Bottom Line: Bank shares may have gone too far

BANK shares have found a second wind recently, resuming their impressive performance of the past 18 months.

Half-year profits from Bank of Scotland - pounds 117.6m before tax compared with pounds 74.2m a year ago - were better than many expectations, and are likely to encourage the optimists still further. The question is whether enthusiasm has gone too far.

Certainly, the cyclical recovery is very evident in the figures, with operating profit before bad debt provisions 39 per cent higher than a year ago. Provisions for bad debts are higher, but down 25 per cent on the immediately preceding half, when there was an unexpected deterioration.

Furthermore, the bank has both raised margins and fees and kept its costs under control at under 50 per cent of income, which puts it not far short of building society levels and far better than the big four clearing banks.

Over the latest four half years operating expenses of the bank have risen only pounds 6m to pounds 180m, while revenue has increased considerably faster.

This is a bank that knows how to stick to its last, even if it did stray a bit too far from its safe home base in Scotland during the corporate lending boom, taking on some English business that cost it money. As one of its senior managers puts it, Bank of Scotland has rather a Presbyterian attitude, trying to improve itself bit by bit without any great leaps forward.

That same caution is evident in its attitude towards dividends, up 5.6 per cent even though the payout is 2.9 times covered and earnings per share are up 69 per cent. The bank justifies its caution by the disappointingly poor momentum of economic recovery, and it is hard to argue with that.

On the debit side, the splurge of rights issues has left corporate borrowers under less pressure to go to their bankers for loans, while personal borrowers are still shrinking violets.

The bank's overall capital strength is up fractionally and likely to be boosted shortly by an issue of around pounds 150m of subordinated loan capital.

But has the share price run ahead of itself? Bank investors are now focusing on 1996 earnings, which on Goldman Sachs' estimates put Abbey National on a 9.3 multiple against Bank of Scotland on 7.7. Bank of Scotland is certainly not the highest rated in the sector, but the greatest risk is that bank shares as a whole are due for a pause.