51. Fair value of financial assets and liabilities

51.1 Categories of fair value valuation of financial assets and liabilities measured at fair value in the consolidated statement of financial position

The Group classifies particular components of financial assets and liabilities measured at fair value to the following categories:

• Level 1: Prices quoted on the active markets
• Level 2: Valuation techniques based on observable market data
• Level 3: Other valuation techniques

The table below presents a classification of financial assets and liabilities presented in the financial statements at fair value divided into 3 levels as at 31 December 2015:

The table below presents a classification of financial assets and liabilities presented in the financial statements at fair value divided into 3 levels as at 31 December 2014:

Depending on the category of classification of financial assets and liabilities to the hierarchy, different methods of fair value valuation are used:

Level 1: Prices quoted on the active markets

Financial assets and liabilities whose fair value is stated directly at prices quoted (not adjusted) from active markets for identical assets and liabilities. The Group classifies to this category financial and equity instruments designated at fair value through profit and loss and available for sale, for which there is an active market and for which the fair value is determined with reference to market value which is a bid price:

• debt securities valued at fixing from Bondspot platform and Bloomberg and Reuters information services,
• debt and equity securities which are traded on regulated market, including the Brokerage House of PKO Bank Polski SA portfolio,
• derivative instruments which are traded on a regulated market.

Level 2: Valuation techniques based on observable market data

Financial assets and liabilities whose fair value is determined with use of valuation models where all significant entry data are observable on the market directly (as prices) or indirectly (based on prices). The Group classifies to this category financial instruments for which there is no active market:

Level 3: Other valuation techniques

Financial assets and liabilities, whose fair value is determined with use of valuation models, for which available input data are not derived from observable markets (unobservable input data).

The Bank classified to that category shares not listed on WSE, which are valued with internal valuation models:

a) participation units in mutual fund (Fund) - the fair value of these financial instruments is determined based on the net asset value of the Fund, i.e. the fair value of investment projects (of the companies) in the Fund, which are subject to semi-annual review or examination by the registered auditor. If the Bank used the values of the unobservable parameters, that are extreme values from the range of possible values, the fair value of the equity financial instruments could be PLN 9 832 thousand higher or PLN 9 832 thousand lower as at 31 December 2015,

b) shares of Visa Europe Limited (VEL), which were measured at fair value on the basis of information received from VEL in December 2015 about proposed participation of the Group in the settlement of transaction of VEL acquisition by Visa Inc. which is expected to amount in total EUR 88 875 079 (EUR 66 167 319 in cash, EUR 22 707 761 EUR in Visa Inc shares). The above mentioned amounts are not final and may change due to the objection submitted by the Group to the proposed method of determining the Group’s participation in the settlement of the transaction or if any objections of remaining members of VEL, costs of the transaction, as well as in the cases indicated in the documentation. Final confirmation of the amounts due to the Group should be settled by the 30 June 2016,

c) Corporate bonds recognized as investment securities available for sale and measured at fair value through profit or loss – valuation of these financial instruments is performed in accordance with a yield curve and a risk margin model. Yield curves are built based on market rates, money market data, IRS transactions market. Credit margins are determined on the basis of initial margins modified by credit indices quotes ascribed to issuers based on their ratings and business sector.

The impact of parameters estimated on measurement of financial instruments at fair value, for which the Bank uses fair value measurement on Level 3 as at 31 December 2015 is as follows:

Instruments transfers between Level 1 and Level 2 are based on the availability of quotations in an active market at the end of the reporting period. Transfer from Level 2 to Level 3 occurs in the situation of the conversion of an observable factor for an unobservable in the valuation or applying a new unobservable risk factor to the valuation, which also results in a significant impact on the valuation of the instrument. Transfer from Level 3 to Level 2 occurs in the situation of the conversion of an unobservable factor for an observable in the valuation or when an impact of an unobservable factor on the instrument valuation ceases to be relevant. Transfers between levels of valuation occur at the date and at the end of the reporting period. In 2015 the Group made partial transfers of corporate bonds recognized as investment securities available for sale from Level 2 to Level 1 and 3 of fair value hierarchy.

The table below presents a reconciliation during the periods of measurement from 1 January to 31 December 2015 and 2014 respectively, at fair value at level 3 of fair value hierarchy:

51.2 Financial assets and liabilities not presented at fair value in the statement of financial position

The Group holds financial assets and liabilities which are not presented at fair value in the statement of financial position.

Where there is no market value of financial instruments available, their fair values have been estimated with the use of various valuation techniques. The fair value of financial instruments was measured using a model based on estimating the present value of future cash flows by discounting them using relevant interest rates. All model calculations include certain simplifying assumptions and therefore are sensitive to those assumptions. Set out below is a summary of the main methods and assumptions used for estimation of fair values of financial instruments which are not presented at fair value.

For certain categories of financial instruments it has been assumed that their carrying amount equals approximately their fair values, which is due to lack of expected material differences between their carrying amount and their fair value resulting from the features of these groups (such as short term character, high correlation with market parameters, unique character of the instrument). This applies to the following groups of financial instruments:

• loans and advances granted by the Group to its customers: a portion of the housing loans portfolio (‘old’ housing loans portfolio), loans with no specified repayment schedule, loans payable at the moment of valuation,
• amounts of the Group due to customers: liabilities with no specified payment schedule, other specific products for which no active market exists,
• deposits and interbank placements with maturity date up to 7 days or with a variable interest rate,
• loans or advances granted and taken on interbank market at a variable interest rate (change of interest rate maximum on a 3 month basis),
• cash and balances with the central bank and amounts due to the central bank,
• other financial assets and liabilities.

For loans and advances to customers with no impairment triggers, present value of discounted cash flow model was used that includes current interest rate with credit margin risk and real maturities that steam from loan agreements. The current level of margins was calculated based on financial instrument transactions with similar risk level, that took place the last quarter that ended on the balance sheet date. For currency loans, the current loan margin for PLN loans was used and it was corrected with the cost of currency acquisition in basis-swap transaction. The valuation does not take into consideration potential currency conversion of loans denominated in CHF in regards to the draft law on possible measures to restore the equality of parties to some loan and advances agreements. For demand deposits, it is assumed that for them, the fair value equals their carrying value.

The fair value of deposits and other amounts due to customers other than banks, with specified maturities has been calculated using the discounted expected future cash flows and applying current interest rates for given deposit products. The fair value is calculated for each deposit and liability, then the fair values of the entire deposit portfolio are grouped by type of product and customer segment. The valuation does not take into consideration potential currency conversion of loans denominated in CHF in regards to the draft law on possible measures to restore the equality of parties to some loan and advances agreements. For demand deposits, it is assumed that for them, the fair value equals their carrying value.

The fair value of the subordinated debt of the Bank has been estimated based on the expected future cash flows discounted using the yield curve.

The fair value of debt securities issued by PKO Bank Polski SA has been estimated based on the expected future cash flows discounted using the current interbank interest rates.

The fair value of debt securities issued by PKO Finance AB has been estimated using Bloomberg data.

Interbank placements and deposits have been estimated based on the expected future cash flows discounted using the current interbank interest rates.

Receivables on financial lease have been estimated based on expected cash flows discounted using internal rate of return for lease transactions of the same kind, concluded by the Group in the period directly preceding the balance sheet date.

The table below presents a summary of the carrying amounts and fair values of individual groups of financial instruments not recognised at fair value in the statement of financial position as at 31 December 2015:

The table below presents a summary of the carrying amounts and fair values of individual groups of financial instruments not recognised at fair value in the statement of financial position as at 31 December 2014: