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Financial institution goodwill impairment in the COVID-19 environment

June 19, 2020 Article 4 min read
Ryan Abdoo Kate Krones

In addition to annual goodwill impairment tests, interim tests are required in cases where current events and circumstances cause concern over possible impairment. Find out if there’s evidence of goodwill impairment at your institution with a qualitative assessment.

Businessman sitting at a desk.As we move further into the second calendar quarter of 2020, the COVID-19 pandemic continues to have financial reporting implications. Due to the large volume of business combinations since the great recession, one of the many considerations facing many financial institutions is goodwill impairment.

The accounting guidance requires entities to perform an annual test of goodwill impairment and requires additional interim tests should current events and circumstances cause concern over possible impairment. Due to the COVID-19 pandemic, stock prices dropped significantly, the Federal Reserve significantly reduced the interest rate environment, and the future of many businesses became increasingly uncertain. The combination of factors gave many institutions reason to consider goodwill impairment at the end of the first calendar quarter, in which several SEC registrants recorded goodwill impairment but many more did not. The question the industry now faces as we move through the second calendar quarter, and even looking toward the end of the calendar year, is what are the next steps?

To answer this, we look at the accounting guidance and complete a qualitative assessment. When completing the qualitative assessment, the preparer considers and weighs all the positive and negative evidence and determines if it’s more likely than not goodwill impairment exists. The applicability of factors to consider per ASC 350-20-35-3C, along with financial institution-specific commentary is as follows:

Relevant events and circumstances to assess from ASC 350-20-35-3C

Applicable and financial institution-specific commentary from Plante Moran 

Macroeconomic conditions such as deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets.Due to record-high unemployment numbers, negative gross domestic product, and overall negative implications to the markets, this is a relevant matter.

Conclusion: Negative evidence
Industry and market considerations such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics (consider in both absolute terms and relative to peers), a change in the market for an entity’s products or services, or a regulatory or political development. Due to monetary policy and stimulus efforts, this is a relevant matter.

Conclusion: Negative evidence
Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows. While there may be specific circumstances for your institution, this likely isn’t a pervasive issue.

Conclusion: Positive evidence
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. The key component here is projected earnings. Due to the change in the interest rate environment and possible credit concerns, most institutions should be updating their projections and comparing to those completed prior to the pandemic. Of note, the updated projections could utilize multiple scenarios (especially around credit concerns) and weigh each scenario with a probability.

When thinking about credit assumptions, it’s important to note that this should be performed similar to the current expected credit loss model (CECL) and not like the incurred loss model. Accordingly, an institution should be looking ahead to assess exposure to some of the hardest hit industries, expectations for specific situations within the loan portfolio, and recognize the increased inherent risk to the portfolio.

On a positive note, with the decrease in interest rates many organizations have seen a significant increase in mortgage banking activity. Additionally, lending associated with the Payment Protection Program (PPP) provides for additional revenue not contemplated prior to the pandemic.

Conclusion: This is to be determined but seemingly carries weight.
Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation. While there may be specific circumstances for your institution, this likely isn’t a pervasive issue.

Conclusion: Positive evidence
Events affecting a reporting unit such as a change in the composition or carrying amount of its net assets, a more-likely-than-not expectation of selling or disposing of all or a portion of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit. While there may be specific circumstances for your institution, this likely isn’t a pervasive issue.

Conclusion: Positive evidence
If applicable, a sustained decrease in share price (consider in both absolute terms and relative to peers). Share prices certainly declined in March 2020 and have almost certainly remained depressed from year-end 2019 values.

Conclusion: Negative evidence

In broadly walking through the above criteria, the biggest factor in determining whether or not an institution should be performing a step-one calculation of value is the projection of earnings. If the projections provide sufficient evidence that indicates it’s not more likely than not goodwill impairment exists, nothing further is required. However, if the aggregated evidence from your analysis continues to leave uncertainty, a calculation of value in the form on a step-one analysis should be completed.

If your team needs help documenting your considerations or performing any calculations, we can assist you. Our team of accounting and valuation experts are uniquely qualified to see you through these challenging times.

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