What Is a Credit Sleeve?
A credit sleeve is a form of credit agreement backed by physical assets, where the sleeve providing party, known as the "sleeve provider," will offer working capital and collateral on behalf of another company, known as the "sleeve recipient." The sleeve provider will essentially co-guarantee certain outstanding credit arrangements that the sleeve recipient has with other lenders, such as banks, and increase the overall credit quality of the sleeve recipient.
Credit Sleeve Explained
A credit sleeve is a type of working capital loan most often found within the energy industry, where sleeves are backed by physical energy assets and carry certain cash flow requirements for the sleeve recipient to continue to operate. Credit sleeves are often set up when a company has seen its credit quality decline and its access to traditional forms of debt financing run dry. Credit sleeves are a form of co-guarantee, where one party steps in to contractually back the other and guarantee to lenders that debts will be repaid. If the credit sleeve recipient is unable to repay, the sleeve provider has physical assets that could be seized and sold to repay the debt.
This form of financing is useful between the subsidiaries of a company where one subsidiary is financially stronger than another one that is struggling to get credit from lenders. The stronger subsidiary could provide a credit sleeve backed by its assets, such as oil reserves, to the weaker subsidiary. This step allows lenders to be comfortable lending to the weaker subsidiary. The sleeve is intended to be a short-term financing arrangement that will provide the weaker subsidiary with the working capital needed to maintain operations. A credit sleeve could also be used in a joint venture where one party is financially stronger than the other.
Limitations of Credit Sleeves
A credit sleeve is meant to be a financial helping hand extended to solve short-term credit difficulties. It differs from longer-term asset-backed financing arrangements, such as reserve-based lending or pre-export financing. Reserve-based lending is an agreement where an oil company pledges its reserves to a bank in exchange for a loan. If the company fails to repay the loan, the bank can seize the reserves. Pre-export financing is an arrangement where an oil company receives a loan from a bank and agrees to use the first proceeds from its oil sales to repay the loan before keeping any remaining cash flows for itself.