54. Influence of macroeconomic situation on the PKO Bank Polski Group results

The macroeconomic situation in the world had a complex effect on the operations and financial position of the Group in 2015. On 15 January 2015 the Central Bank of Switzerland (SNB) resigned from the upper limit for the EUR/CHF pair. This resulted in abrupt strengthening of the CHF against other currencies, including PLN. SNB decided to lower the target for 3M LIBOR by 50 bp to -0,75% to offset the negative effects of the franc’s strengthening. Due to the persistence of reduced inflation (partly because of a decline in oil prices), and in order to defend against the strengthening of the euro, in March 2015 the European Central Bank (ECB) introduced asset purchases program (QE) providing the purchase of bonds and other asset-backed securities and Treasury bonds (EUR 60 billion of securities a month until September 2016.). Due to the deepening decreases in oil prices and continuingly declining inflation, in December 2015 the ECB lowered the deposit rate by 10bps to -30%, the QE program was extended to March 2017, extending its scope to bonds issued by the local public sector and decided to reinvest interests from maturing securities. Apart from the ECB actions, resulting in a positive credit impulse and a weak euro, euro zone economy benefited from the drop in oil prices. As a result, euro zone GDP growth accelerated in 2015 to 1.5% y/y from 0.9% in 2014. Slowing economic growth in China (from 7.4% in 2014 to 6.9% in 2015) has not significantly harmed European economy. Uncertainty about economic situation in China and other emerging markets, was a major factor contributing to the delayed start of monetary policy tightening by the Federal Reserve System (FED). The continuation of robust GDP growth in the US (2.5% y/y in 2015 compared to 2.4% y/y in 2014) and a further decline in an unemployment rate (down to 5% at the end of 2015 from 5.6% at the end of 2014) prompted the Federal Open Market Committee (FOMC) to make the first increase of interest rates in eight years (increase of the range for the fed funds rate by 25bp to 0.25-0.50% in December).

Polish economy growth rate throughout 2015 remained stable at around 3.5% y/y, despite the volatility in external environment. Deep recession in Russia and Ukraine, together with the slowdown / recession in many emerging countries (mainly in China) limited the strength of external demand, but was overweighed by the positive impact of the recovery in the euro zone. Significant drop in oil prices was an positive external environment impulse. As a result, domestic demand remained on a clear path of recovery. Consumption growth remained stable at just over 3% while the situation on the labour market further improved and the deflation increased the real purchasing power of households. Strong investment demand at the beginning of the year was supported, among others, by favourable weather conditions, while in the second half of the year nearly double-digit growth of investment dynamics was fuelled by expansion of production potential in the automotive industry and the energy sector. On the other hand, decrease in municipal investment in the second half of the year reflects the end of the financial prosperity of the EU 2007-2013. Throughout 2015, GDP growth amounted to 3.6%. In March 2015 the Monetary Policy Council (RPP) decided to reduce all NBP interest rates by 50bps (reference rate: 1,50%), which was influenced by the decline in inflation to the lowest level in the contemporary history of the Polish economy. Later in the year, RPP decided not to cut rates, which was supported by: progressively shallowing deflation, maintaining GDP growth above 3% y/y and the depreciation of the PLN.

PKO Bank Polski SA successfully passed the stress tests during the second half of 2015, conducted by the PFSA. They were aimed at determining the potential impact of variable macroeconomic events on financial situation and particularly capital situation of Polish financial sector institutions. Test results confirm the Bank’s high resistance on the occurrence of macroeconomic shocks. In each of the scenarios, the Bank recorded a net profit and the level of capital adequacy ratios remains above the internal and external limits.  

Taking into account the impact of the macroeconomic events on the financial condition of customers of PKO Polish Bank SA, the Group consistently applies a conservative approach to credit risk, recognizing impairment losses which scale and structure reflects the impact of the current macroeconomic situation on the financial statements of the Group.

Consolidated net profit of the PKO Bank Polski SA Group for 2015 amounted to PLN 2 609.6 million and was PLN 644.6 million lower than in 2014. After eliminating non-recurring events: - payment to the Bank Guarantee Fund (BFG) within the fund for the protection of guaranteed deposits (FOŚG) to cover payment of the guaranteed deposits to depositors of the Spółdzielczy Bank Rzemiosła I Rolnictwa in Wołomin due to its bankruptcy in the amount of PLN 338 million, - payment for Borrowers Support Fund (FWK) in the amount of PLN 142 million, comparable net profit amounted to PLN 2 998.3 million and was lower than in 2014 by PLN 255.7 million. The structure of the statement of financial position of the PKO Bank Polski SA Group, characterized by strong deposit base and safe level of equity, made it possible to maintain a high result on business activities. As a result of actions taken in 2015 the Group increased its total assets by more than PLN 18 billion, including nearly PLN 11 billion portfolio of loans to customers, while maintaining a high market share in loans and deposits. The quality of loan portfolio, measured by ratio of impaired loans and cost of risk, has improved.

