By Andrew Fargason
Originally published by Stout
What Does 2008 Tell Us About the COVID-19 Market Crash?
The current economic crisis and market volatility driven by the COVID-19 pandemic are causing flashbacks to prior massive asset impairments.
The 778-point drop in the Dow Jones Industrial Average on September 29, 2008, the largest single-day point drop in history at the time, is dwarfed by the 2,000-plus-point drops experienced on three separate days this month so far. Questions common in board rooms in 2008 are back, as well. Companies want to know when the economic disruption and/or share price collapse should be considered sufficiently sustained to trigger impairment testing processes under the ASC 350 and ASC 360 rules. Questions regarding how the market share price should or should not figure into these tests, if triggered, will not be far behind. Experience gleaned in 2008 provides some useful early reference points as companies begin to work their way through the drastically changed landscape.
The simple, initial response of many executives to the market crash a dozen years ago was, “The market has clearly over-reacted.” I recall one CFO saying, “The market has lost its mind and I’m not going to write off $5 billion in asset value because of it”. It appeared, for a short time, that this logic might hold. But before the end of 2008, the SEC stepped in to emphasize their view that market prices generally contain important information that companies may not ignore. One key statement came in a widely circulated speech in December 2008 by Robert G. Fox, Professional Accounting Fellow, Office of the Chief Accountant at the SEC. That speech is worth revisiting in full and can be found here. A critical point made by Fox that was subsequently emphasized by many auditors in impairment review discussions was the following.
"I would also note that it would not be reasonable for a registrant to simply ignore recent declines in their stock price, as the declines are likely indicative of factors the registrant should consider in their determination of fair value, such as a more than temporary repricing of the risk inherent in any company’s equity that results in a higher required rate of return or a decline in the market’s estimated future cash flows of the company."
Regarding the timing of impairment triggers based on the economic disruption and market downturn, however, there is room for some judgement. No specific time-frames are included in the guidance, which tends to use terms like “sustained decrease” to the extent that timing is discussed at all, and in practice, it is commonly recognized that neither a drop in share price nor a short-term blow to company performance triggers an immediate requirement for impairment testing. These events require the passage of some time to allow for assessment of the relative permanence of the changes and the expected effects on future performance. That said, it is also true that the list of billion-dollar impairments included in December 31, 2008 10-Ks, just two months after the market crash, is long.
Corporate managers will need to pay close attention to any new signals coming from the SEC. So far there is no indication that any change in rules interpretation is in the works, although the SEC did recently provide some temporary relief in the form of extended filing deadlines in certain circumstances (see the March 4 SEC Order here). But past experience in the 2008 crash does shed some light on the current crisis. It is possible that companies affected by the crisis will take related write-downs in the 2020 first quarter, but we may see only general management comments regarding likely future impairment in first-quarter filings, with an impairment wave breaking later, depending on developing events.