26.3 Testing for impairment

Impairment tests for goodwill were performed as at 31 December 2019 for all the CGUs, to which goodwill was allocated. As a result of the tests, no need has been found to recognize impairment losses.

The goodwill impairment test involves a comparison of carrying amounts (including the allocated goodwill) and recoverable amounts of the CGUs to which goodwill has been allocated. An impairment loss for a CGU should be recognized in the profit and loss account if CGU’s recoverable amount is less than its carrying amount.

Cash-generating units (CGUs)

Goodwill is allocated to the individual companies (constituting CGUs for the purposes of the impairment test) and is monitored at this level. During the final purchase price allocation, the goodwill arising from the acquisition of Link4 was fully allocated to the mass insurance segment in non-life insurance, which – due to the scale of integration of Link4’s business with PZU under the ‘two brands’ strategy that assumed synergies resulting from the management of the mass client portfolio and sale of additional insurance products – is the smallest CGU to which goodwill can be allocated. Goodwill on the acquisition of PIM was fully allocated to Pekao, since that was the lowest level at which goodwill is monitored at the Group level.

Carrying amount

For the purposes of the test, the net carrying amount of the mass insurance segment was determined on the basis of allocation of the PZU Group’s net assets. The assets were allocated in the proportion corresponding to the ratio of the hypothetical solvency capital requirement, which may be allocated to the mass insurance segment, to the total solvency capital requirement. The Euler method was used to allocate the solvency capital requirement. This method allocates to a segment the risk measures, which are based on Solvency II regulations and take into account diversification effects.

The carrying amount of the remaining entities includes CGU’s net assets and goodwill. For the entities, in which non-controlling interests exist, the carrying amount for the purposes of the test is increased by the portion of goodwill allocated to non-controlling interests (it is not presented in the consolidated statement of financial position).

Recoverable amount

The recoverable amount of individual CGUs was determined based on value in use of the entities, using the discounted cash flow method based on the most current financial projections, for a period not exceeding 5 years, which are presented in the table below. The discount rates used for testing of the insurance companies were set at the cost of equity level. In the case of medical companies, the weighted average cost of capital (WACC) was used. The cost of equity was set in accordance with the CAPM model. Also, size premiums were applied in justified cases. Risk-free rates were determined based on the average yield of 10-year government bonds offered by the country where the CGU is domiciled and the betas were based on measures of similar listed entities. Market premiums were 5.5% (5.5% in 2018). For regulated entities (banks and insurance companies, financial institutions), the projected cash flows incorporate the requirement to maintain an adequate level of own funds (economic capital). Cash flows of the mass insurance segment were calculated based on the amount of hypothetical dividends that the segment could have paid if it had operated as a separate insurance company. The amount of dividends depends on the projected technical results of that segment, net of income tax and levy on financial institutions and capital surpluses allocated to that segment as at the balance sheet date and in subsequent periods. The growth ratios after the projection period were determined while taking into account the long term growth prospects for the market on which the entity conducts its business. Growth rates do not exceed the long-term GDP growth forecasts of the country in nominal terms.

Sensitivity analysis

Estimation of the recoverable amount is a complex process that requires the parent company’s Management Board to make professional judgments and apply complicated and subjective assumptions. Relatively small changes in key assumptions may have a significant impact on the results of the recoverable amount measurement. The key assumptions in the process of estimation of the recoverable amount are: growth rates during the residual period, discount rates, expected profitability level, future capital requirements and minimum level of solvency as a condition for the disbursement of dividends by regulated entities.

The table on the next page presents the surplus of recoverable amounts over carrying amounts and the maximum discount rates and minimum marginal growth rates after the projection period, at which the carrying amounts and recoverable amounts of the individual CGUs. The surplus amount was stated as PZU’s share.

The decrease in Alior Bank’s surplus is due to the recognition of cash flows from dividends in periods later than expected as at 31 December 2018. The deferral of dividends was caused by a decrease in current and forecasted financial results, which were adjusted due to, without limitation, the CJEU judgment of 11 September 2019, as referred to in section 43.3, as well as credit losses incurred in 2019 in the agribusiness sector. As a result of the losses incurred and in light of the capital needs associated with the development of Alior Bank, the disbursement of the forecasted dividends was deferred, which resulted in a decrease in the current value of cash flows generated by the Alior Bank CGU.

The key assumption made in the context of Alior Bank’s goodwill recoverability test is the achievement of objectives set forth in its strategy for 2020-2022. The bank strives to maintain its position as a technology leader on the market. Better fulfillment of client needs, deepened client relations and client satisfaction will translate into growth of business and a higher profitability of the bank.

The strategy calls for reconstruction of the bank’s business model:

• the growth strategy will be based on a selection of industries and clients. In order to mitigate the high risk profile, particular emphasis will be put on the growth of products characterized by a good profitability-to-risk ratio, such as leases, mortgage loans and factoring, in the segment of small and medium-sized enterprises and active retail clients. It is assumed that involvement in large exposures and investment projects will be reduced.
• In connection with the CJEU judgment of 11 September 2019, the revenue profile will change. A lower rate of growth of cash loans is assumed. The key assumption remains the maintenance of the existing interest margin and a significant increase in the share of non-interest income that does not tie up capital, such as bancassurance and assurbanking initiatives conducted within the framework of strategic cooperation with PZU.
• The bank will increase the efficiency of its sales processes through digitization and robotization using the best IT practices available on the market. Automation will have a key impact on changes in the integrated risk management process. The purpose of these activities is to use the available capital in the best possible manner and reduce credit risk while maintaining the efficiency of the process. In order to maintain profitability, the optimization will include reconstruction of the branch network and reduction in the number of traditional outlets. In their place, the bank will provide online services.

The extent of intended changes puts the projections on an heightened level of uncertainty. This is why adjustments have been made to the estimates, lowering the rate of revenue growth in periods beyond the term of the strategy and, in respect of bancassurance and assurbanking initiatives, the risk premium was increased.

The progress of work on these plans will be monitored in the coming periods. Unfavorable deviations from the plans may constitute, in the future, grounds for impairment of goodwill.