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LONDON (Reuters) - Britain's biggest retail bank Lloyds set aside another 1.5 billion pounds to compensate customers mis-sold loan insurance, halting a strong rise in its shares and cooling prospects for a sale of the government's stake.
MPs want to sell the state's 39 percent shareholding, acquired when it bailed out Lloyds during the 2008 financial crisis, as soon as possible and certainly by the next election in 2015.
Returning to taxpayers some or all of the 20 billion pounds spent on rescuing Lloyds would give the Conservative led-coalition a boost against the opposition Labour party which is ahead in opinion polls.
Senior executives at rival Royal Bank of Scotland, which was also bailed out with taxpayers' money, said on Thursday they were hopeful that the government would start selling its 82 percent stake next year.
Shares in Lloyds have had a strong run, up 44 percent in the last 12 months, as Chief Executive Antonio Horta-Osorio impressed investors by cutting the bank's loan book and costs more quickly than expected and reining in bad debts.
They closed on Thursday, the day before Lloyds announced the latest compensation figures, at 54 pence.
The strong performance had fuelled market expectations that the shares would soon hit 61 pence - the level the government regards as its break-even price, which could trigger a partial sale.
But on Friday they fell as much as 8.6 percent to just under 50 pence at one point after the higher compensation bill overshadowed full-year results that beat forecasts. The shares recovered partially and closed 2.2 percent lower.
Horta-Osorio said he was "very confident" taxpayers would get their money back.
His annual bonus of 1.5 million pounds will be paid only when the shares are trading above the 73.6 pence the government bought in at or the government sells at least a third of its holding for more than the break-even 61 pence. The break-even price takes account of fees the government has already received from the bank.
The CEO's bonus will be paid in shares and deferred until 2018.
Britain's Finance Ministry said on Friday there was "still work to be done" as the bank continued to deal with past problems. It did not comment on the likely timing of any share sale.
Lloyds expects to pay out a total of 6.8 billion pounds to customers wrongly sold payment protection insurance (PPI), more than any other bank. The next highest is Barclays on 2.6 billion pounds.
The policies were meant to protect customers in the event of sickness or redundancy, but were often sold to borrowers who did not want or need them.
More than 14 billion pounds has now been set aside by UK banks to deal with the issue and industry sources have said the final bill could hit 25 billion pounds.
Lloyds made an underlying pretax profit of 2.6 billion pounds in 2012, up from 638 million a year earlier and ahead of the consensus forecast of 2.4 billion pounds, according to Thomson Reuters I/B/E/S data.
The bank is also one of more than a dozen still being investigated by regulators for their role in a global rate-rigging scandal, but Finance Director George Culmer said it was not one of the lenders at the centre of the probe.
"This isn't something we're just passive about," he said. "We do make proactive enquiries. It's not something that we get a lot of heat on."
Lloyds also set aside 400 million pounds to compensate small businesses mis-sold complicated interest-rate hedging products. The provisions dragged the bank to a pretax loss of 570 million pounds for the year, compared with a 3.5 billion loss in 2011.
Horta-Osorio said Lloyds' plan to sell 632 branches to the Co-Op remained "on plan" despite reports that it was on the verge of collapse.
However, the bank is also preparing for a stock market listing of the branches as a fall-back option.
Editing by Erica Billingham