The bank was one of the first to call a peak in bad debts during 2009 and it says it sees further improvements this year, with impairments continuing to reduce at the rate it saw between the first and second half of 2009, when they fell 21 percent.
That trend would imply bad debts will drop to about 15 billion pounds this year, despite ongoing uncertainty over Ireland which helped hold back shares in early trade.
The group, also Britain's largest mortgage lender, said it saw signs of stabilization for the broader UK economy and a slow recovery in 2010, with house prices expected to be broadly flat and its own, closely watched, retail banking margins improving in 2010 and beyond.
Lloyds, 41 percent state-owned after it was bailed out by the UK government, posted a loss of 6.3 billion pounds, hit by the 60 percent increase in impairments. That compares to a 6.7 billion loss in 2008 and a consensus loss estimate of 7.1 billion, according to Thomson Reuters I/B/E/S/.
Excluding the 6.1 billion pound impact of gains on its own debt, however, losses sank to 12.4 billion pounds.
On a statutory level -- which includes an 11.2 billion pound goodwill gain on HBOS -- the group made a pretax profit of just over 1 billion pounds.
MARGIN IMPROVEMENTS AHEAD
Lloyds, which completed the deal to take over troubled rival HBOS in January last year, said it expects margins to improve this year, with a target of 2 percent this year as pricing increases begin to feed through.
Margins stood at 1.8 percent in the second half of 2009, an improvement on 1.7 percent in the first six months.
The comments echoed a cautiously positive outlook from peer Royal Bank of Scotland
Analysts said impairments and capital ratios were ahead of their expectations, but cautioned some elements, including Lloyds' international business, were below estimates.
Not too good in our opinion, Andrew Lim, analyst at Matrix said, quoting a miss on net interest income and an increase in risk-weighted assets.
The capital ratios are in line with expectations, but the claim that management is restructuring the balance in the correct way is not being shown with these results -- in fact, the opposite is shown to be the case.
Others, however, welcomed news on margins, with UBS analysts pointing to margin guidance as putting likely income generation well ahead of market consensus.
Shares in Lloyds were virtually flat in early morning trade, but fell to change hands at 53.8p, down 2 percent, at around 0830 GMT, well below the 122.6p average level at which the government bought its stake in the bank.
It said it achieved cost savings of 534 million pounds from the HBOS deal during the year and raised its target for annual synergies expected from the deal to 2 billion a year by 2011.
Like bailed-out rival HBOS, Lloyds will have to make a string of disposals to satisfy EU regulators and compensate for state aid. These include hundreds of retail branches.
But CEO Eric Daniels said the group's priority was improving its balance sheet and completing the HBOS integration.
You can't do everything at once, he told Reuters.
The bank declined to comment on bonus payments, after it said earlier this week that Daniels had decided to waive his own bonus. It said the one-off payroll tax imposed by the government would not be significant.
(Reporting by Clara Ferreira-Marques and Steve Slater; Editing by Mike Nesbit)