Lloyds Banking Group returned to profit in the first three months of this year, earlier than expected, as losses on both retail and commercial bad debts for Britain's largest bank continue to fall.

Bailed-out Lloyds -- which surprised the market just last month by forecasting a 2010 profit on the back of improved impairments -- said on Tuesday it now expects to deliver a profit on a combined basis at both the half-year and full-year.

Analysts, welcoming news on revenues and debts, said consensus had pointed to a return to profitability for 2010, but with second half profits offsetting losses for the first half.

It is very reassuring, said Ian Gordon, analyst at Exane BNP Paribas in London. The main driver being the very positive news on wholesale impairments, but encouragement elsewhere notably in personal unsecured impairments and on revenues.

Shares in Lloyds, 41-percent state owned, climbed as much as 4.4 percent on the news to touch a seven-month high of 73.3 pence, well above the average price of 63.2 paid by the government for its stake, net of fees already received. At around 4:20 a.m. ET, the shares had pared some of those gains and were up 1.5 percent.

The bank -- which was dragged to another big loss in 2009 by 24 billion pounds of bad loans -- said bad debt trends had slowed significantly in the first quarter for both its retail and wholesale divisions, helped by the management of problem loans and the tentative economic recovery.

We are seeing lower impairments than we had expected in our guidance at the beginning of the year, so we are ahead of the curve on that. It is very comforting to be inside our own guidance, Finance Director Tim Tookey told Reuters.

Losses on commercial real estate in Ireland, however, remain a problem, despite passing a peak, and impairments in the wealth and international division remained at a high level in the first quarter, although below the fourth quarter of 2009.

At the full year, the bank had said one in three of its Irish loans -- most of them real estate-related and inherited from troubled rival HBOS, bought last year -- was impaired.

I am not sure I'd say there are grounds for more optimism, but we are certainly less pessimistic about the Irish position and what we've seen in the first quarter is a very encouraging trend, Tookey said.


Lloyds was saddled with billions of pounds of losses from its controversial purchase of mortgage lender HBOS, but said on Tuesday it is on track to deliver cost savings of 2 billion pounds from that deal by the end of next year.

It said its net interest margin was running in line with guidance and should be about 2 percent for 2010, the forecast it provided two months ago. Margin improvements helped offset the impact of asset reductions, as the group continues its overhaul.

Lloyds also reassured the market on funding, with news customer deposits grew by over 5 billion pounds ($7.73 billion) in the first quarter, slightly ahead of forecast growth rates for 2010. The advance was mainly in retail.

Lloyds, Britain's largest mortgage lender and one of the UK banks most geared to a UK recovery, declined to comment on whether an unclear outcome from Britain's general election next month would affect its prospects.

Tookey confirmed, however, that the bank continued to see flat house prices for 2010.

(Reporting by Clara Ferreira-Marques and Steve Slater; Editing by Hans Peters)