Goodwill impairment: Bad omen or good news?

Kevin Brand, Rick L. Childs, Sydney S. Menefee, Patrick Vernon, Alex Campbell
| 7/11/2023
Goodwill impairment: Bad omen or good news?

As banks take a closer look at their balance sheets, they should consider the potential effects of goodwill impairment testing.

Since the Federal Reserve’s adoption of a more hawkish monetary policy in March of 2022, many have wondered what the resulting economic impact would be. Terms like “transitory” and “soft landing” were thrown about, but the general consensus seemed to be that the unprecedented rise in interest rates could affect every sector of the economy.

While many questions remain, time has granted some clarity on this era of quantitative tightening. It was anticipated that rising interest rates would lead to increased unemployment and higher borrowing costs for many businesses, which in turn would lead to delinquency and defaults on loans held by the banking sector. While the impact of rising rates has been somewhat tempered on banks’ loan portfolios, the rapidly changing interest rates led to deposit attrition, security portfolio losses, and even the failures of Silicon Valley Bank, Signature Bank, and First Republic Bank. These events were understandably unnerving to investors, and financial institution equity prices have fallen to reflect this uneasiness.

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Exhibit 1 shows how the rising effective federal funds rate (EFFR) has corresponded to declining share prices of the S&P Global Bank exchange-traded fund (ETF).

Exhibit 1: Changes in EFFR and volatility in S&P Global Bank ETF

Exhibit 1: Changes in EFFR and volatility in S&P Global Bank ETF
Source: Crowe analysis of data collected from publicly available filings as of June 21, 2023.

Stock declines are not necessarily the direct result of rising rates, as higher interest rates typically boost the yield on a bank’s assets. However, rising interest rates have led investors to fear looming economic contraction and rising unemployment, which can weigh on bank stock prices. While the story is nowhere near finished on this era of monetary policy, the events that already have transpired have led many banks to take a closer look at their balance sheets.

The mechanics of goodwill impairment testing

The October 2022 Crowe article “Goodwill Impairment Testing: Navigate Economic Volatility” discussed how a variety of economic factors could be potential triggering events that would necessitate formal goodwill impairment (GWI) testing. Given the banking-specific events in early 2023, conversations related to goodwill impairment have only accelerated.

As a quick refresher, Accounting Standards Codification (ASC) 350, “Intangibles – Goodwill and Other,” defines a triggering event as any event or circumstance that indicates that the fair value (FV) of an entity (or an entity’s reporting unit [RU]) might be below its carrying amount. Under ASC 350, goodwill is tested for impairment when a triggering event occurs. The following events and circumstances listed in ASC 350-20-35-3C are examples of triggering events:

  • Macroeconomic conditions (for example, deterioration in the general economy)
  • Industry and market considerations (for example, deterioration in the environment in which the entity operates)
  • Cost factors (for example, increases in costs of raw materials or labor)
  • Overall financial performance (for example, negative or declining cash flows)
  • Other relevant entity-specific events (for example, changes in management or key personnel)
  • Events affecting an RU (for example, change in composition of net assets or expectation of disposing of all, or a portion, of the RU)

These events and circumstances are examples and not an all-inclusive listing of triggering events. Companies should consider other relevant events and circumstances that might affect their FV or carrying amount of the entity (or RU) when evaluating whether to perform a goodwill impairment test.

If an entity concludes a triggering event has occurred, the steps for assessing goodwill impairment are as follows:

Exhibit 2: Goodwill impairment test process (ASC 350) – GAAP and Private Company Council accounting alternative

Exhibit 2: Goodwill impairment test process (ASC 350) – GAAP and Private Company Council accounting alternative

What does goodwill impairment actually mean?

With ongoing economic uncertainty weighing on investor sentiment and bank stock prices, many banks are wondering what the potential downstream effects of recognizing a goodwill impairment could be. To explore this, consider two audiences that watch a bank’s balance sheet closely: the market (that is, customers, shareholders, industry analysts, etc.) and regulators.

Goodwill is an accounting construct that has no direct impact on ongoing bank performance, cash balances, or other tangible assets. The process of impairing or writing off goodwill is simply to remove the goodwill asset from the balance sheet, with the offsetting entry recorded in retained earnings via an expense. From a regulatory perspective, goodwill is excluded from regulatory capital. Therefore, goodwill impairment has no impact on regulatory capital ratios.

Banks also might consider the market’s interpretation of recording an impairment, since investors, boards, and customers might view the event as a sign of distress. To determine the reasonableness of this conclusion, Crowe compiled data on institutions that reported goodwill impairment from 2005 to 2023 to explore whether the event is viewed in the market as a harbinger of financial instability. (The data is limited to publicly reported events and publicly traded bank holding companies.)

Exhibit 3 and Table 1 show 317 public bank holding companies that have reported goodwill impairment since 2005. From those 317 observations, Crowe sought to determine how likely or unlikely any of the following market events were to occur following the disclosure of goodwill impairment.

  • Credit ratings downgrade within six months of GWI (31 out of 317, approximately 9.8%)
  • Filed for bankruptcy within 12 months of GWI (10 out of 317, approximately 3.2%)
  • Dividend cut within six months of GWI (43 out of 317, approximately 13.6%)

Notably, the majority (245 of 317, approximately 77.3%) of institutions that recognized goodwill impairment experienced none of these adverse events. Furthermore, when 2008 to 2009 was excluded (a period in which broader economic uncertainty stemming from the housing crisis might explain the adverse events), more than 90% of institutions reporting goodwill impairment did not experience any of the market events identified.

Exhibit 3: Market events after reported goodwill impairment

Exhibit 3: Market events after reported goodwill impairment
Source: Crowe analysis of data collected from publicly available filings as of June 21, 2023.

Table 1: Market events after reported goodwill impairment

Table 1: Market events after reported goodwill impairment
Source: Crowe analysis of data collected from publicly available filings as of June 21, 2023. 

From these results, goodwill impairment appears to have some bearing on short- to midterm stock price volatility, yet it doesn’t appear to be a reliable indicator of long-term, institution-specific financial hardship.

Closing thoughts

With recent declines in bank stock prices and events affecting the banking industry in 2023, goodwill impairment assessments have drawn increasing attention, and it is important for banks to get to the right conclusion about whether impairment should be recognized.

While recognizing any type of impairment can carry a negative connotation and might raise questions about an institution’s financial condition, the actual recording of goodwill impairment does not affect cash flows. It is important to keep in mind that the recognition (and implications) of a goodwill impairment:

  • Has no effect on regulatory capital ratios. Goodwill is deducted from regulatory capital. Therefore, recognizing goodwill impairment does not adversely affect regulatory capital.
  • Does not affect core earnings. Goodwill is a nonearning asset.
  • Has no carrying costs. Institutions incur costs to maintain goodwill; for example, the ongoing valuations and impairment assessments are burdensome and costly. Writing off goodwill alleviates institutions of the burden and cost associated with a nonearning asset.
  • Has not typically triggered adverse market events that would indicate perceived financial instability.

While adherence to ASC 350 is not optional, entering the process with a clearer understanding of the guidance and the potential consequences of recording an impairment can help banks approach goodwill impairment assessments more confidently.

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Kevin Brand
Kevin Brand
Partner, Advisory
Rick Childs - Large
Rick L. Childs
Partner, Advisory
Sydney Menefee
Sydney S. Menefee
Partner, Financial Services