Forming a Checklist to Adjust for Off-Balance Sheet Liabilities

[rory]

In line with Pabrai's advice I'm currently forming a checklist, but specifically with off-balance sheet liabilities in mind here. I'm interested in net-nets and Martin Whitman's approach so I'm trying to make adjustments based on asset values rather than cash flows. I've provided what I have so far and have attached links to sources I have used from Moodys and S and P, but would greatly appreciate any feedback and book/article recommendations to build knowledge about off-balance sheet liabilities. Parts b, d and e are probably what I am least unclear about.   

 

Net Current Asset Value (NCAV) Adjustments:

 

a) Unfunded Pension Obligations and Self-Insurance Claims 

Subtract from NCAV

Nb- unfunded pension obligation liability recognised on the balance sheet in US GAAP

 

b) Executory contracts-

Subtract from NCAV-

• operating leases

• forward purchase or sale commitments

• take-or-pay contracts

I've read that these are often cancelled on liquidation so perhaps no need to subtract?

 

 

c) Options Issued –

Reduce NCAV by the dollar % of value of options/market cap

 

This is because the NCAV will be dispersed among a great number of shares when the options are exercised

Example:

 

2 mil (options value)/ 18 mil (market cap)= 11.1%

 

1-.11= 0.89

 

40mil (NCAV) x 0.89= 35.6mil Adjusted NCAV

 

d) Contingent obligations

                Subtract from NCAV

1) Contractual-  these include:

• Guarantees

• Standby liquidity agreements (typically provided by financial institutions)

• Letters of Credit

 

2) Non-contractual- these include:

• Lawsuits- search report/articles for any estimated liabilities

• Environmental Remediation

 

e) Related Legal Entities

                  Subtract RLE exposure from NCAV 

 

1) Assets are sold to a Special Purpose Entity, but significant loss exposure to the assets and related liabilities has been retained e.g. in Securitization. In many securitization transactions, credit support is either provided by the originator (for example, a cash reserve account) or retained by the originator (if the subordinated tranches or equity is held)

 

2) Company has partial ownership in an Off-Balance Sheet Entity

 

f) LIFO reserve

Add back the LIFO reserve for companies using a FIFO method of inventory accounting. 

Net Present Value used

 

 

Moodys- https://www.moodys.com/sites/products/AboutMoodysRatingsAttachments/2002900000432882.pdf

S and P- https://www.nact.org/sponsorPubs/S&P_encyclopedia_of_analytical_adjustments.pdf

 

 

[rukawa]

Its way too complicated. I would probably have a single item:

 

1) Avoid companies with significant or complicated off-balance sheet liabilities.

 

I have experience with checklists in other contexts and in my experience the way you create checklists is by trying something and making mistakes. Right after the mistake, you avoid spending time feeling bad and instead you think about how the mistake could have been avoided. Then you create a checklist item accordingly.

 

Checklist are not supposed to cover every possibility. And they should not describe in detail a process or method.  They are just supposed to cover things that are frequent sources of error and are specific to the person/organization using them.

[rory]

Thanks for your advice rukawa. I appreciate your response.

 

My intention with the checklist here is to avoid making these mistakes before they happen. I agree that a company with complicated off-balance sheet liabilities is best avoided, but you have to first identify all these liabilities. Even Tobias Carlisle discussed missing off-balance sheet liabilities in one of his articles and he's incredibly intelligent.

 

My personal opinion is that searching annual and quarterly reports using keywords like these could save time and avoid trouble down the line. I don't think it would consume more than a couple of minutes to cntr-f these terms either.