As financial institutions plan to reopen and adjusting 2020 budgets for partial-year actual results, it is important to consider the financial reporting implications COVID-19 may cause.
Economic growth of the last several years included significant M&A activity that resulted in many financial institutions adding more goodwill and intangibles to their balance sheets. According to data compiled by the FDIC, goodwill and other intangible assets for all banks totaled approximately $409 billion at December 31, 2019, a 13% increase in the last five years. Over the same period, goodwill and other intangible assets on community banks’ balance sheets increased 40% to $18 billion at December 31, 2019.
COVID-19 has created significant market volatility, economic uncertainty and disruption of normal operating conditions. Such circumstances may signal the existence of impairment indicators and the need to perform a goodwill impairment analysis to determine whether the fair value of the intangible asset is less than its carrying amount.
ASC 350-20 outlines circumstances companies should consider when determining when an interim test may be necessary. The following are examples of possible impairment indicators from ASC 350-20:
- Deterioration in general economic conditions.
- Industry and market considerations such as a deterioration in the environment an entity operates in, an increased competitive environment or a decline in market-dependent multiples or metrics.
- Overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods.
- If applicable, a sustained decrease in share price (considered in both absolute terms and relative to peers).
No one indicator alone should be considered evidence that goodwill is more likely than not impaired. Financial institutions should take a holistic approach and evaluate both the positive and negative factors. This process involves significant judgment and should be appropriately and thoroughly considered and documented.
If financial institutions conclude that goodwill is more likely than not impaired, they should carefully consider ASU 2017-04, which simplifies testing for goodwill impairment by eliminating step two of the impairment test. Although not yet effective for all financial institutions, early adoption of the update is permissible. In addition, financial institutions with other long-lived assets held for use and other indefinite-lived intangible assets will need to consider those assets for possible impairment because they will be critical in measuring goodwill impairment.
During the first quarter of 2020, dozens of public financial institutions disclosed that events caused by COVID-19 — such as a decline in the macroeconomic environment, a challenging banking environment, stock market and price volatility and the low interest rate environment pressure on future earnings — caused a triggering event, necessitating an interim goodwill impairment analysis.
At least five of these interim tests resulted in goodwill impairment being recorded because fair values had declined below carrying value.
Many other financial institutions indicated that if events that happened near the end of the first quarter continued or worsened throughout the second quarter and further into the future, additional analysis would need to be performed, and the results of that analysis could have a significant impact on earnings.
As we continue to deal with the financial reporting ramifications caused by COVID-19, there will be increased disclosures by public financial institutions in the second quarter and possible additional goodwill impairment charges recognized, especially among larger community and regional banks that may be more significantly impacted by COVID-19 because of their operating markets and the goodwill those institutions recently created through M&A activity.