Acquisitions of subsidiaries by the PZU Group are recognized by the purchase method of accounting.
For each acquisition transaction, the acquirer is identified and the acquisition date is determined, which is the date on which the acquirer obtains control over the acquiree. As of the acquisition date, the acquirer recognizes, separately from goodwill, the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree.
As at the date of acquisition, the identifiable assets acquired and the liabilities assumed are measured at fair value.
For each acquisition, any non-controlling interest in the acquiree are measured at the non-controlling interest’s proportionate share in the fair value of the acquiree’s identifiable net assets.
The fair value measurement of assets and liabilities is associated with significant uncertainty regarding estimates, as it requires the Management Board of PZU to develop professional judgments and make use of complex and subjective assumptions. Relatively small changes in key assumptions may have a significant impact on the results of the measurement. Key assumptions include, among others: discount rates, credit risk costs, prepayment rates for performing portfolios and the timing and amount of expected cash flows for non-performing portfolios.
Determination of goodwill or a gain from a bargain purchase
Goodwill is measured and recognized as at the date of obtaining control as the surplus of:
over the obtaining control date net amount of the fair value of the identifiable assets acquired and the liabilities assumed.
If the net fair values of identifiable assets acquired and the liabilities assumed exceeds the fair value of payment received, increased by the value of all non-controlling interests in the acquiree and the fair value of the interest in the acquiree’s equity and held before obtaining control, the gain from a bargain purchase is recognized in the consolidated profit and loss account. Before a gain from a bargain purchase is recognized, a reassessment is made whether all of the assets acquired and all of the liabilities assumed have been correctly identified and all additional assets or liabilities have been are recognized.
In the period of maximum 1 year from taking the control, PZU Group may retrospectively adjust the provisional fair values of assets and liabilities recognized as at the date of obtaining control to reflect new information obtained about facts and circumstances that existed as of the date of obtaining control and, if known, would have affected the measurement of these assets and liabilities. Such adjustments are charged directly to the recognized goodwill or gain from a bargain purchase.
Intangible assets acquired in business combination transactions are recognized at fair value as at the date of obtaining control. The fair value of an intangible asset reflects expectations as to the probability that the entity achieves economic benefits from the asset in the future. The fair value of intangible assets is determined as follows:
The discount rate used for the measurement of intangible assets reflects the time value of money and risks related to expected future cash flows. It is calculated on the basis of the expected return from the best investment alternative to the investment being measured. This rate sets the lowest return from the measured asset that is required by an investor in such a manner that the rate of return achieved by the investor is at least equal to the best available investment alternative. The return on the alternative investment must be comparable in terms of value, time and certainty.
Cost of equity (CE) is estimated as at the date of obtaining control in accordance with the Capital Asset Pricing Model (CAPM): CE = RF + ERP x β + SP + SR, where RF stands for risk-free rate, ERP – market risk premium, β – measure of systematical risk borne by the equity holders, including the operational and financial risks associated with the business, SP – small cap premium, SR – specific risk premiums.
Loans and advances to customers
The measurement of the loan portfolio to fair value was performed using the income method involving the discounting of future cash flows arising from the loan portfolio component being measured. For performing loans, fair value was estimated as the present value of cash flows defined as the sum of the contractual installments of principal and interest (in accordance with the contractual margin rates and outstanding principal), adjusted by prepayments where relevant. The following is used to discount cash flows:
For measurement purposes, the loan portfolio has been divided by currencies, product groups, risk level and client segments.
The standard curve was calculated on the basis of quotations for deposits for nodes up to 1 year and IRS transactions for nodes above 1 year.
The credit spread curve was calculated on the basis of estimated cumulative probability of default curves and expected average recovery rates for a given product group and client segment.
The liquidity curve for PLN was determined as the higher of zero or the difference between the PLN:BOND curve (zero-coupon curve based on Treasury bond prices) and the PLN:Std curve. For other currencies, the liquidity curve was increased by the cost of a swap converting PLN into the currency in question (calculated from FX Swap and Cross Currency Basis Swap quotations). When the cost was negative, the value of zero was assumed.
Market margin was calibrated for loans granted in the period of 3 months preceding the date of obtaining control, so that the fair value is equal to the gross carrying amount. If the market margin became negative following the calibration, it was assumed to be zero. For foreign currency mortgage loans, the margin was determined as the margin for PLN mortgage loans plus the difference in the average margin between mortgage loans granted in foreign currencies and the average margin of PLN mortgage loans.
For short-term working capital loans, the net carrying amount was taken as fair value.
Analyses have shown that the fair value of impaired loans did not differ materially from their carrying amount.
Property, plant and equipment
Property is measured using the income method, while other tangible assets – using market or replacement method.
Liabilities arising from unfavorable (liability-generating) lease agreements
In order to determine the fair value of liabilities arising from unfavorable (liability-generating) real property lease agreements, an analysis was carried out of the standard market lease rates in various locations at the time of determination of the fair value. Then these rates were compared to the amounts resulting from the lease agreements. Due to the large number of such agreements, the analysis was conducted on a sample of agreements concluded in different years. The differences obtained on the examined sample for a given year of execution were then extrapolated to the entire portfolio of agreements concluded in such a year. In the determination of the fair value, no renegotiation or termination of the lease agreements prior to the end date of the agreement was assumed (in particular for agreements where the contractual rate of rent differed from the estimated market rate). Based on the leased area, the location of the real property, the term of the lease and the difference between the market rate and the rate actually paid, cash flows were projected along with the dates of their occurrence in the projection period. These cash flows were then discounted as at the valuation date using a risk-free rate. The value of the discounted cash flows represents the fair value of the liability as at the valuation date.