HBOS, Britain's biggest mortgage lender, unveiled a 13% jump in profits and its biggest dividend rise since it was formed six years ago but problems in its core U.K. retail unit hit its shares.
Shares in Britain's fourth-biggest bank fell 5%, unsettled by a weak broader market and concern over a fall in profits in its retail banking business and that profits on asset disposals inflated headline profits.
HBOS said on Wednesday its retail unit's underlying profit fell 8% to 1.04 billion pounds ($2.1 billion), hit by a sharp fall in its mortgage lending and further pressure on margins from price competition.
Its Corporate unit's profits were well above expectations, but analysts voiced concern that the growth was unsustainable as it included profits from investment securities of 253 million pounds versus 69 million a year ago.
That helped boost underlying pretax profits to 2.96 billion pounds in the six months to the end of June, from 2.61 billion a year ago, beating an average forecast of 2.89 billion in a Reuters Estimates survey of six analysts.
"HBOS has continued the recent U.K. bank trend, beating estimates but with poor quality, especially in corporate income," analysts at Keefe, Bruyette & Woods said.
Andy Hornby, HBOS chief executive, said the investment portfolio was spread across more than 600 investments and its diversity would sustain earnings growth.
HBOS raised its half-year dividend by 23% to 16.6 pence per share and said it expected its full-year payout ratio to rise to 46% from 41%.
Hornby said he planned to increase the dividend beyond this year in line with earnings growth and would continue to consider buying back shares.
"We would expect dividends to continue to go up in line with earnings going forward, and alongside we will continue to use buybacks as and when appropriate," Hornby told Reuters in an interview.
HBOS which has the biggest private shareholder base in Britain with 2.1 million small investors said it can maintain the higher payout due to its confidence in future earnings and strong capital generation.
Competition in the mortgage market kept pressure on its net interest margin, however, which dipped to 1.68% in the first half from 1.71% in the previous six months.
The bank told analysts it expected competition to remain stiff in the second half and its full-year margin was likely to be down 7-8 basis points from the 2006 level of 1.72%.
Its share of net mortgage lending slumped to 8% in the first half, confirming guidance it gave in June, and less than half its traditional share of 20% as competition intensified and a new pricing plan to retain more borrowers backfired.
Hornby said lending had recovered and in the latest three months net lending was "comfortably" back within its target range of 15 to 20%. He expected it to remain there for the second half.
Retail bad debts rose by 15 % as impairments on unsecured loans rose by almost one-third to 690 million pounds, but HBOS said they had peaked and would be lower in the second half than a year before.
The bank paid 79 million pounds in refunds to customers who have disputed past bank overdraft charges in the first half in between a 116 million pound charge by HSBC and a 36 million pound charge by Lloyds TSB.
Insurance claims related to floods in Britain in June totaled 60 million pounds and Hornby said he expected claims for July's floods to be near 70 million pounds.