Lloyds sees increased profits on mortgages

Part-nationalised Lloyds Banking Group said today it remained on track to report its first annual profit since the banking crisis thanks to falling bad debts and rising mortgage margins.

The group, which is 41% owned by the Government, said it was profitable in the third quarter and expected to remain in the black for the full year, which would mark its first annual profit since being bailed out by the state.

It said performance in the retail banking arm was being helped by increased rates on new mortgages and as borrowers switch from cheaper fixed-rate deals to standard variable rates.

This was helping offset "subdued" demand for home loans, according to the group.

The Halifax and Cheltenham & Gloucester owner said it had a "good" third quarter overall thanks to further declines in losses on loans turned sour since the half year, when it reported profits of £1.6 billion.

Mortgage arrears remained stable at the group during the third quarter, despite recent weakness in the housing market, although Lloyds disclosed higher loan losses in economically stricken Ireland and higher-than-expected charges in Australia.

It said the third-quarter performance kept it on track for a "good financial performance" for the full year.

Chief executive Eric Daniels, who last month announced plans to retire in 2011, said: "I am pleased to report that we had a good third quarter in our core business as we continue to deliver against the group guidance we provided at the interims."

He added that Lloyds had repaid £7 billion in funding support from the Bank of England and other central banks after successfully raising money in wholesale markets.

This is likely to ease market concerns over a credit squeeze in the sector as the Bank of England withdraws funding assistance to banks over the next few years, such as the special liquidity scheme (SLS).

But shares in the group fell 4%, with some analysts wary of a less positive tone in the update as Lloyds outlined "modest" improvements in the second half so far.

Lloyds has also come under pressure in recent days as banking experts have speculated on the potential bill the group could face for claims relating to controversial payment protection insurance (PPI), with one analyst estimating it could be forced to pay up to £1.5 billion.

The company is among a group of major banks backing a British Bankers' Association move to seek a judicial review against rules on PPI compensation.

Mr Daniels said he believed the banks had a "very good case" and "don't believe there will be a charge".

But experts are also fearful over the bank's exposure to the housing market and consumer woes.

Nic Clarke, financial analyst at Charles Stanley, said: "Despite good progress this year we believe the market still frets about the significant amount of wholesale funding that matures in the next couple of years and the potential impact that a weakening UK economy would have on Lloyds, given its significant exposure to both UK retail and commercial customers."

Lloyds said it was pricing new mortgages to "more appropriately reflect risk and funding costs", hitting first-time buyers and home-movers.

However, the bank stressed that interest rates were still below the average seen before the credit crunch in 2007.

It also signalled it would not need to raise more capital to meet tough new rules on capital strength under the so-called Basel III plans.

There had been worries that other UK banks would follow the lead of Standard Chartered, which recently announced aims to tap shareholders for cash to help bolster its balance sheet to take the new regulations into account.

Lloyds is the first of the UK's major banks to report back on the third quarter, with Royal Bank of Scotland and HSBC following on Friday and Barclays next week.

End-of-year bonuses will once more be in sharp focus as the bounce back in the sector continues apace.

Lloyds said its staff bonus was on average around £1,000 a year, paid largely to retail staff rather than the multimillion-pound deals seen by many investment banking rivals.

Efforts to help Britain's businesses will likewise come to the fore once more amid concerns over availability of finance.

Lloyds said gross lending to businesses had reached more than £35 billion so far this year.

The group confirmed its search for a replacement to Mr Daniels "continues at pace".

He said last month he would retire in a year's time, having led the group since June 2003.

Mr Daniels oversaw the group's ill-fated rescue of Halifax Bank of Scotland, which saw it turn to the state for bail-out money and left it with mammoth bad debts.

But Lloyds's performance turned the corner this year, clawing back into profit in the first half as bad debt charges plunged.

Keith Bowman, an equity analyst at Hargreaves Lansdown stockbrokers, said the improving trend on bad debts and success in funding markets "underpins confidence that the bank will eventually exit current Bank of England support".