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Lloyds TSB kicked off the UK bank reporting season on Wednesday by signalling its confidence in riding out the economic downturn by raising its interim dividend in spite of a 70 per cent fall in first-half pretax profits to £599m ($1.2bn).

But shares in the UK’s fourth-largest bank slid 4.6 per cent to 306p amid investor doubts about the sustainability of the dividend as the UK economy slows further and bad debts squeeze profits.

Analysts flagged concerns that the dividend – raised by 2 per cent to 11.4p per share – may come under pressure. They pointed to the bank’s core equity tier one capital – a measure of financial strength – which fell from 7.4 per cent to 6.2 per cent because of faster asset growth and market volatility in its insurance operations.

James Eden, BNP Exane analyst, said: “It is clear the market has severe doubts about the sustainability of the dividend – rightly so” . He said that in a 1990s-style recession, “the dividend is toast”.

Rivals such as Barclays and HBOS have already raised £21bn of capital this year.

Tom Rayner, banks analyst at Citigroup. said: “Although not especially weak, we would have preferred to see Lloyds TSB strengthening its capital position at this point in the cycle,” .

Lloyds said it remained cautious on the UK economy and forecast that house prices would fall by 10-15 per cent this year and 5 per cent next year, forcing it to hold more capital against its mortgage loans.

A downturn would also force banks to hold more capital against mortgage loans. Lloyds said that it would have to hold £100m more against its £109bn home loans book if house prices were to slide by 12.5 per cent this year.

Eric Daniels, chief executive, said the bank was comfortable with its capital position.

It reported an 11 per cent rise in underlying pretax profit to £2.16bn driven by growth in its retail bank which took a 24 per cent share of net new mortgage lending in the first half and opened half-a-million current accounts.

However, the strong income growth was offset by exceptionals including writedowns of £585m on the its structured credit portfolio and a £794m charge related to market volatility in its insurance operations.

Lloyds said it would continue to seek acquisition opportunities.

Sir Victor Blank, chairman, said yesterday that “a bank that is well capitalised and agile on its feet should be looking at opportunities if it can” although he stressed it was focused on growing its existing business.

He said: “We’re a very strong bank and it would be wrong for us not to look at ways we can broaden ... That [acquisitions] is not something that is likely to happen in the very short term – don’t hold your breath.

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