Lloyds warns of £10bn loss at HBOS after hefty write-offs

Darling defends handling of crisis after Lloyds profit warning sends stocks reeling

The spectre of nationalisation returned to haunt Lloyds Banking Group yesterday after the company predicted £10bn full-year losses at its HBOS subsidiary, twice as bad as analysts' worst expectations.

The group – which was formed by the Government-brokered merger of Lloyds TSB and the ailing HBOS in January – blamed underlying pre-tax losses of £8.5bn, plus another £1.5bn for impairments and ancillary losses, on "increasingly difficult market conditions, an acceleration in the deterioration of credit quality and falls in estimated asset values".

Last night, Alistair Darling, the Chancellor, defended the Government's handling of the banking crisis. He said the Government had to intervene quickly. "We didn't have months or weeks to look at it, we had to intervene quickly and we did," he said.

Mr Darling said there would have been knock-on effects for all UK banks if the Government had allowed HBOS to collapse. "The banking system would have gone down, taking millions of families, millions of businesses with it. No responsible government could have done that."

Of the £10bn losses forecast at HBOS, £7bn is from writing off corporate loans considered too risky for Lloyds TSB's more conservative guidelines – some £1.6bn more than expected. The other £4bn is the result of "market dislocation", the company said.

Despite accompanying forecasts of £2.4bn pre-tax profits from the Lloyds TSB business, HBOS losses so far beyond City expectations sent the shares plummeting by more than 32 per cent to 61.4p, valuing the bank at just £1bn. As the collapse spread to other banking stocks, taking Barclays and Royal Bank of Scotland down by 4.3 per cent and 9.2 per cent respectively, the FTSE 100 index slid into the red and sterling dropped by more than a cent against the dollar.

HBOS's escalating losses bring back to the fore the threat of nationalisation. Vince Cable, the Liberal Democrat Treasury spokesman, said yesterday that Lloyds risks "being dragged under by the dead weight of HBOS". "This is yet more alarming news about the disastrous state of the banking sector," Mr Cable said. "It looks increasingly as if Lloyds HBOS will now go into majority public ownership, followed inevitably by nationalisation."

Lloyds did what it could to allay concern in the market yesterday, emphasising its core tier one capital ratio was between 6 and 6.5 per cent at the end of 2008 – significantly higher than regulatory requirements. Eric Daniels, the chief executive, said: "Whilst we recognise that the short-term outlook is more challenging, Lloyds Banking Group has the largest UK financial services franchise, with excellent long-term earnings potential."

Although capital ratios comfortably higher than 4 per cent do not add substantive support to the case for nationalisation, there could be more losses to come, said Simon Maughan at MF Global Securities. "There might not be writedowns of another 6 per cent of the loan book, but it will get worse in 2009 because the economy is getting worse."

The losses add to the chorus of criticism of Sir James Crosby, an adviser to the Prime Minister who resigned as deputy chairman of the Financial Services Authority earlier this week amid allegations that, in his earlier role as chief executive of HBOS, he not only ignored warnings that the institution was taking undue risks, but fired the executive who voiced his concerns.

Martin Slaney, the head of derivatives at GFT Global Markets, said: "This merger is turning out to be the merger from hell for Lloyds. The figure for expected losses is five or six times worse than expected and dispels any view that the worst is over."