Due to the capital commitment in Ukrainian companies, in particular in KREDOBANK SA, the Bank is exposed to the effects of risks typical for the Ukrainian market. In Ukraine the bottom of recession was reached in the first quarter of 2015 (-17.2% y/y). Subsequently, GDP growth increased to -1.2% y/y in the fourth quarter of 2015. Collapse of hryvnia and increase in administered prices in April 2015 (hot water, gas, electricity) have led to a drastic rise in CPI inflation. It amounted on average 48.2% y/y with a peak of 60.9% y/y in March and 43.3% y/y at the end of 2015. Very high inflation contributed to deterioration in households’ situation (real wages fell in the period between January-December 2015 at an average rate of -18.5% y/y). In 2016 a downward trend in inflation is to be seen. It will be supported by expiring effect of increases in utility prices in April 2015.

Strong depreciation of the hryvnia exchange rate (from 15.82 UAH/USD at the end of December 2014 to 33.75 UAH/USD on 26 February 2015) forced the central bank to raise interest rates to 30% (from 14% at the end of 2014). Stabilization of the exchange rate allowed (from August) reduction in the main interest rate to 22%. After reaching the bottom in February ($ 5.6 billion) foreign exchange reserves grew steadily reaching 13.3 billion US dollars in December (which is 3.6 times the monthly imports). National Bank of Ukraine (NBU) continued to finance the Ukrainian budget (increase in government bonds holders’ structure from 69.5% to 77.1% at the end of the year). At the beginning of the year reversal of this trend can be seen resulting from the increase in purchases of bonds by commercial banks.

An important achievement of 2015 became the restructuring of Ukraine's Eurobonds, which will allow for a significant reduction in the cost of external debt over the next four years, while creating favourable conditions for economic reforms. Due to the debt restructuring credit ratings of Ukraine were raised to B- with a stable outlook (Standard & Poor 's on 19 October 2015), to Caa3 with a stable outlook (Moody's on 19 November 2015) and CCC (Fitch on 19 November 2015). This led to an increase in the rating of banks operating in Ukraine - including KREDOBANK SA to CCC +.

The banking sector was in a difficult financial situation. The number of banks operating in Ukraine dropped in 2015 (latest data from 1 December 2015) from 163 to 120. Share of foreign capital in the sector declined in the first half of the year (from 32.5% in December 2014 to 27.5 % in June 2015) to rise to 35.3% at the end of November. The value of total assets in the Ukrainian banking sector in 2015 decreased (with exception of period of rapid UAH depreciation) and in early December amounted to UAH 1275.4 billion (down by UAH 41.5 billion against the end of 2014). Until the end of 2015 the value of loan portfolio fell by UAH 30.2 billion (insignificant scale of the decline in the volume of loans resulted mainly from the depreciation of the hryvnia - the increase in the volume of foreign currency loans amounted to UAH 86 billion, i.e. 17.5%). The decrease in volume of loans to households by UAH 36.3 billion has not been compensated by an increase in corporate loan portfolio of UAH 9 billion. The deposit base of the banking sector in Ukraine in 2015 increased by UAH 47.1 billion, mainly due to the growth in UAH deposits (UAH 28.1 billion). Volume of foreign currency deposits increased (UAH 19 billion), however it only resulted from depreciation of the hryvnia. Household deposits fell by UAH 7.2 billion, and enterprises deposits increased by UAH 46.7 billion. Major changes in volumes of loans and deposits occurring in the first half of the year were associated with fluctuations in the hryvnia exchange rate. In 2015, the ratio of loans to deposits improved (down from 147.4% to 134% in December). The share of currency loans in the currency structure of the loan portfolio increased to 56.9% in December 2015 (against 47.0% at the end of 2014). In 2015, banks gradually rebuild its capital base after a sharp decline in the 1st quarter. Compared to the end of 2014 the share of defaulted loans significantly increased (21.2% at the end of November 2015 vs. 13.5% in December 2014). In the period January-November ROA ratio fell (-5.1% vs -4.1% in 2014) while ROE fell deeply (-47.8% vs -30.5% in 2014). In 2016, the economy should recover from the recession and grow by approx. 1-2%.

Simultaneously, there are significant risks to the GDP growth in Ukraine (the risk of macroeconomic instability and insolvency, the risk of foreign financing availability, the risk of instability of the financial market and the hryvnia exchange rate, risks to the stability of the banking sector and regulatory uncertainty). Other relevant circumstances that may affect prospects of economic growth in Ukraine, escalation of military conflict in the east of Ukraine and turbulence in political environment.

PKO Bank Polski SA continues efforts to ensure the safe operation of its companies in Ukraine under the current political and macroeconomic situation, including the strengthening of supervisory activities, i.a. tracking the funds transferred by the Bank to its subsidiaries and changes in regulatory requirements set by the National Bank of Ukraine. The Bank constantly analyses the macroeconomic operational risks of KREDOBANK SA. Development of the situation in Ukraine can bear a significant impact on Group’s entities operating on that market.