4.1. Classification and measurement

In connection with the application of IFRS 9, as of 1 January 2018 the Group classifies financial assets into the following categories:

• measured at amortized cost;
• measured at fair value through other comprehensive income (FVOCI);
• measured at fair value through profit or loss (FVP&L).

Classification as at the date of acquisition or origin depends on the business model adopted by the Group for the purposes of managing a particular group of assets and on the characteristics of the contractual cash flows resulting from a single asset or a group of assets. The Group identifies the following business models:

• the “held to collect cash flows” model, in which financial assets originated or acquired are held in order to collect gains from contractual cash flows – this model is typical for lending activities;
• the “held to collect cash flows and to sell” model, in which financial assets originated or acquired are held to collect gains from contractual cash flows, but they may also be sold (frequently and in transactions of a high volume) – this model is typical for liquidity management activities;
• the residual model – other than the “held to collect cash flows” and “held to collect cash flows and to sell” model.

Financial instruments are classified at the moment of the first-time application of IFRS 9, i.e. as at 1 January 2018, and at the moment of recognition or modification of the instrument. A change in the classification of financial assets may be caused by a change in the business model. Changes in the business model are caused by changes that occur within or outside the Group or by discontinuation of a particular activity, and therefore they occur very rarely.

Businnes model

The business model is selected upon initial recognition of financial assets. The selection is performed at the level of individual groups of assets, in the context of the business area in connection with which the financial assets originated or were acquired, and is based, among other things, on the following factors:

• the method for assessment and reporting the financial assets portfolio;
• the method for managing the risk associated with such assets and the principles of remuneration of persons managing such portfolios.

In the “held to collect cash flows” business model, assets are sold occasionally, in the event of an increase in credit risk or a change in the laws or regulations. The purpose of selling the assets is to maintain the assumed level of regulatory capital.

Assets are sold in accordance with the principles described in the portfolio management strategy or close to maturity, in the event of a decrease in the credit rating below the level assumed for a given portfolio, significant internal restructuring or acquisition of another business, execution of a contingency or recovery plan or another unforeseeable factor independent of the Group.

Assessment of contractual cash flow characteristics

The assessment of the contractual cash flow characteristics establishes, based on a qualitative test of contractual cash flows, whether contractual cash flows are solely payments of principal and interest (hereinafter ‘‘SPPI’’). Interest is defined as consideration for the time value of money, credit risk relating to the principal remaining to be repaid within a specified period and other essential risks and costs associated with granting loans, as well as the profit margin.

Contractual cash flow characteristics do not affect the classification of the financial asset if:

• their effect on the contractual cash flows from that asset could not be significant (de minimis characteristic);
• they are not genuine, i.e. they affect the contractual cash flows from the instrument only in the case of occurrence of a very rare, unusual or very unlikely event (non-genuine characteristic).

In order to make such a determination, it is necessary to consider the potential impact of the contractual cash flow characteristics in each reporting period and throughout the whole life of the financial instrument.

The SPPI test is performed for each financial asset in the “held to collect cash flows” or “held to collect cash flows and to sell” models upon initial recognition (and for modifications which are significant after subsequent recognition of a financial asset) and as at the date of change of the contractual cash flow characteristics.

If the qualitative assessment performed as part of the SPPI test is insufficient to determine whether the contractual cash flows are solely payments of principal and interest, a benchmark test (quantitative assessment) is performed to determine the difference between the (non-discounted) contractual cash flows and the (non-discounted) cash flows that would occur should the time value of money remain unchanged (the reference level of cash flows).

Financial assets measured at amortized cost

Financial assets (debt financial assets) are measured at amortized cost, provided that both the following conditions are met:

• the financial asset is held in accordance with the “held to collect cash flows” business model;
• the terms and conditions of an agreement concerning the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal outstanding (the SPPI test is passed).

Financial assets measured at fair value through other comprehensive income (FVOCI)

Financial assets (including debt instruments) are measured at fair value through other comprehensive income if both the following conditions are met:

• financial assets are held in the business model whose purpose is to collect contractual cash flows and to sell financial assets; and
• the terms and conditions of an agreement concerning the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal outstanding (the SPPI test is passed).

Financial assets measured at fair value through profit or loss (FVP&L)

If financial assets do not satisfy any of the above-mentioned criteria of measurement at amortized cost or at fair value through other comprehensive income, they are classified as financial assets measured at fair value through profit or loss.

Additionally, on initial recognition, a financial asset may be irrevocably classified as measured at fair value through profit or loss (option to measure at fair value through profit or loss) if this eliminates or significantly reduces inconsistency of measurement or recognition which would arise as a result of measuring assets or liabilities, or recognizing the related gains or losses according to different accounting principles (accounting mismatch). This option is available for debt instruments both under the “held to collect”, and “held to collect and sell” models.

