March 7 (Bloomberg) -- Lloyds Banking Group Plc, Britain’s biggest mortgage lender, will cede control to Prime Minister Gordon Brown’s government in return for state guarantees covering 260 billion pounds ($367 billion) of risky assets.

The government’s stake will rise to as much as 75 percent, making Lloyds the fourth U.K. bank to slip into state control since the run on Northern Rock Plc in September 2007. Brown is using that leverage to force banks to increase lending to homeowners and businesses and spur an economy that is facing its worst recession since World War II.

“In order to get British banks lending again the government needed to take them over,” said Simon Willis, an analyst at NCB Stockbrokers Ltd. in London, who has a “sell” rating on Lloyds stock. “It is likely to be at least three of four years before the banks return to the private sector.”

Lloyds will pay more for asset protection than Royal Bank of Scotland Plc, the first lender to enter the program, because of the deteriorating quality of loans acquired when it bought HBOS Plc in a government-brokered deal. London-based Lloyds will pay 15.6 billion pounds, or 5.2 percent of the insured assets, in the form of non-voting shares, the bank said in a statement. RBS last month paid 2 percent.

About 83 percent of the assets Lloyds is insuring came from HBOS, the bank said.

‘Rubbish Bank’

The HBOS loan book “is more toxic than anyone ever dreamed,” said Alan Beaney, who helps manage $2 billion, including Lloyds stock, at Principal Investment Management in Sevenoaks, England. “As a Lloyds shareholder you are very annoyed because you had a bank that did not need the government very much and now you have inherited a rubbish bank.”

In September, Lloyds agreed to buy HBOS for about 7.7 billion pounds as the government sought to prevent HBOS from collapsing after credit markets froze.

Last month, HBOS posted a pretax loss of 7.5 billion pounds, bigger than Lloyds anticipated at the time of the takeover, and Chief Executive Officer Eric Daniels said he would have liked more time to examine HBOS’s accounts before the purchase. Lloyds wouldn’t have needed taxpayers’ money if it hadn’t made the acquisition, he said.

Some shareholders are pressuring Daniels to resign because of the HBOS deal, Beaney said. Daniels, who joined Lloyds in 2001, will receive a 3 million-pound pension, the London-based Times reported today, without saying where it got the information. The 58-year-old CEO will be entitled to payments of 150,000 pounds a year when he turns 60, the newspaper said.

Deepening Recession

Before today, the government had invested 17 billion pounds in Lloyds and HBOS, giving the Treasury a 43 percent stake when the banks combined. In January, Lloyds said it would resist any attempt to increase state ownership.

That position changed as the economy worsened, spokesman Shane O’Riordain said in an interview today.

“Banks across the world are facing unprecedented market conditions right now,” he said. “Our first objective is ensure that we have a very strong balance sheet given the downturn.”

Governments in the U.S. and Europe have stepped in to prop up ailing banks and stimulate lending. On Feb. 27, the U.S. government agreed to a third bailout of Citigroup Inc., increasing its stake in what was once the world’s biggest financial services company to 36 percent.

Increased Lending

In Britain, Brown’s government has tightened control over the banking system since October, when it pledged 37 billion pounds to recapitalize Lloyds and Royal Bank of Scotland Group Plc. While that cash kept the industry out of bankruptcy, it hasn’t bolstered lending to consumers.

As a condition of today’s deal, Lloyds agreed to increase lending to businesses and homeowners by 28 billion pounds over the next 24 months.

In return, Lloyds will get government insurance for 74 billion pounds of residential mortgages, 18 billion pounds of unsecured personal loans, 151 billion pounds of corporate and commercial loans and 17 billion pounds of treasury assets, the bank said in the statement.

Lloyds will be responsible for the initial 25 billion pounds of losses on the insured assets, the bank said. It will cover 10 percent of any additional losses, with the Treasury responsible for the rest.

The government will also underwrite a 4 billion-pound share sale and convert existing preference shares into equity, the bank said in the statement. Converting the preference shares will save Lloyds 480 million pounds a year in dividend payments.

Tier 1 Capital

The additional capital and reduction in Lloyds’ risk- weighted assets will boost its Tier 1 capital ratio -- a measure of the bank’s strength -- to 18.7 percent, Lloyds said.

“Our significantly enhanced capital position will ensure that the group can weather the severest of economic downturns and emerge strongly when the economy recovers,” Daniels said in the statement.

Lloyds has declined 66 percent in London trading this year, making it the worst performer in the five-member FTSE 350 Banks Index. The lender is now valued at 7.1 billion pounds.

The government waived competition rules to allow Lloyds to buy HBOS for about 7.7 billion pounds and create a bank with 3,300 branches, 140,000 employees and 28 percent of Britain’s mortgage market.

Lloyds may sell assets and cut jobs as it integrates HBOS and tries to reach a target of cutting 1.5 billion pounds of costs by 2011.

As a result of the government bailout, it will be years before any benefits flow to shareholders, said Alex Potter a London-based analyst at Collins Stewart, who has “hold” rating on the stock.

“This is not going to be generating any cash for its shareholders dividend in the next four or five years,” he said. “It is good for the bank because it stabilizes the banks balances, but it is not good for the shareholders.”

To contact the reporter on this story: Andrew MacAskill in London at amacaskill@bloomberg.netJon Menon in London at jmenon1@bloomberg.net

Last Updated: March 7, 2009 09:32 EST