 250 525
Settlement/sell/purchase 17 357 (15 736) 147 15 710 156 406
Change of valuation recognized in equity 0 0 172 0 0
Interest income and other of similar nature 0 0 0 0 114 665
Results on financial assets and liabilities held for trading 8 507 (9 624) 0 0 0
Result on non-trading financial assets mandatorily at fair value through profit or loss 0 0 45 000 44 104 (23 401)
Result on exchange differences 0 0 6 0 0
Balance on 31.12.2020 61 294 (60 944) 95 976 103 001 1 498 195

 

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