Financial assets measured at fair value through profit or loss are presented in the consolidated financial statements of the Group in the following manner:

1. held for trading – financial assets which:
   • have been acquired mainly for the purpose of their sale or redemption in the short term;
   • upon initial recognition constitute a part of a portfolio of financial instruments, which are managed jointly and which actually generate short-term gains on an ongoing basis, or
   • are derivative instruments (other than financial guarantee contracts or designated and effective hedging instruments);
2. financial assets that are not held for trading and must be measured at fair value through profit or loss – financial assets that have not passed the test of cash flow characteristics (irrespective of the business model); or financial assets classified to the residual model;
3. financial assets designated for measurement at fair value through profit or loss upon initial recognition (measurement at the fair value through profit or loss option).

Equity instruments

Investments in equity instruments are measured at fair value through profit or loss. Upon initial recognition an irrevocable choice may be made to recognize subsequent changes in the fair value of investments in equity instruments which are not held for trading and are not a contingent payment recognized by the Group under accounting for a business combination pursuant to IFRS 3 in other comprehensive income (measurement at fair value through other comprehensive income option). If the measurement at fair value through other comprehensive income option is applied, only the dividend resulting from the investment is included in the profit or loss. Gains or losses on measurement recognized in other comprehensive income are not subject to reclassification to the income statement.

In the case of investments in equity instruments, the Group did not use the option of measurement at fair value through other comprehensive income.

Financial assets are reclassified only in the event of a change in the business model relating to the asset or a group of assets resulting from the commencement or discontinuation of a significant part of the entity’s operations. Such changes are very infrequent. Reclassification is presented prospectively, i.e. without changing the effects of fair value measurement in earlier periods, write-downs or accrued interest that have been recognized to date.

The following are not treated as changes in the business model:

• changes in the intentions regarding specific financial assets (even in the event of significant changes in market conditions);
• temporary discontinuation of a specific market for financial assets;
• a transfer of financial assets between business areas that apply different business models.

No financial liabilities are reclassified.

In the event of reclassification of a financial asset from amortized cost to measurement at fair value through profit or loss, the fair value of the asset is determined as at the reclassification date. Any gains or losses arising from a difference between the previously recognized amortized cost of the financial asset and its fair value are recognized in the income statement.

In the event of reclassification of a financial asset from the fair value through profit or loss category to the amortized cost category, the fair value of the asset becomes its new gross carrying amount as at the reclassification date. The effective interest rate is determined based on the fair value of the asset as at the reclassification date.

In the event of reclassification of a financial asset from amortized cost to measurement at fair value through other comprehensive income, the fair value of the asset is determined as at the reclassification date. Any gains or losses arising from a difference between the previously recognized amortized cost of the financial asset and its fair value are recognized in other comprehensive income. The effective interest rate and expected credit losses are not adjusted as a result of such reclassification.

In the event of reclassification of a financial asset from the measurement at fair value through other comprehensive income category to the amortized cost category, the asset is reclassified at the fair value as at the reclassification date. Accumulated gains or losses previously recognized in other comprehensive income are removed from equity and adjusted based on the fair value of the financial asset as at the reclassification date. As a result, the financial asset is measured as at the reclassification date in such a manner as if it has always been measured at amortized cost. This adjustment concerns other comprehensive income and it does not affect the financial result; therefore, it is not a reclassification adjustment in accordance with IAS 1. The effective interest rate and expected credit losses are not adjusted as a result of such reclassification.

In the event of reclassification of a financial asset from the fair value through profit or loss category to the fair value through other comprehensive income category, the Group continues to measure the asset at fair value. The effective interest rate is determined based on the fair value of the asset as at the reclassification date.

In the event of reclassification of a financial asset from the fair value through other comprehensive income category to the fair value through profit or loss category, the Group continues to measure the asset at fair value. Accumulated gains or losses previously recognized in other comprehensive income are reclassified from equity to profit or loss in the form of a reclassification adjustment in accordance with IAS 1 as at the reclassification date.

Modification – understood as a change in the contractual cash flows in respect of a financial asset based on an annex to the contract. A modification may be significant or insignificant. A change in the contractual cash flows resulting from execution of the terms of the contract is not a modification.

If the contractual cash flows associated with a financial asset are renegotiated or otherwise modified based on an annex to the contract, and such renegotiation or modification does not lead to such a financial asset no longer being recognized (“an insignificant Modification”), the carrying amount of the financial asset is recalculated and gain or loss arising from such modification is recognized in the financial result. Adjustment of the carrying amount of a financial asset resulting from the modification is recognized in the interest income/ expenses over time using the effective interest rate method. The carrying amount of a financial asset is calculated as the present value of renegotiated or modified contractual cash flows, discounted using the original effective interest rate on the financial asset (or, in the case of credit-impaired purchased or granted financial assets, the effective interest rate adjusted for credit risk) or, if applicable (e.g. with respect to gain or loss on a hedged item resulting from hedging), the updated effective interest rate. Any costs or fees incurred adjust the carrying amount of the modified financial asset and are amortized over the remaining part of the life of the modified financial asset.

In certain circumstances, renegotiation or modification of contractual cash flows associated with a financial asset may lead to derecognition of the financial asset. If an existing financial asset is derecognized due to its modification, and a modified asset is subsequently recognized, the modified asset is treated as a “new” financial asset (“a significant Modification”). The new asset is recognized at the fair value and a new effective interest rate applicable to the new asset is calculated. If the characteristics of a modified new financial asset (after signing an annex) comply with the arm’s length conditions, the carrying amount of that financial asset is equal to its fair value.

