Bad debts at Lloyds soar but bank says worst is over

Half-year earnings plummet from £2.75bn profit to £4bn loss; Bank writes off £13bn in unpaid loans following HBoS merger

Lloyds Banking Group, the bank part-owned by British taxpayers, made a pre-tax loss of £4bn during the first half of the year, compared with a profit of £2.75bn over the same period a year ago.

The bank revealed yesterday that it had been forced to write off a colossal £13bn in bad loans – 80 per cent of which stemmed from its merger with Halifax Bank of Scotland (HBoS) in January. HBoS was driven to the brink of collapse by the cavalier lending of its corporate division.

Lloyds also admitted that 400,000 of its mortgage customers were in negative equity, 4,400 were more than three months in arrears and it had been forced to repossess 3,000 homes.

Lloyds, which is 43 per cent-owned by the Treasury, has placed £260bn of assets into the Government's asset guarantee scheme. It said it burned through £10bn of the first £25bn of losses on those assets before calling on yet more funds from the taxpayer.

It has a £300bn book of loans – again largely from HBoS – that violate its risk criteria, including large sums advanced to individuals. A substantial proportion of that £300bn is included in the guarantee scheme.

The bank refused to say how much of the portfolio of Peter Cummings, dubbed "the man who broke HBoS", was included in the £260bn of assets in the guarantee scheme. Mr Cummings was head of corporate lending at HBoS and its highest-paid executive.

Despite the losses, the Lloyds chief executive Eric Daniels insisted the HBoS merger had been "a good deal" and would prove its worth to shareholders. He said the bank's bad loans had probably peaked, with the second half of the year likely to show a fall in impairment levels.

Mr Daniels refused to comment on the fact that Lloyds later issued figures for the "legal entity" that is Lloyds TSB. These showed Lloyds TSB made an £800m profit, while HBoS lost £7bn. "I don't look at those numbers," he said. "I'm here to run the group as a whole."

A spokesman for the bank added: "You don't look at a deal of this size and complexity after six months' trading. This is a deal where the City will want to take at least three years to judge it."

Despite forecasting a fall in bad loans in the second half, Mr Daniels said it was still important to be a part of the Government's protection scheme. "It is the same as a householder buying fire insurance," he added. "We may not need to call on it."

He also bypassed questions about whether European regulators would order Lloyds to make disposals on competition grounds, given its dominance in current accounts and mortgages following the HBoS merger. "We are working with Her Majesty's Treasury and we expect to bring it to a satisfactory conclusion," he said.

Mr Daniels insisted Lloyds was lending to small businesses after the Treasury ordered banks to provide finance to help the economy recover, in return for the £1.2trillion of support pumped into the system by taxpayers. The fact Lloyds had approved 180,000 overdrafts and 60,000 loans during the half-year showed it was "clearly very active in the market", Mr Daniels added. However, on Tuesday the Bank of England reported that lending to businesses in many sectors of the economy had fallen again.

Lloyds said its total income, net of insurance claims, rose by 7 per cent to £11.9bn. The bank aims to save £700m on costs this year and to cut its expenditure by more than £1.5bn a year by 2011. It has shed 6,000 jobs so far, with more losses to follow.

Lloyds believes it can deliver high single-digit revenue growth over the next two years but it warned yesterday that its margins had fallen sharply. Its net interest margin – the difference between the interest income it generated and the amount of interest it paid out to depositors – had fallen to 1.72 per cent from 2 per cent a year ago.

Despite the news about its losses, Lloyds' shares finished the day 8.93p higher at 93.2p, an increase of 10.6 per cent that made it the biggest riser on the FTSE 100 index. Investors took heart from the bank's suggestion that its bad debts had peaked, and its forecasts of an economic recovery, albeit a slow one, in the UK next year.

However, analysts at Charles Stanley said the deterioration in margins was "alarming" and added: "We remain concerned that [it] might be being a bit too optimistic about its prospects. We are confused about its rationale for coming to the conclusion that the peak in impairments has passed."