By Matt Scuffham and Steve Slater
LONDON (Reuters) - Britain's biggest retail bank Lloyds <LLOY.L> set aside another 1.5 billion pounds ($2.3 billion) to compensate customers mis-sold loan insurance, hitting its shares and tempering prospects for a swift sale of the government's stake.
The state wants to sell its 39 percent shareholding, which it acquired from bailing out Lloyds during the 2008 financial crisis, as soon as possible - ideally before the next election in 2015.
Shares in Lloyds have had a strong run, up by 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.
That had fuelled expectations the shares would soon hit 61 pence - the level which the government regards as its break-even price that could trigger a partial sale after deducting fees it has already received from the bank. The shares closed on Thursday at 54 pence.
On Friday they fell 7 percent to just over 50 pence after the higher compensation bill overshadowed Lloyds full-year results.
Horta Osorio said he was "very confident" taxpayers would get their money back - so much so that he has asked for his annual bonus of 1.5 million pounds to be paid back 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 CEO's bonus will be paid in shares and deferred until 2018.
Lloyds now 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 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.
Lloyds is also one of more than a dozen banks 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 banks at the centre of the probe.
"This isn't something we're just passive about," he added. "We do make proactive enquiries. It's not something that we get a lot of heat on."
Lloyds 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.
($1 = 0.6588 pound)
(Editing by Erica Billingham)