Implications of GM's non-cash writeoff

Last week, GM posted its biggest quarterly loss ever.

General Motors reported a nearly $39 billion third-quarter loss, its largest ever, after it took a huge noncash charge to write down deferred tax credits.

The company also lost far more on its operations than analysts expected and warned the outlook for markets in North America and Europe is challenging.

Minyan Peter, a former treasurer at a very large US bank had this to say about the writeoffs:

Lost in all of yesterday's bank related news was General Motors' (GM) announcement that it was writing off $39 bln in deferred tax assets. For non-accountants (of which I am one), GM's deferred tax assets largely represented future tax benefits that the corporation had intended to apply as a credit against future income taxes.

In looking through GM's 2006 10-K, there does not appear to be any time limitations for these credits to be used. By writing off substantially all of these assets, GM (likely with encouragement from Deloitte) is effectively stating that its future earnings prospects are so uncertain that it may never have the opportunity to apply these tax credits against future taxable income.

While the corporation and the media would lead one to be believe that because this $39 bln write off is "non-cash", a deferred tax write-off it is about as clear a message about future earnings as you will ever see.

As I have previously written, the income statement is the past and the balance sheet is the future. When you see companies writing down balance sheet assets (which, by the way, will always be non-cash), they are telling the world that the future is not what they thought it would be. Whether the items are deferred tax assets, subprime CDO's, securitization gains, inventory, loans, securities or anything else on the asset side of the balance sheet, when they are written down (which, to be clear, an increase in loan loss provision is effectively doing), a corporation or bank is admitting that prior earnings were overstated and future earnings will be lower than they thought. Until the writedowns stop, it will only get worse.

For more on the concept that income statements are the past and the balance sheet is the future please see Bank Earnings 102: The Best of Times, The Worst of Times.

I pinged Peter over the weekend asking him if GM was obliged to take those writedowns if it did not expect future earnings. I also asked about the prospect of those assets going back on GM's balance sheet at a later date. Peter responded with these comments:

The accounting is very clear that if management doesn't think it will use the credits, it must write them off.

Is it possible that they will come back onto the balance sheet, absolutely, but given how hard corporations generally plead to keep them on balance sheet, GM has to know pretty darn sure that they are gone forever.

Ignoring the $38.6 billion deferred tax charge and other one-time items, G.M. still managed to lose $1.6 billion, or $2.80 a share, in the third quarter. This was more than 10 times the lost forecast by a consensus of industry analysts.

When do shareholders start to realize that "one-time items" are a way of life at GM?

From the NY Times article:
"Moody’s Investor Service cut its recommendation on G.M. from positive to stable, citing a “significant weakening in market conditions” and the impact they would have on the automaker through 2009. Moody’s kept its ratings in place on G.M.’s debt, but said it would watch how G.M.’s new vehicles perform in a weaker car market, and whether it is able to take advantage of savings under a new union contract."

Moody's is clearly behind the curve as it always is along with the S&P and Fitch. Unless GM is playing some risky financial accounting game here, the implications of those writeoffs should be obvious. That means a stable rating on GM is nonsense.

Thanks to Minyanville and Minyan Peter for helping to sort this all out.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com
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