A private energy company survives a downturn on its maturity schedule, and the leverage ratio everyone watches will not tell you what it is

Page forty of the board book, in the section nobody reads until the second cup of coffee, there is a table headed debt maturities. It lists each borrowing the company has, the amount outstanding and the date it comes due. It is three or four rows long in most private energy companies. I read it before I read anything else in the book, including the page one summary with the leverage ratio in a box, and I have done so for long enough that people have stopped asking why.

The leverage ratio is debt divided by some measure of earnings. It is on page one because lenders put it in the covenants and because it is easy to compare across companies. It tells you how much the company owes relative to what it makes. It does not tell you when it has to pay, and in a downturn when is the whole question.

Here is the mechanism. A company with modest leverage and a term loan due in eleven months is in a worse position, at the moment a price breaks, than a company with high leverage and nothing due for four years. The first company has to refinance in a market that has just closed, or repay from cash it is about to need for operations, or sell something at the bottom. The second company has time, and time is the only thing that reliably turns a downturn from a crisis into a bad year. The ratio would tell you the first company is safer. The schedule tells you the truth.

The decision this line quietly shapes is what the company does in the good years, and that is where I want to make a claim that an experienced director might resist. I think a private energy company should accept a higher leverage ratio in exchange for longer maturities, almost always, and should treat a lender’s offer of a lower rate on shorter paper as a trap rather than a bargain. The lower rate is real. The shorter maturity is a bet that the refinancing market will be open on a date the company does not control, and in this industry that market closes on a schedule of its own, usually about a month after the price does. A company that has paid a little more each year for term has bought the right to make its own decisions in the one year when that right is worth something.

The working detail is how the schedule and the covenants interact. A covenant test is a date. A maturity is a date. A borrowing base redetermination is a date. Lay all three on one calendar and you will often find that they cluster, because lenders like to line up their protections, and a cluster of dates inside one bad quarter is what a default actually looks like from inside a company. It is rarely a single failure. It is three dates in six weeks that the company could have survived one at a time. A board that has looked at the calendar can move a date, negotiate a waiver early, or arrange a maturity extension while the lender is still friendly. A board that has only looked at the ratio finds out about the cluster when the notices arrive.

I ask management, at least once a year and always at the first meeting after a price break, to produce a single page with every financing date on it for the next thirty six months. Not the amounts. The dates. Take a company with $40 million drawn on a facility that redetermines in April, a $10 million term loan maturing in June and a covenant test at the end of March, in a year when the price broke in February. The ratio on page one might still be inside the covenant. The calendar shows three dates in ninety days, each of which hands the lender a decision, and a board that sees that in February can still negotiate. In May it can only listen. The amounts are on page forty. What page forty does not show is the shape of the calendar, and the shape is what kills companies.

Where the metric misleads in the other direction is worth saying too. A long maturity schedule can lull a board into treating the debt as permanent, when it remains a loan with a date on it, and a company that spends four quiet years assuming the market will be open in the fifth has learned nothing from the last cycle. The schedule buys time. It does not buy the outcome. I have seen a company with generous maturities use the time to do nothing at all, and arrive at the refinancing in exactly the shape it would have been in with short paper, only later.

And there is a case where my preference for term is simply wrong, which is a company that genuinely expects to be sold inside the period. Paying for five years of maturity when the business will change hands in two is paying for an option the company will never exercise, and a lender who offers short paper to such a company is offering the right thing. The judgment is about the company’s real horizon, and I have misjudged that horizon before, on both sides.

So the question to ask at the next meeting is a short one. Not what is our leverage. What is the earliest date on which we would have to go to a market we do not control, and what happens if that market is shut.