The assessment whether a given modification of financial assets is a significant or an insignificant modification depends on satisfaction of certain quantitative and qualitative criteria.

The following qualitative criteria have been adopted:

• Currency translation;
• Change of debtor, other than caused by the debtor’s death;
• Introducing or removing a contractual characteristic that adversely affects the test of cash flow characteristics (SPPI test);
• Increased engagement of the debtor, which includes the amount of capital increase and an increase in off-balance sheet liabilities granted which exceed 10% of equity and off-balance sheet liabilities from before the increase for each individual exposure.

The occurrence of at least one of these criteria results in a significant modification.

The quantitative criterion consists of a 10% test analysing the change in the contractual terms of financial assets resulting in a difference between the amount of future cash flows arising from the changed financial asset discounted using the original effective interest rate and the amount of the future cash flows that would arise from the original financial asset discounted using the same interest rate.

In the event of the occurrence of a quantitative criterion (a difference) of more than 10%, the modification is considered significant, whereas a quantitative criterion of 10% or less means that the modification is considered insignificant.

The quantitative criterion is not applicable to loans that are subject to a restructuring process (i.e. their modification is treated as insignificant) as the settlement or restructuring agreement serves a recovery strategy and does not constitute a new transaction concluded on different terms.

IFRS 9 distinguished a new category of purchased or originated credit-impaired financial assets (POCI).

POCI comprise debt financial assets measured at amortized cost and measured at fair value through other comprehensive income, i.e. loans and debt securities. Such assets are initially recognized at the net carrying amount (net of write-downs), which corresponds to their fair value. Interest income on POCI assets is calculated based on the net carrying amount using the effective interest rate adjusted for credit risk recognized for the whole life of the asset. The interest rate adjusted for credit risk is calculated taking into account future cash flows adjusted for the effect of credit risk recognized over the whole life of the asset. The change in estimates of future recoveries in further reporting periods is recognized as an impairment loss or revaluation gain in profit or loss.

As at 1 January 2018 the change in the classification and measurement of financial assets concerned:

• NBP bills amounting to PLN 4 199 million, which were measured at fair value through profit or loss on a portfolio basis in accordance with IAS 39. In accordance with IFRS 9, a portfolio of bills is measured at the fair value through other comprehensive income due to the fact that the “held to collect cash flows and to sell” model is applied;
• loan portfolios for which, due to the occurrence of the leverage component (an interest formula based on a multiple that is higher than 1) in the interest rate formula, the SPPI test has not been passed: ARiMR (the Agency for Restructuring and Modernization of Agriculture) investment loans, selected working capital loans, student loans, preferential housing loans with BGK financing, housing loans (Alicja), selected loans granted to local government units. Due to not passing the SPPI test, despite the application of the “held to collect cash flows” model, it was necessary to change the measurement category for such loan portfolios in the amount of PLN 1 070 million from amortized cost to fair value through profit or loss;
• to selected tranches of corporate bonds acquired by the Group (one entity), despite the application of the “held to collect and sell” model, due to the SPPI test not being met, the fair value measurement through profit or loss was applied. The classification of corporate bonds also changed (they had previously been recognized in available for sale ivestment securities) with an embedded option of conversion to shares (presented in derivative financial instruments), which in accordance with IFRS 9 are jointly measured at fair value through profit or loss. The total amount of reclassified bonds was 157 million.
• corporate and municipal debt securities, which were previously presented under “Loans and advances granted to customers” and measured at amortized cost, are now recognized under securities measured at amortized cost amounting to PLN 4 368 million (this reclassification does not affect the measurement).
• reclassification of equity securities being minority interests from the „available-for-sale” category (measured at cost less impairment losses) to the „not held for trading, mandatorily measured at fair value through profit or loss” category. The effect of the reclassification on the income statement amounted to PLN 92 million.

The implementation of IFRS 9 as of 1 January 2018 has not affected the classification and measurement of the Group’s financial liabilities.

The Group has estimated that, in connection with the IFRS 9 implementation, the total effect of adjustments arising from changes in the measurement and classification on equity (retained earnings or other comprehensive income) as at 1 January 2018 will amount to PLN 66 million (PLN 54 million after tax).

Furthermore, the Group prospectively applied a method of recognition of modifications in cash flows from financial assets, which as of 1 January 2018 are recognized in profit or loss on a one-off basis as at the date of the modification, and the change in the measurement as at the balance sheet date is calculated using the original effective interest rate. Up to 31 December 2017, the effect of modifications was spread over time using the effective interest rate method throughout the remaining part of the product’s life.

As at the moment of the first time application of IFRS 9, i.e. 1 January 2018, the Bank recognized POCI acquired as a result of mergers and acquisitions of impaired exposures (merger with Nordea Bank Polska and SKOK “Wesoła” in Mysłowice and Raiffeisen-Leasing Polska SA) and exposures which meet the POCI criteria in respect of corporate entities and lease receivables with a carrying amount of PLN 706 million, net, as assets.