ING Bank Śląski | Annual Report 2014

ING BANK ŚLĄSKI

ING BANK ŚLĄSKIAnnual Report 2014

2. Accounting estimates

The preparation of financial statements in accordance with IFRS requires from the Group the use of estimates and assumptions that affect the amounts reported in the consolidated financial statements and notes thereto. 

Estimations and assumptions applied to the presentation of value of assets, liabilities, revenues and costs are made on basis of historical data available and other factors considered to be relevant in given circumstances. Applied assumptions related to the future and available data sources are the base for making estimations regarding carrying value of assets and liabilities, which cannot be determined explicitly on the basis of other sources. The estimates reflect the reasons for/ sources of uncertainties as at the balance sheet date. The actual results may differ from estimates.

The estimations and assumptions are reviewed on an on-going basis. Adjustments to estimates are recognized in the period when the estimation was changed provided that the adjustment applies to this period alone or in the period when the estimation was changed and in the following periods, should the adjustment impact both the current and future periods.

Below are the most significant booking estimates made by the Group.

2.1. Impairment

The Group assesses whether there is objective evidence of impairment of financial assets (individual items or groups) and property, plant and equipment items as at balance sheet date.

2.1.1. Impairment of financial assets

Objective evidence of impairment of financial assets stems from occurrence of one or more events which have a direct impact on valuation of future asset-related cash flows. 

The estimates can take into account observable data indicating occurrence of unfavourable payment situation on the part of borrowers from a certain group or unfavourable economic situation of a given country or its part, which translates into the problems sustained by this group of assets. For significant assets classified to the ISFA portfolio (Individually Significant Financial Assets), impairment is calculated as a difference between the present value of a credit exposure and expected discounted future cash flows for a given exposure.

For IBNR (Incurred But Not Reported) and INSFA (Individually Non- Significant Financial Assets) portfolios, calculations are made with the use of PD, EAD and LGD parameters plus the loss identification period in line with the following formula:

Impairment loss  = (1-(1-PD)(M/12)) x (EAD + EI) x LGD 
Where:

  • PD – probability of an impairment trigger occurrence over a 12 month horizon in line with the Point-in-Time approach (i.e. taking account of the current risk profile of a given portfolio), 
  • EAD (exposure at default) – current balance sheet exposure plus the projected balance sheet equivalent of unutilised credit lines and off-balance sheet liabilities including the conversion rate (the so called CCF or K-factor) in line with relevant EAD models.
  • EI (effective interest) – contractual interest accrued and unpaid including outstanding commissions and effective interest rate adjustment for those exposures for which the effective interest rate is set and contractual interest accrued and unpaid for those exposures for which the effective interest rate is not set,
  • LGD – the expected loss ratio, which is the complement to unity of the ratio of the recoverable amount and the basis for impairment losses including all direct costs incurred as of the impairment date until the end of the debt recovery process. Historical loss parameters are adjusted with the data coming from current observations in order to account for current market factors which were not present during the period covered with historical observations and exclusions of effects of past developments which are no longer present today,
  • LIP – a loss identification period expressed in months, which depending on business segment is:
    • 8 months for small enterprises and consumer credits,
    • 9 months for strategic clients, mid-sized and mid corporates, 
    • 12 months for retail mortgage loans.

The PD parameter is 100% for impaired exposures (INSFA). 

The LGD parameter for calculating the impairment loss under collective method for impaired exposures (with default) depends on the time for which the exposure is impaired.

Moreover, for separated portfolios that comprise exposures defaulted for at least 2 or 3 years (depending on the segment) the LGD parameter is also 100%. 

Detailed disclosures as to credit risk estimation models used by the Group are presented further in this report, see Chapter: Risk Management at the ING Bank Śląski S.A. Capital Group, item I discussing credit risk management.

To determine impairment (or reverse it), the present value of expected future cash flows has to be calculated. The methodology and assumptions used to estimate both the amount and the time of future cash flows are regularly reviewed and adjusted as needed. 

Some examples of impairment triggers for financial assets and the recording rules applied therefor were described in item Impairment (item 5.10).

