Dec. 13 (Bloomberg) -- HBOS Plc, the U.K.'s biggest mortgage lender, said writedowns and higher funding costs will hurt earnings this year, while an investment gain of about 1 billion pounds ($2 billion) probably won't recur in 2008.

HBOS had the biggest drop in more than five years of London trading after Finance Director Phil Hodkinson told analysts on a conference call that increased funding costs are offsetting higher rates on mortgage loans. Profit margins will fall more than it forecast for the year, and corporate lending, which helped it meet analysts' 2007 earnings estimates, will slow in 2008, HBOS said.

``It has become a more risky stock,'' said Mike Trippitt, a London-based analyst at Oriel Securities Ltd. who has a ``hold'' rating on the shares. ``It met estimates by higher realizations on its investment portfolio, and that is a quality-of-earnings question mark. The market doesn't think that is the same as having a big book of mortgages delivering the income.''

The Bank of England cut its benchmark interest rate on Dec. 6 from a six-year high, a day after HBOS said the U.K. property market had its worst three-month performance since 1995. HBOS, which predicts the number of U.K. property transactions will drop 15 percent next year, said it's ``too early'' to say when loan- pricing increases will offset the higher cost of funds.

HBOS fell 8.2 percent to 764.5 pence in London, valuing the bank at 28.5 billion pounds. The shares, down 33 percent this year, led declines for U.K banking stocks today.

HBOS wrote down about 550 million pounds of assets in the second half. A 180 million-pound loss on securities trading will come off this year's profit, while the writedowns on credit- related assets won't because HBOS plans to keep them on its books rather than sell them at a loss, it said.

Writedowns

HBOS marked down 30 million pounds of U.S. subprime assets, which stood at 430 million pounds as of Nov. 30, down from 550 million pounds in August. HBOS also wrote down about 340 million pounds on asset-backed securities, it said.

Net income at HBOS will rise 3.2 percent to about 4 billion pounds this year, according to the mean estimate of 16 analysts surveyed by Bloomberg. Second-half net income will fall 11 percent to 1.9 billion pounds, according to Bloomberg data.

Lloyds TSB Group Plc, the U.K.'s largest provider of consumer loans, said earlier this week that 2007 profit will be hurt by a 201 million-pound writedown on credit related assets, including collateralized debt obligations. The London-based bank will also write down ``just over 200 million pounds'' on credit-related assets that won't hurt profit.

No Buybacks

HBOS's said this year's net interest margin, the difference between what it earns on lending and pays for funding, will fall more than the 7 basis points it forecast earlier this year. The margin fell to 1.68 percent in the first half from 1.74 percent a year earlier, the bank said in August.

The bank said it won't start a new program to buy back shares until there is ``greater certainty'' about market conditions. Its planned 500 million-pound buyback was completed in 2007, it said.

Increased funding costs have hurt retail earnings ``exclusively,'' Hodkinson said. Consumer-banking profits in the second half will be as much as 70 million pounds lower than the 1.04 billion pounds it posted in the first half, he said.

HBOS, which booked ``exceptional'' gains related to private equity investment of about 1 billion pounds in 2007, forecasts lower gains in 2008. Corporate-lending profit rose 54 percent in the first half to 1.24 billion pounds, helped by lending to private equity companies.

`Less Sustainable'

``Exceptionally strong investment portfolio realization gains'' at HBOS are ``certainly less sustainable into 2008 and are certainly less valued by investors,'' said Deutsche Bank AG analysts in an e-mailed note to clients. Deutsche Bank, which has a ``hold'' rating on HBOS shares, may cut its forecast for retail profit by 11 percent.

While there are no signs of ``stress'' among mortgage borrowers, bad debts will probably rise in 2008 as the U.K. economy slows, Hodkinson said. HBOS will ``temporarily'' miss its tier-1 capital ratio target this year, Hodkinson said. Tier-1 capital is a measure of capital strength.

Today's report adds to evidence the housing boom in the U.K. is grinding to a halt after a rise in credit costs, sparked by the collapse the U.S. subprime mortgage market, made Britons more reluctant to buy homes.

U.K. real-estate agents and surveyors became the most pessimistic about house prices since at least 1998 last month as a property-market decline spread to London, the Royal Institution of Chartered Surveyors said.

Slowdown in London

An index of expected house prices fell to minus 47 in November, from minus 35.3 the previous month, London-based RICS said today, citing a survey. The result was the lowest since the group first recorded the outlook for future property values in 1998. A gauge of house prices also fell to the least in 2 1/2 years and the London market started to show declines.

``The big issues for HBOS are where mortgage margins are going and where mortgage originations are going,'' said Antony Broadbent, a London-based analyst at Sanford C. Bernstein & Co. ``There is a high degree of uncertainty about the macro environment in the U.K., and HBOS is clearly dependent on that,'' said Broadbent who has an `outperform' rating on the stock.

HBOS depends less on capital markets for earnings growth than bigger U.K. competitors including Royal Bank of Scotland Group Plc and Barclays Plc, which together have written down more than 3 billion pounds in credit-related loans and securities backed by U.S. subprime loans.

HBOS was forced to step in and repay as much as $35 billion of commercial paper owed by its Grampian Funding LLC unit in August as borrowing costs rose. The bank is ``very, very comfortable'' with the unit, which is funding itself, he said.

The U.K. floods of June and July will reduce insurance profits by 140 million pounds, it said.

``I am confident in terms of the outlook,'' Chief Executive Officer Andy Hornby said in a conference call with journalists. The U.K. housing market and the corporate lending market will be ``resilient'' next year, he said.

To contact the reporter on this story: Ben Livesey in London blivesey@bloomberg.net

Last Updated: December 13, 2007 12:13 EST