Prime bank loans guaranteed by merchant bank ?

[trajan]

In the last episode of season 4 of The Brothers, the family business' rights issue is a flop and its underwriting merchant bank is stuck with a shoal of unwanted shares that a jittery market quickly marks down to 70% of their issue price.
To unlock the situation the merchant bank's non-exec director on the Hammond Transport board tries to get the MD/Chairman to stand down in favour of the more City-appealing appointees. For MD he wants the current finance director (a former City accountant) and for chairman he wants himself.

The compelling argument in his appeal is that all the company's operations require ongoing access to both long- and short-term loans. Although these are being readily extended by the company's prime bank, that bank's readiness to do so is currently predicated on a guarantee from the merchant bank. So if the board changes sought by the merchant bank are not obtained, they will withdraw their guarantee and the prime bank will demand immediate repayment of outstanding loans - a terminal blow to the company's trading capability. In a short time the company would become insolvent and then have its assets acquired by the merchant bank - who will trade them to a asset stripping conglomerate.

My question is how did the company's prime bank loans come to get guaranteed by a merchant bank that only very recently started lending to the company for a specific expansion project ?

Does this sort of thing happen commonly where a business has both a prime and merchant bank supporting it ?

 

[Peanuts20]

Bear in mind the Brothers is from the 70's.

There is a great episode of Yes Prime Minister where the PM finds out his predecessor was a Russian spy but has been cleared of suspicion in the past because he was "one of us". ie a public school boy "chap". There's another episode where a bank requires a bailout and again, the Chairman was a good chap (even though he was totally useless)

Much less regulation back then, very much who do you know approach.

 

[trajan]

Much less regulation back then, very much who do you know approach.

Some might say Thatcher deregulated things a lot. But let's look rationally at this.

A company back then has say £200,000 long-term loans from NatWest and a current account red zone of say £30,000 to cover income variation/struggling debtors/immediate needs/etc. If a new expansion requires more funds than NatWest would want to - or could under NatWest's managers' own limits - extend to them, NatWest might well suggest an approach to a separate (i.e. not part of greater NatWest group) merchant bank.

However if the merchant bank approves the investment to the company there will be a change to the risk scenario facing the company. This new risk scenario is not factored into the original long- and short-term loans given by NatWest to the company prior to the merchant bank's involvement. Accordingly NatWest would like to have additional security for their loans. The company cannot provide any more security than it already has, e.g. deeds of premises, lien on reserve funds, bar on sale of directors' homes, etc.

It is not inconceivable in such circumstances that NatWest may demand an additional guarantee from the merchant bank for the increased risk to their existing loans to the company. After all it is the confidence of the merchant bank in the company that elevated the risk for all banks involved; the prime bank is simply asking the merchant bank to put their signature where their mouth is.

In The Brothers situation the merchant bank and the prime bank are separate commercial concerns. But it's often the case that high street banks have a merchant bank division, e.g. AIIB, IBoI, etc. In this case maybe the elevation of loan risk from prime bank to merchant bank plus the guarantee process is implicit and borrowing companies remain blissfully unaware of it ?