2.1.2. Impairment of other non-current assets

For property, plant and equipment, valuation is based on estimating the recoverable amount of non-current assets being the higher of their value in use and net realisable value at the review date. The value in use of an item of property, plant and equipment (or a cash-generating unit when the recoverable amount of an asset item forming joint assets cannot be determined) is estimated, among others, through adoption of estimation assumptions for amounts, times of future cash flows which the Group may generate from a given asset item (or a cash-generating unit) and other factors. To determine the value in use, the estimated future cash flows are discounted to their present value at pre-tax discount rate, which reflects the current market expectations as regards value of money and the specific risk of a given asset item.

When estimating the fair value less costs of sale, the Group makes use of relevant market data available or valuations made by independent appraisers which are based on estimates by and large. The relevant recording rules were delineated in item 7.4. Impairment of other non- financial assets.

2.2. Credit risk connected with derivative instruments

The approach employed by the Group to estimate credit risk for derivatives with future settlement date (active deals unsettled as at the balance sheet date) is consistent with its approach to assessing credit risk for credit receivables. Valuation adjustments are estimated per counterparty considering the expected presettlement exposures and the same risk incurred by the Group. This approach assuming the possibility of occurrence of risk of bilateral value adjustments. The adjustment is made using the expected positive exposure estimated through numerous simulations (the results from the scenarios leading to a negative outcome are eliminated) and the present market value (or its estimation through referencing to comparable data) of credit default swaps (CDS). Own risk of the Group and the risk of realisation of a scenario of concurrent client and Group insolvency are calculated by analogy.

In addition for matured or terminated and unsettled transactions as at the balance sheet date, the Group establishes impairment losses using the methodology for assessing the risk of impaired loans.

The two types of fair value adjustments as mentioned above were differently reflected in the consolidated financial statements. Fair value adjustments due to risk for non-matured transactions were presented under the item Net income on instruments measured at fair value through profit or loss and FX result, whereas the impairments losses for matured transactions under the item Impairment losses for financial assets and provisions for off-balance-sheet liabilities. If a transaction whose fair value was adjusted in the previous reporting period in the item Net income on instruments measured at fair value through profit or loss and FX result becomes mature or subject to restructuring, then the amount of the previous fair value adjustment is moved to the item Impairment losses and the added part of the impairment loss for such already matured transaction is presented in the income statement in the item Impairment losses for financial assets and provisions for off-balance-sheet liabilities

Therefore the financial result is impacted only by the amount of surplus of the current impairment loss (or write-down) for a mature transaction above the amount of the fair value adjustment established before the transaction has matured.

2.3. Measurement of financial instruments that do not have a quoted market price

The fair value of financial instruments not quoted in active markets is measured using valuation models. For non-option derivatives, the models based on discounted cash flows apply. Options are measured using appropriate option valuation models.

Valuation models used by the Group are verified prior to their usage. Where possible, in models the Group uses observable data from active markets. However, in certain circumstances, to choose the right valuation parameter, the Group makes an estimation by comparing a given instrument to another one present on another market but having similar or identical features. 

Application of the prudence principle requiring to choose the lower value of assets and the higher value of liabilities as being more probable – especially in the conditions of lower liquidity or/and volatility of the financial markets – is fundamental in the valuation made based on this approach. The change of assumptions concerning these factors may influence valuation of some financial instruments.

2.4. Retirement and pension benefit provision

The Group establishes the provisions for retirement and pension benefit in accordance with IAS 19. The provision  for retirement and pension benefit pay awarded as part of the benefits under the Labour Code regulations is calculated using the actuarial method by an independent actuary as the current value of the future long-term Group obligations towards its employees according to the headcount and payroll status as at the update date. 

The provisions are calculated based on the range of assumptions, related to both macroeconomic conditions as well as to those related to staff rotation, death risk and others. The employees provision is calculated based on the estimated retirement or pension benefit which the Group undertakes to pay under the General Conditions of Remuneration effective in every Group unit. 

