Britain's biggest mortgage lender disclosed yesterday that it has almost £5 billion of problem home loans on its books as it gave a downbeat forecast for this year's housing market.

HBOS predicted a 9 per cent fall in property prices this year, up from its previous predictions of a “mid-single digit” decline, and wrote down £100 million on its own investments in the troubled housebuilding sector.

Standard & Poor's, the ratings agency, knocked HBOS's rating down from “stable” to “negative” because of the potential hit to its business from Britain's slowing economy.

HBOS laid bare its trading up to the end of May in an update to accompany the prospectus for its £4 billion rights issue. The 194-page document was posted to the bank's 2.1 million retail shareholders yesterday, with the capital raising due to close on July 21.

Investors had feared huge increases in arrears after the decision two weeks ago by Bradford & Bingley to rejig its rights issue in the wake of a trading slump and rocketing bad debts. But Andy Hornby, chief executive, emphasised that the lender's business was in line with expectations. Mr Hornby said that bad debts had increased, but only as expected. “You're bound to see arrears tick up for a couple of years but we're coming from a very benign period,” he said.

HBOS had some good news, predicting margins would improve in 2009 as the bank passed on its higher borrowing costs to customers. Impairments on the bank's investments in the US mortgage market were flat at £2.8 billion, £1.8 billion of which is held in the bank's treasury so will not have an effect on profits or regulatory capital. Mr Hornby said that he was unconcerned by the £929 million increase to £1.4 billion in HBOS's exposure to monoline insurers.

Specialist mortgages - buy-to-let and self-certified - make up almost 26 per cent of HBOS's £250 billion mortgage book. Yesterday the bank said that 3.09 per cent of its specialist mortgages were in arrears. This is a measure of the number of borrowers that had missed their mortgage repayments for three months or more. It does not include repossessed houses. Overall, 1.89 per cent of HBOS's mortgages were in arrears at the end of May, up from 1.67 per cent at the end of last year. This is equivalent to £4.9 billion-worth of souring loans.

Mr Hornby said that the bank made its specialist mortgages more expensive to counteract the higher arrears.

HBOS also revealed £4.2billion-worth of loans and investments in the housebuilding sector, which has seen share prices collapse in the past few weeks amid fears of rescue refinancing. The bank had put £200 million of its own money into housebuilders but said yesterday that this investment had halved in value.

The property and construction sector makes up 38 per cent of HBOS's £120 billion commercial loan portfolio but Mr Hornby said that he was comfortable with the bank's exposure. “When you look at a corporate bank like us, you have to look at the entire portfolio and in general the corporate portfolio has performed well,” he said.

Despite the worsening economic climate, the value of HBOS's private equity investments increased by £600million, which Mr Hornby attributed to improvements in the value of some of the bank's small investments and to new deals. He warned that revenues from the bank's stakes would be lower this year than that of 2007.

The bank revealed it would spend £160 million on its rights issue, which is designed to bolster its capital base. Its share price, which had been fluctuating wildly and had fallen below the 275p subscription price, has stabilised since the FSA announced plans last week to crack down on short-selling. The bank's stock closed down 6.9per cent at 296p per share. Mr Hornby insisted nothing would derail the capital raising: “Our rights issue is fully underwritten, it's on track and we're going to get it completed and get back to normal life.”

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