By Sudip Kar-Gupta and Steve Slater
LONDON (Reuters) - Lloyds slumped to a 3.25 billion pound ($5.3 billion) first half loss, hit by the cost of compensating customers mis-sold insurance and as bad loans in Ireland and Australia piled up.
Shares in Britain's biggest high street lender sank as much as 8 percent to a new two-year low following the results, making any sell down of the government's 41 percent stake acquired after a credit crisis bailout an even more distant prospect.
The loss compared with a 1.3 billion pound pretax profit a year earlier and its results deteriorated even after stripping out the 3.2 billion pounds already earmarked to help cover compensation for industry-wide insurance mis-selling.
Overall, Lloyds cut losses on bad loans by 17 percent to 5.4 billion pounds but the rate of improvement was much slower than the 45 percent reported for 2010, and would have been much better had there not been a further deterioration in Ireland.
"We're long-standing bears on it," said SVM Asset Management managing director Colin McLean. "There was a slower rate of improvement on their (loan) impairments and a weakness in the UK housing market could lead to more impairment losses."
Lloyds shares were down 4.5 percent at 37.21 pence by 0837 GMT having earlier fallen as low as 35.755 pence to a new two-year low and a long way short of the 63 pence level at which the British taxpayer effectively bought its stake.
A cash-strapped British government is hoping to sell down bank stakes accumulated via credit crisis bailouts but is unlikely be able to make a profitable exit anytime soon.
Losses on bad loans at Lloyds' Irish operations hit 1.8 billion pounds in the first six months of the year, 14 percent worse than a year ago. Lloyds has now lost 9 billion pounds on its Irish loans since the end of 2008 and said 64.1 percent of its 27.6 billion pounds of loans in Ireland are now impaired.
Losses on Australian loans also jumped 29 percent versus a year earlier to 586 million pounds as property prices there deteriorate. It has 12.9 billion pounds of loans to customers in the country, and more than a third are deemed to be at risk.
On an adjusted basis, pretax profit at the group was 1.1 billion pounds, down from 1.6 billion year earlier and broadly in line with the 1 billion pounds expected by analysts, according to the average forecast on Thomson Reuters I/B/E/S.
The bank stuck to its overall guidance for 2011.
In terms of risks posed by a worsening euro zone sovereign debt crisis, Lloyds said its aggregate direct exposure to the national and local governments of Spain, Italy, Portugal, Ireland, Greece and Belgium totaled 189 million pounds.
Also eroding profits, the bank's net interest margin -- the gap between what it charges for loans and pays to borrow -- shrank to 2.07 percent from 2.12 percent this time last year.
Lloyds said the lower profitability on lending reflected continued high funding costs, repayment of government and central bank facilities, and competitive deposit markets.
Its results fell way short of British rivals Barclays and HSBC <0005.HK>, which reported respective first-half profits of 2.6 billion pounds and $11.5 billion this week.
All three banks have had to cut thousands of jobs, however, with Lloyds announcing 15,000 job cuts in June.
Lloyds was saddled with billions of pounds of losses after buying troubled rival HBOS in a 2008 rescue deal brokered by the government, and it has been forced by EU regulators to put 630 branches up for sale as payback for a subsequent state bailout.
Sources have told Reuters Lloyds is talking to six parties, of which two -- new bank venture NBNK and mutual Co-Op Bank -- have made formal expressions of interest. Others have been put off the assets by high levels of lending relative to deposits.
Chief Executive Antonio Horta-Osorio told reporters he hoped to find a buyer by end 2011 and that Lloyds would allow them to take on a smaller amount of mortgages to facilitate a sale.
($1 = 0.609 British Pounds)
(Writing by Paul Hoskins; Editing by Andrew Callus)
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