The estimated benefit amount is calculated as the product of the following elements:

  • the estimated assessment basis for retirement or pension benefit, in keeping with the General Conditions of Remuneration for each Entity, 
  • the estimated growth of assessment basis by the time of reaching the retirement age,
  • percentage rate depending on seniority (in keeping with the General Conditions of Remuneration). 

The resulting amount is discounted on an actuarial basis as at the yearend date. In accordance with IAS 19 requirements, the financial discount rate used to calculate the current value of the employee benefit obligations is determined on the basis of the market yield on government bonds, whose currency and maturity date are consistent with the currency and estimated term of the employees benefit obligations. 

The discounted amount is lowered by the annual provisions discounted using actuarial method as at the same date, the purpose whereof is to increase the employee provisions. The actuarial discount stands for the product of the financial discount and the probability that the given individual will survive until the retirement age as the Group employee. The amount of annual provisions and the probability are calculated based on the models assuming the following three risks:

  • probability of termination of employment,
  • full incapacity to work,
  • mortality.

The probability of quitting work is estimated according to the statistical distribution principle, with the consideration of the Group’s statistical data. The probability of employee quitting work depends on the age of employee and it is at fixed level in every work year.

The mortality risk has been reflected in the latest statistical data from the Polish life-tables for men and women published by the Central Statistical Office as at the valuation date.

The provision being the result of actuarial valuation is updated annually based on the valuation of the independent actuary, and in quarterly intervals, based on the quarterly forecasts indicated in the valuation. 

The Group recognises the actuarial gains and losses in other total income at the moment when they arise, so that the net amount of the retirement assets or liabilities recognised in the statement of financial position reflects full amount of the financial surplus or deficit of the programme. The amendment is of forward-looking nature due to immateriality of the amounts concerned.

2.5. Valuation of incentive schemes

2.5.1. Valuation of options granted under ING Group incentive system benefits

The fair value of the options granted under the ING Group incentive system benefits was measured with the Monte Carlo simulation. The model takes the risk-free interest (from 2.02% to 4.62%) as well as the expected exercise date for the options granted (from 5 to 9 years), the option exercise price, the present option price (EUR 2.9 – EUR 26.05), the expected volatility of ING Group share certificates (25% – 84%) and the expected dividend yield (from 0.94% to 8.99%). 

The ING incentive scheme determines the volatility used to price the stock options, which is defined by the volatility of market data and not the historical volatility.

2.5.2. Valuation of variable remuneration programme benefits

As at the balance sheet date, the Group presents in the books the estimated present value of benefits to be rendered under the variable remuneration programme. Benefits will be granted to employees covered with the programme, based on their performance appraisal for a given year. The programme was launched in 2012. 
Benefits granted as phantom stock are valued based on the median of closing prices of Bank’s shares on the Warsaw Stock Exchange during a certain period.

The fair value of the deferred benefit element is adjusted with the reduction factor which accounts for probability of occurrence of an event requiring adjustment of the value of the granted benefit which the employee is not fully eligible to as at the balance sheet date. The catalogue of events has been defined in the programme assumptions. The present value of the said benefits is determined at market discount rate.

2.6. Residual value of leased assets

The expected residual value is usually the agreed future price of non-current asset purchase by the client after the end of the leasing term. The value is calculated as at the leasing commencement, based on the non-current asset initial value. The residual values are usually established based on certain contractual amount and recognised in net leasing investment position. Recovery of non-current asset residual value in leasing operations depends on the fulfilment of terms and conditions of leasing agreement and completion thereof.

2.7. Valuation cost basis  of debt and capital securities

Estimation of fair value of and result on sale of securities requires application of a certain cost basis for investment. The cost basis for investment applied in that respect is based on the interpretation resulting in application by an analogy to the guidelines given in IAS 2 Inventories, however only as far as possible considering the unique nature of the financial instruments of this type. 

The Group applies the “weighted average purchase price” as the effective cost basis for investment to estimate fair value of and result on sale of securities with the capital rights. 

The Group applies the “first-in first-out” (FIFO) method as the cost basis of investment for debt securities.

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