Why buy a bank? Because that's where the money is

Never mind the numbers, feel the bid fever: that sums up investors' current attitudes to the banking sector. If the City rumour machine is to be believed, just about every one of our high street banks is a potential target for predators ranging from US giant Citigroup to Spain's BBVA via banks in Germany, the Netherlands and Italy. The honourable exception is HSBC which, with a market value over £100bn, is deemed too big a mouthful.

The excitement is partly because, as the spate of foreign approaches for companies such as P&O and Pilkington demonstrates, the UK stock market is readily accessible to expansionist foreign companies. But it is also true that despite years of fierce competition and the sharp fall in lending growth as over-borrowed consumers cut back, British banking is still a very attractive place to be.

That much was clear from Barclays and Lloyds TSB's results last week. True, Barclaycard profits fell by almost a fifth as bad debts ratcheted up and, yes, Barclays' mortgage lending was dismal, even allowing for the housing slowdown. But the UK banking business still managed to increase profits by 8 per cent to almost £2.5bn.

And, with cost-saving initiatives in train and a new American chief executive, Deanna Oppenheimer, who is already making her mark through initiatives such as 10 per cent interest on current accounts (which has already won the bank 400,000 customers) and a focus on retaining mortgage customers tempted by better offers elsewhere, the prospects for further profit improvement look good.

And, although Lloyds TSB's retail banking profits fell by 7 per cent as provisions against bad debts increased, the bank's chief executive, Eric Daniels, expects the business to stabilise in the second half of this year. Results from Royal Bank of Scotland, HBOS and HSBC, due over the next two weeks, are expected to underline the resilience of banking profits.

It is easy to make a case for bidding for any one of them. Mark Durling, financials analyst at Brewin Dolphin, thinks Barclays' international spread 'could catch the eye of a US bank'. Two-fifths of group profits already come from overseas, while in the fastest-growing businesses, Barclays Capital and Barclays Global Investors, the proportion is 70 per cent.

But he thinks HBOS, which is almost entirely domestic, could be an even more attractive target for an American predator. Under James Crosby, who is standing down as chief executive at the end of July, it has built a formidable retail business, which includes asset management and insurance, through businesses such as Clerical Medical, St James Place Insight Investment and esure, as well as its core mortgage and business banking. Durling estimates that it would cost the equivalent of around £13 a share for a foreign bank to recreate HBOS's business, almost a quarter more than the bank's current share price.

The bidding logic for the other two banks - Lloyds TSB and Royal Bank of Scotland - is simply price. Having once been the doyen of the banking sector, Lloyds is now the dog, partly because of its heavy reliance on the UK banking market and partly because of fears over the poor performance and heavy capital requirements of its Scottish Widows insurance business.

RBS has also lost its fearsome reputation following its acquisition of NatWest and is dogged by fears that it will do another big deal - and by antipathy towards chief executive Fred Goodwin, who is criticised for treating the City and shareholders with disdain bordering on contempt. That has left shares in the two banks languishing - indeed, RBS is the cheapest of all the international banks. That is seen as making them attractive targets.

Richard Peirson, who runs Framlington's Financial fund, says that despite the low price he cannot see why anyone would want Lloyds: 'Why would you want to buy the weakest of the UK banks - except possibly because they would find it hardest to fight off an approach, while Barclays and Royal Bank of Scotland could mount a credible defence?'

James Leal, banking analyst at Teather & Greenwood, thinks that the takeover speculation is overdone - indeed, he thinks it is much more likely that British banks will be acquiring overseas businesses than being swallowed up by foreigners.

Certainly, the results from Barclays' recent acquisitions - Banco Zaragozano in Spain and Absa in South Africa - underline the growth potential from acquiring overseas. Guy de Blonay, who runs New Star's global financials fund, points out that loan growth across Europe is much stronger than in the credit-saturated British market - Spain is growing at 25 per cent a year while Italy and France are hitting 8 per cent.

But RBS's lowly share price is testimony to the City's distrust of acquisitive banks. Rivals seem to have taken that on board: Barclays chief executive John Varley was careful to play down the prospect of further deals at last week's results briefing, while HBOS's Crosby was applauded for deciding not to have a tilt at Abbey National.

But the most interesting question is whether a banking bid would tempt one of the other British banks into a rival offer. Consolidation in the banking market has been seen as impossible since Lloyds TSB was banned from bidding for Abbey National by the Competition Commission.

Now, however, HBOS has become a much more formidable rival to the Big Four clearing banks, expanding aggressively into current accounts and business banking, while Abbey's new owner, Banco Santander, is at least trying to make it more competitive. Add in the fact that Chancellor Gordon Brown seems to have realised the importance of having big national champions to compete internationally, and it would not be surprising if banking chief executives were quietly lobbying the government to take a more relaxed view of consolidation.

The political obstacles to that would be formidable: the scale of the banks' profits means they invariably attract a lot of criticism for everything from the level of their charges - Barclays upped those for bouncing cheques last week despite its record profits - to their lending criteria, attacked both for being too lax and too restrictive. The bumper profits from HSBC and RBS - which are expected to be respectively around £14bn and £8bn - will doubtless reignite the fury.