Investment: Tread warily around bombed-out banks

HAS THE sell-off in the banking sector gone too far? Britain's bombed-out bank shares staged something of a recovery yesterday as analysts argued that they discount too much gloom. And a timely reminder from Sir Brian Pitman, chief executive of Lloyds, that consolidation is still very much on the agenda also prompted investors to have another look at some potential targets.

Over the past three years, investors briefly forgot to beware bankers bearing promises of safe, mishap-free growth. Beguiled by new shareholder- friendly chief executives such as Martin Taylor at Barclays, bank shares shot to undreamed-of ratings. Lloyds at one stage sold for nine times its book value and Barclays for four times, and even NatWest managed twice book at its peak.

Russia and the Long-Term Capital Management debacle shattered these pretensions and investors' retribution has been severe. Especially when, on top of provisions against Russia, Asia and hedge funds, there is a looming UK recession to contend with.

However, a number of analysts now reckon sentiment is outweighing good judgement. Broker Credit Lyonnais thinks Barclays' share price, now 1,130p, discounts an economic downturn that would mean turning all the lights out. Worries over commercial banking are overblown. UK plc is nowhere near as much in hock as it was in the late 1980s, further horrors in the investment bank sector are unlikely and Barclays itself is a good brand.

But why should an investor take anything on trust? The high returns on capital enjoyed by retail banks in the latter half of this decade are now shown to be the result of speculative investment banking. Even the mortgage banks such as Halifax and Abbey are facing a slowdown.

The exception is Lloyds. Even so, the prudent will wait until Sir Brian takes the plunge himself before again giving banks the benefit of the doubt.