Bailed out British lender Lloyds Banking Group said on Friday it would return to profit this year thanks to a bigger than expected drop in bad debts, wrong-footing forecasts for another loss and sending its shares sharply higher.

Lloyds, which sank 6.3 billion pounds ($9.63 billion) into the red last year after being hit by a steep jump in bad loans believes that it will be profitable on a combined basis in 2010, it said in an unscheduled trading statement.

The bank said the improved outlook reflected good overall trading in the first ten weeks of 2010, with bad debts trending at lower levels than anticipated, while costs were down compared with the same period last year.

Lloyds shares were up 9.6 percent at 60.9 pence by 1101 GMT, making them the top riser in the FTSE 100 share index.

Analysts said news bad debts were falling faster than hoped would reassure after a previously-flagged drop in impairments during the second half of last year fell short of some investors' expectations.

Having disappointed a little bit with the full-year results, this kind of puts them back on track, said Simon Willis, banks analyst at stockbroker NCB.


Lloyds is currently forecast to make a 300 million pound loss this year, analysts said, citing the bank's own calculation of consensus expectations.

Lloyds' stronger performance makes it more likely the British government will try to sell part of its stake in the bank before an election expected to take place in May, Execution Noble analyst Joseph Dickerson said.

The stock should be strong today and we anticipate follow through, but would flag the prospect of a pre-election placing in the stock, he wrote in a note.

Lloyds, Britain's biggest retail bank, is 41 percent owned by the state after receiving a series of bailouts in the wake of the 2008 banking crisis.

The group, created by the government-engineered takeover last year of ailing lender HBOS by high street rival Lloyds TSB, has been hit by spiraling bad debts -- mostly inherited from HBOS -- as loans advanced during the boom years turned sour.

Lloyds, whose loans as a ratio to deposits stood at 169 percent at the end of last year, high by industry standards, is also striving to bridge the gap so as to reduce its reliance on expensive wholesale funding.

The bank had previously said that its bad debts probably peaked in the first half of 2009, and confirmed last month that total loan impairments fell by about a fifth in the second half of the year.

Lloyds, which cut 13,000 jobs in 2009, is also pushing through an austerity drive aimed at taking out 2 billion pounds in costs by the end of 2011.

The bank's 2009 results were reported on a combined business basis, which excludes some accounting items associated with the HBOS acquisition, and assumes HBOS was acquired at the start of 2008.

Lloyds' 6.3 billion pound loss last year compares with a 6.7 billion pound loss the previous year.

($1=.6545 pounds)

(Editing by Hans Peters)