As Britain's biggest banks beg their shareholders for cash in a series of rights issues designed to boost dwindling reserves, rock-bottom share prices may tempt other investors to enter the sector. But as for when bank shares will recover, the jury is still out.

Richard Hunter, of Hargreaves Lansdown Stockbrokers, suggests that existing bank shareholders should think very carefully before taking up any rights issue. He says: “Ask yourself, if you had £1,000 to invest in any sector, would you buy bank shares? I would say that the market considers that there is better value to be found in other stocks. The banking sector is still dogged by fears of further writedowns around the corner.”

HBOS, which owns Halifax and Bank of Scotland, has invited its two million shareholders to buy extra shares at 275p. Shareholders have until Friday to decide whether to exercise their rights, but the bank's tumbling share price stood at only 272p on Thursday.

Bradford & Bingley, meanwhile, has revised its rights issue for a third time after a private equity investor pulled out last week. High street banks have been forced to back underwriters Citigroup and UBS, who have guaranteed to buy the new shares at the rights issue price. The share price fell to a record low of 34p on Tuesday, while the rights issue remains at 55p. The offer is open until the middle of next month.

Royal Bank of Scotland (RBS) successfully completed a £12 billion rights issue last month. TD Waterhouse, the stockbroker, says that two thirds of its eligible investors chose to take up the rights offered by RBS, but only about 13 per cent of its HBOS shareholders have taken up their rights. In a statement, the broker said: “The low activity has been attributed to the current low value of the HBOS rights, which have been trading between 16.25p and 4p and trending down along with the shares, but anything could happen between now and the deadline.”

Barclays has raised £4 billion from sovereign wealth funds as part of its £4.5 billion rights issue, which closes on Thursday, and other banks are rumoured to be considering following suit, including Alliance & Leicester.

Investors buying bank shares for the first time or extending their holdings are effectively taking a gamble on the UK housing market, experts caution. Specifically, stockbrokers are concerned about the exposure of both HBOS and Bradford & Bingley to buy-to-let and sub-prime mortgages. House prices are down 6.3 per cent on this time last year and a recent survey showed prices tumbling faster than at any point since the last recession of the early Nineties.

Mark Dampier, of Hargreaves Lansdown, the independent financial adviser, believes that house prices will fall by 25 per cent in the next year, leaving bank shares in tatters. “I would not touch bank equities,” he says. “Banks have been hit by the sub-prime crisis in the US, but the sector is facing a second storm in the shape of the UK market. Mortgage approvals are a good indicator of what the market will look like in six months' time, and the figures are shockingly bad. You will have to wait a long time for a recovery in bank share prices.”

However, private investors do not have to sink their cash into equities to gain exposure to the banking sector. The yields on bonds issued by banks are at levels unseen for years, up to 12 per cent in some cases. These bonds are issued by financial institutions, such as HBOS and HSBC, to raise capital and are then traded on the market.

At the moment, fund managers are flocking to invest in bonds as yields have been pushed upwards by uncertainty in the market, fuelled by the credit crunch. Yields depend on the risk that a bank will default on repayment of the debt. Although the risk is slim, the returns have been boosted by the shortfall in funding in the wholesale market, the nationalisation of Northern Rock and the collapse of Bear Stearns in the US.

Adam Courdrey, manager of the Schroders Corporate Bond Fund, insists: “This is the most exciting time to invest in bank bonds in the past ten years.”

Mr Courdrey's fund has invested in the debt of some of the UK's biggest banks, including HSBC, Barclays and RBS. Rights issues at RBS and Barclays have only strengthened the case to invest in capital securities, he says.

Many hedge funds are also reported to have adopted a trading strategy of buying banks' debt while simultaneously selling short the banks' shares. This means that they are borrowing the banks' stock to sell and hopefully buy back at a profit later when the share price has fallen.

Mr Courdrey says: “Banks have needed desperately to rebuild capital reserves. A lack of wholesale funding has led many of the banks to raise cash through rights issues - and more are expected to follow. This might not be great news for equity holders, but it is certainly excellent news for bond investors.”

Owen Murfin, manager of BlackRock's BGF Global Capital Securities Absolute Return Fund, believes that the subordinated bond market represents a unique opportunity for investors at the moment. But his fund is focusing on the US, where financial institutions were quick to come clean about their exposure

to the sub-prime crisis. “We feel that US banks have greater transparency, compared with European banks, and have better addressed their capital issues,” he says.

