Britain's Lloyds Banking Group sank to a 4 billion pounds ($6.8 billion) loss in the first half, battered by a surge in bad debts from its HBOS business, but the bank told investors it was through the worst.

Britain's biggest retail bank said on Wednesday its impairment losses for the six months to June jumped to 13.4 billion pounds, more than five times the 2.5 billion pounds a year ago and up from 12.4 billion in the previous six months.

But it said the impairments -- some 80 percent of which came from the business of beleaguered rival HBOS acquired in earlier this year -- peaked in the first half, reflecting its tough valuation of real estate assets badly hit in the credit crunch.

Consumer impairments and normal corporate impairments -- non-property related -- will peak a year or two after the trough of the recession, but because we have taken a prudent view on the property book, we expect this to be the top of our total impairments, Lloyds Chief Executive Eric Daniels told Reuters.

He added 70-80 percent of the impairments would be included in a government-backed asset insurance plan, which aims to limit the bank's exposure to losses on bad loans. The bank is still in talks to finalize terms for the complex scheme, Daniels said.

Lloyds is 43 percent owned by the UK government after taxpayer cash was used to rescue the lender.

News of a peak in bad debts, combined with hopes of further cost savings to come, helped lift the bank's shares in early trading. At 0847 GMT the shares were up 7.2 percent, compared with a 1.1 percent rise in the European sector <.SX7P>.

I am rather encouraged. What you have is a bit of a line in the sand -- people can really start to look at the underlying operating performance of this bank, analyst Mike Trippitt at Oriel Securities said.

IMPROVEMENTS AHEAD?

Lloyds' first-half pretax loss compared to a proforma profit of 2.8 billion pounds in the first half of 2008 and a forecast loss of 5.1 billion pounds, according to the average forecast of six analysts polled by Reuters.

Unlike rivals HSBC , Barclays and Royal Bank of Scotland retail-focused Lloyds does not have a major investment banking arm to help offset pressure on margins and bad debts.

But the lender, which warned in May that it expects to post a loss in 2009, said lower impairment charges in the coming months would more than offset continued pressure on margins, helping it to post improved results in the second half and into 2010. It expects to deliver high single-digit income growth within two years.

Margins will increase in 2010, though not to 2008 levels.

Lloyds said its integration of HBOS was on track to deliver more than 1.5 billion pounds run rate annual cost savings by the end of 2011.

Lloyds said it expects to run off around 200 billion pounds of assets over the medium term to reduce the balance sheet, which it said would have a modest impact on income.

But Daniels declined to comment on asset sales.

The bank also reassured investors on its capital position, with a core tier one of 6.3 percent and news it had extended the maturity of its wholesale funding.

($1=.5903 pounds)

(Reporting by Clara Ferreira Marques and Steve Slater; Editing by Mike Nesbit)

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