A growing number of banks may need to record goodwill impairment charges once the coronavirus crisis finally shows up in their credit quality.
A handful of banks have already announced impairment charges, doing so in the first and second quarter of this year. Some have written off as much as $1 billion of goodwill, dragging down their earnings and, in some cases, dividends. Volatility in the stock market could make this worse in the second half of the year.
“It was a very hot topic for all of our financial institutions,” says Ashley Ensley, a partner in DHG’s financial services practice. “Everyone was talking about it. Everybody was looking at it. Whether you determined you did … or didn’t have a triggering event, I expect that everyone that had goodwill on their books likely took a hard look at that amount this quarter.”
Goodwill at U.S. banks totaled $342 billion in the first quarter, up from $283 billion a decade ago, according to the Federal Deposit Insurance Corp.
Goodwill is an intangible asset that reconciles the premium paid for acquired assets and liabilities to their fair value. It’s recorded after an acquisition, and can only be written down if the subsequent carrying value of the deal exceeds its book value. Although goodwill is an intangible asset excluded from tangible common equity, the non-cash charge can have tangible consequences for acquisitive banks. It immediately hits the bottom line, reducing income and, potentially, even capital.
Several banks have announced charges this year. PacWest Bancorp, a $27.4 billion bank based in Beverly Hills, California, took a charge of $1.47 billion. Great Western, a $12.9 billion bank based in Sioux Falls, South Dakota, took a charge of $741 million. And Cadence Bancorp., an $18.9 billion bank based in Houston, Texas, recorded an after-tax impairment charge of $413 million.
Boston-based Berkshire Hills Bancorp announced a $554 million charge during its second-quarter earnings that wiped out all its goodwill. The charge, combined with higher loan loss provisions, led to a loss of $10.93 a share. Without the goodwill charge, the bank would’ve reported a loss of only 13 cents a share.
“The primary causes of the goodwill impairment were economic and industry conditions resulting from the COVID-19 pandemic that caused volatility and reductions in the market capitalization of the Company and its peer banks, increased loan provision estimates, increased discount rates and other changes in variables driven by the uncertain macro-environment,” the bank said in its quarterly filing.
Goodwill impairment assessments begin by evaluating qualitative factors for positive and negative evidence — both internally and in the macroeconomic environment — that could cause a bank’s fair value to diverge from its book value.
“It really is not a one-size-fits-all analysis,” says Robert Bondy, a partner in Plante Moran’s financial services group. “Just because a bank — even in the same marketplace — has an impairment, it’s hard to cast that shadow over everybody.”
One reason banks may need to consider impairing their goodwill is that bank stock prices are meaningfully down for the year. The KBW Regional Banking Index, a collection of 50 banks with between $9 billion and $63 billion in assets, is off by 33%. This is especially important given the deceleration in bank deals, which makes it hard to evaluate what premiums banks could fetch in a sale.
“[It’s been] one or two quarters and overall markets have rebounded but bank stocks haven’t,” says Jay Wilson, Jr., vice president at Mercer Capital. “You can certainly presume that the annual impairment test, when it comes up in 2020, is going to be a more robust exercise than it was previously.”
Banks could also write off more goodwill if asset quality declines. That has yet to happen, despite higher loan loss provisions — and in some cases, banks saw credit quality improve in the second quarter.
The calendar could influence this as well. Wilson says the budgeting process and cyclical cadence of accounting means that annual tests often occur near year-end — though, if a triggering event happens before then, a company can conduct an interim test.
That’s why more banks could record impairment charges if bank stocks don’t rally before the end of the year, Wilson says. In this way, goodwill accumulation and impairment mirror the broader economy.
“Whenever the cycle turns, banks are inevitably in the middle of it,” he says. “There’s no way, if you’re a bank to escape the economic or the business cycle.”
Bank buyers preparing to review a potential transaction or close a purchase may encounter unexpected challenges.
At 232 pages, Accounting Standards Update (ASU) No. 2016-01, issued in January of 2016, might be intimidating, but we will boil down the essentials you need to know as a bank accountant, chief financial officer, or member of an audit committee. In 2010, the Financial Accounting Standards Board (FASB) issued a massive proposal with many significant changes including marking the majority of a bank’s balance sheet (securities, loans and deposits) to fair value. The FASB has come a long way since then and completes part one of its financial instruments project with the issuance of this standard. When boiled down, the standard contains eight or nine significant changes of interest to banks. Not every bank will be affected by all of the changes, and whether you view these changes as positive or negative depends upon whether you are a preparer or user.
FASB’s past proposal to carry most financial instruments (loans, securities and deposits) on the balance sheet at fair value was received with little enthusiasm, for two primary reasons. First, robust market data doesn’t exist for many of those instruments, raising concerns about the reliability of the fair values that would be used. Second, the proposal did not take into account management’s intent–when management does not intend to ever sell most of those instruments, what is the point in recording them at fair value?