Mr Murfin is bullish about his predictions for growth over the next year - between 9 per cent and 12 per cent - and says: “As long as a bank doesn't go under, investors will always get their investments back.”

Case Study: Taking the long view

Christine Trueman recently bought £700 of shares in HBOS with her investment club, the Double Ds. The club paid 273.2p a share three weeks ago through the Share Centre.

Mrs Trueman, of Broadway, Somerset, is taking a long-term view on her HBOS investment. The 60-year-old believes that the stock's performance will improve and is prepared to wait. “It might be an awful long time before they reach the values seen 12 months ago, but I would still be pleased if the shares doubled in value,” she says.

The holding means that the Double Ds club is eligible to buy new shares through the HBOS rights issue. But Mrs Trueman is not convinced that they represent good value. HBOS shares have fallen below the rights issue price of 275p and on Thursday stood at 272p. “Why would you buy the shares at the rights-issue price when you can pay less on the open market?” she says. “Even with stamp duty and commission it is still cheaper.”

The investment in HBOS represents the first entry into the banking sector for her all-woman investment club, which has 15 members. The Double Ds have opted for a diverse portfolio of stocks and are expecting 4.2 per cent growth this year.

The club members are meeting in a week's time to consider whether to make any further investments in the banking sector. But Mrs Trueman says: “Bank shares are very cheap at the moment but I do not think we will buy any more for the time being.”

Mrs Trueman set up the investment club with her friends in March after the success of her husband's club, the Duckers and Divers.

Investment Club

The recent turmoil in the stock market has triggered a rethink among the members of the Upton St Leonards investment club, Mark Atherton writes.

The men, mostly retired professionals from a village in Gloucestershire, have decided to ditch their stop-loss limit, which has resulted in too many automatic sales in today's market conditions.

The original idea behind the stop-loss was an entirely sensible one: set a firm limit on the level of loss that you are prepared to tolerate on any share and sell automatically before any modest loss becomes a catastrophic one.

But in the past two months the operation of this mechanism has forced the sale of three of the four shares held by the club: Keller, the construction company, Cadbury Schweppes, the confectionery and drinks group, and Prudential, the insurer. This left the club with only one share: Marks & Spencer.

Dave Robinson, the club's treasurer, explains: “Getting rid of our stop-loss was a massive change, but we felt that it was necessary to give us the freedom to hold shares for the long term. In today's market conditions, when share prices can rise or fall quite dramatically, we were finding that the stop-loss was triggering sales of shares only days after they had been bought.”

At their most recent meeting, members decided to buy one new share: Lloyds TSB. This might seem a brave move in the light of the problems that all UK banks are experiencing at the moment, but Mr Robinson explains: “We felt that banks looked good value at their current, much lower, share prices. Within the sector, we thought that Lloyds TSB was one of the best-placed banks to weather the credit crunch.

“It is largely concentrated in the UK and so has little exposure to the US sub-prime mortgage market. It has also been more upfront than most other banks about the level of bad debts that it has. We think that there may be more bad news to come from some of the other banks, whereas Lloyds TSB has dealt with the problems early on.

“On top of that there is a very attractive yield of about 12 per cent.”

Expert Analysis: Lloyds TSB

Analysts regard Lloyds TSB as something of a plodder among UK banks; not suffering too badly in downturns but not doing especially well when the economy is booming. Arguably this should stand it in good stead right now, as UK growth slows substantially.

As a predominantly UK-focused bank, Lloyds is not too exposed to the global credit crunch and is not heavily involved in the troubled buy-to-let or sub-prime markets. It has one of the strongest retail deposit bases of the UK banks.

However, its lack of global diversification could be seen as a drawback. While Lloyds may be glad to be out of the US market, it also has little exposure to the more dynamic Asian and emerging European markets. It does, however, have some exposure to South America.

One potential source of excitement is the possibility that Lloyds could be a bid target for a European or US bank seeking to establish a presence in the UK.

Then there is the mouthwatering dividend yield of about 12 per cent. There will always be a question mark over whether such a high yield is sustainable. If financial conditions do not tighten much further and the dividend is held, investors will enjoy a juicy yield with the prospect of a recovery in the share price thrown in for good measure.

But if the credit crunch worsens, the dividend could be cut. Without the prop of a high yield, the shares could resume their downward slide. The current dividend is covered one and a half times by earnings, a little less than the preferred level of two times.

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