5. The takeover of the Spółdzielcza Kasa Oszczędnościowo- Kredytowa ”Wesoła” in Mysłowice by PKO Bank Polski SA on 01 August 2015

On 18 June 2015, Bank agreed to participate in the restructuring of the Spółdzielcza Kasa Oszczędnościowo- Kredytowa Wesoła in Mysłowice (SKOK ”Wesoła”). On this basis, also on 18 June 2015, Polish Financial Supervision Authority(‘PFSA’) made a decision about takeover of SKOK Wesoła by the Bank.

This decision has been taken in accordance with article 74c clause 4 of the Act of 5 November 2009 on Credit Unions (the "Act on Credit Unions") According to this article, if it impossible to take over the credit union by the other union, PFSA taking into account the need to safeguard financial market stability and safety of funds held on accounts of the union, can decide whether to accept the takeover of the credit union or the takeover of some property rights or union’s obligations, by a domestic bank with its consent, or to liquidate the credit union. According to the decision of the Polish Financial Supervision Authority, since 19 June 2015 the management of property of SKOK ”Wesoła” has been taken over by the Management Board of Bank, and 1 August 2015 has been set as the date of the takeover of SKOK ”Wesoła” by Bank. According to the PFSA decision, the credit union conducted activities and offered services to its members in the full current range, until the date of the takeover.

The takeover was settled in accordance with IFRS 3. According to IFRS 3.45 Bank has 12 months – ie. until 31 July 2016. to determine the final values. The takeover of SKOK ”Wesoła” did not involve a transfer of the payment by the Bank. Whereas the takeover of SKOK ”Wesoła” was conducted with the financial support granted by the ( BFG ) pursuant to art. 20g of the Act of14 December 1994 on the Bank Guarantee Fund. The Bank received support from the BFG in the form of subsidies to cover the difference between the value of the taken over property rights and liabilities from guaranteed funds in the accounts of depositors in the amount of PLN 278 858 thousand and guarantees to cover losses arising from the risks associated with the taken over property rights of SKOK “Wesoła”.

As a result of the transaction settlement, there is no non-controlling shares in the taken over entity.

The following balance sheet items were analysed in terms of valuation:

• credit and loan portfolio;
• deposit portfolio;
• properties.

Loans and advances to customers measured at fair value

Fair value measurement of the loan portfolio was conducted by discounted cash flow method, which consists of the following steps:

• loan portfolio was divided into sub-portfolios of loan contracts with a similar risk profile; sub-portfolios have been separated on the basis of the period of granted financing. (vintage), as well as the type of product (retail or high volume). A feature differentiating the risk of the loans was also the distribution channel, retail loans were also divided on the internal and external retail loans segment;
• future expected cash flows were estimated based on the analysis of monthly cash flows of capital instalments and interest payments adjusted for the rate of prepayment, the estimated cost of risk and the value of other costs and revenues associated with the portfolio (eg. the fees and charges and the costs of operating the portfolio);
• the sum of above mentioned cash flows was then discounted using the appropriate discount rate, estimated on the basis of interest rates for risk-free instruments plus the premium over the risk-free rate reflecting the cost of capital of the Bank, the cost of financing the typical buyer, as well as capital requirements and risk weight for the given type of assets. Cash flows of not functioning loans portfolio were discounted at the risk-free rate enlarged by premium, determined as the weighted average yields on Polish companies from the debt collection market;
• the sum of the discounted cash flows set the fair value of the portfolio of loans.

As part of the Fair value measurement of the loan portfolio the effect of guarantee to cover losses was included. Losses arise from the risks associated with the taken over property rights of SKOK “Wesoła” granted by the Bank Guarantee Fund to support the restructuring of SKOK ”Wesoła” and the tax effect in the form of a provision for deferred income tax.

As part of the settlement of the purchase transaction no additional intangible assets were recognized.

The position of tangible fixed assets consists primarily of real estate in the carrying value of PLN 12 127 thousand, which reflects their fair value. Real estate values reported by the Credit Unions in the position of tangible fixed assets and other assets were adjusted to the value of the current estimates prepared by an external, independent property valuation experts.

For an insubstantial part of the assets, where the value of the estimate exceeded the gross book value, the property was carried in the gross book value.

The balance due to customers including current accounts and term deposits amounts to PLN 595 128 thousand, of which the value of non-interest bearing current accounts to approximately PLN 9 899 thousand . The remaining balance are term deposits, of which approximately 90% falls within one year from the takeover date according to the following table. The difference between the fair value of the portfolio in relation to its book value is not significant due to the short maturity of the contracts. Therefore it is assumed that the fair value of the portfolio of liabilities may be reflected by its book value.

As at 31 July 2015 conditional liabilities the SKOK ”Wesoła” consisted of:

a) liabilities granted: financial: arising from unutilized credit lines and overdrafts amounted to PLN 216 thousand, and guarantee: in respect of guarantees issued by the SKOK ”Wesoła” due to insuring works performed for the General Directorate for National Roads and Motorways amounted to PLN 47.6 thousand,
b) liabilities received: guarantee: in respect of received guarantees of loans granted by the Credit Union amounted to PLN 45 017 thousand.

As of 31 July 2015 SKOK ”Wesoła” did not have the promises of the loan.

As a result of the takeover , the Bank recognized goodwill in the amount of PLN 451 thousand calculated as the difference between the fair value of the net identifiable assets taken over and liabilities valued in accordance with IFRS (PLN -279 309 thousand), and the amount of grants received from BFG (PLN 278 858 thousand). The test for recoverability of goodwill resulted in impairment recognition. As a result, on 31 December 2015, the Bank wrote-off in other operating expenses the full amount of goodwill. This write-down is not deductible for the purposes of tax law.

According to the reached agreement and applicable law, the takeover and restructuring of SKOK “Wesoła” is realized with the support of the (BFG). In accordance with the aid scheme of an orderly liquidation of the cooperative savings and credit unions (SKOK), BFG gave the Bank guarantees to cover losses arising from the taken over property rights, ie. loans and advances, means in the Kasa Krajowa arising from the contributions to the stabilization fund, real estates and other, assets arising from intangible assets and other receivables, including commercial, created in the period from the takeover date to 30 June 2020.