* Small decline in pretax profits expected
* Likely to boost provision for mis-selling payouts
* Shares have outperformed rivals this year
LONDON, July 26 (Reuters) - Lloyds Banking Group kicks off the results season for British banks on Thursday with the industry still reeling from an interest rate-rigging scandal and the fallout from mis-selling loan insurance and interest rate hedging products.
Britain’s biggest retail bank, which is 40 percent-owned by the government after a 2008 bailout, is expected to report a small decline in first-half profits, reflecting a scaling back of activities.
Lloyds has reduced its loan book, cut costs and reined in bad debts as part of a recovery plan, helping its shares to perform better than those of its rivals so far this year.
It is expected to make an underlying pretax profit of 1.03 billion pounds ($1.6 billion), down from 1.1 billion pounds a year ago, according to its own poll of analysts.
The bank is likely, however, to increase the 3.6 billion pound provision set aside to cover compensation for mis-selling loan insurance after a sharp rise in claims in recent months, which banks say is fueled by aggressive marketing by claims-management companies.
The latest data from Britain’s financial regulator shows that payouts have risen every month this year, with May’s 730.5 million pounds representing an increase of more than 80 percent on January’s figure.
Along with other British banks, Lloyds has also agreed to pay compensation to customers misled about interest rate hedging products, though it has said that the costs from this are not expected to be material.
It also faces questions on the extent of its involvement in manipulation of the Libor interbank lending rate, which has rocked the industry and resulted in Barclays being fined a record $453 million.
Lloyds said in its 2011 annual report that it was a defendant in several Libor-related lawsuits and a recent research note from Liberum Capital said that it could have to pay out up to 1.5 billion pounds.
Since the start of the year, shares in Lloyds have risen by 11 percent, compared with falls of 14 percent and 3 percent at Barclays and RBS respectively.
Lloyds struck a deal last week to sell 632 branches to the Co-operative, having been ordered by European regulators to offload them as payback for receiving state aid. However, Lloyds has faced criticism for accepting a knock-down price. It had been expected to raise as much as 1.5 billion pounds from the sale but will receive only 350 million pounds upfront.
Following Lloyds, Barclays will report first-half results on Friday, with HSBC posting its first-half numbers on Monday and RBS reporting on August 3. ($1 = 0.6441 British pounds)
Reporting by Matt Scuffham; Editing by David Goodman