Bankers face a difficult decision about the goodwill sitting on their balance sheets.
The coronavirus pandemic has punished the economy and the stock market, undermining the value of many banks’ intangible assets. That convinced a handful of banks, including PacWest Bancorp, Umpqua Holdings and Cadence Bancorp., to take goodwill impairment charges in the first quarter.
Many more will likely do the same this summer, barring a sudden and unexpected reversal of fortune, sending goodwill impairment to levels that haven’t been seen since the financial crisis, industry experts said.
The KBW Nasdaq Bank Index has fallen by more than 30% since early March.
“I think the likelihood of more impairments to come is pretty high,” said Rick Childs, a partner at the accounting firm Crowe LLP.
Goodwill represents the premium an acquirer pays when buying an asset for more than its actual value. Accounting rules require the buyer to evaluate goodwill annually, though a triggering event such as fallout from the pandemic can also prompt a review.
Banks tend to take impairment charges after concluding that the fair value of an asset — or what it would reasonably fetch in a sale — has declined. Some banks opted to write off goodwill in the first quarter after the value of their stock fell below their tangible book value.
Accounting guidelines call for banks to book goodwill impairments after a “sustained” drop in share price, Childs said. While that leaves banks some leeway on timing, many will face pressure to proceed with charges if bank stocks remain under heavy pressure through June.
Some opted to take their lumps sooner rather than later.
PacWest, of Beverly Hills, Calif.,
PacWest faces “bleak economic forecasts,” President and CEO Matt Wagner said in the company’s quarterly release. He noted that the impairment was a noncash charge that had no impact on regulatory capital, cash flows or the bank’s liquidity position.
Aggressive merger activity, and a consistently expanding economy, has created an abundance of goodwill on banks’ balance sheets.
Goodwill and other intangible assets at banks increased by nearly 14% over the last five years, totaling $409 billion on Dec. 31, according to data compiled by the Federal Deposit Insurance Corp. It is the industry’s largest amount of goodwill since mid-2009, just before the last series of goodwill impairment charges took place.
“It’s an incredibly difficult time right now — you could see a lot of this happening again,” said Charles Wendel, president of Financial Institutions Consulting.
Goodwill impairments not only make for ugly quarterly losses, Wendel said. They also serve as a leading indicator of profitability challenges, making it more difficult — and more expensive — for banks to raise capital.
Those factors, along with low stock prices, could hamstring acquisitive banks and stunt industrywide consolidation, Wendel said.
Cadence, which is based in Houston, provided a sobering economic outlook after it booked a $412.9 million goodwill impairment charge and a $399 million quarterly loss. The $17 billion-asset company is facing a slump in oil prices that hit its energy portfolio.
“We expect to be dealing with credit stress" resulting from COVID-19 "for a meaningful period of time, and that will be our primary focus,” Chairman and CEO Paul Murphy Jr. said during a conference call to discuss quarterly results.
The experience of Umpqua, of Portland, Ore., demonstrates the fluid nature of the downturn.
The $27.5 billion-asset company did not initially book an impairment charge, though it noted in a release announcing a $28 million loss that a review was underway. It disclosed a $1.8 billion write-down two weeks later in its quarterly filing with the Securities and Exchange Commission.
Umpqua wrote off all the goodwill in its wholesale and retail banks, leaving it with $2.7 million tied to its wealth management business.
Market volatility, forecasts of prolonged low interest rates and a drop in Umpqua's stock price informed the assessment, Ron Farnsworth, the company’s chief financial officer, told analysts during a quarterly call.
“It's something that just came on so fast late in the quarter,” Farnsworth said.
