Profits at Alliance & Leicester have been virtually wiped out after the mortgage lender took a £209 million hit on credit-related investments.

Pre-tax profits for the six months to June 30 fell more than 99 per cent from last year’s £290 million to just under £2 million as the bank also grappled with higher funding costs.

A&L said that the value of certain Treasury investments had fallen by £66 million in the first half and the impairment of other assets had cost £143 million. The £209 million charge is above the £192 million for the first four months, which the bank announced in May.

At the same time the bank, which is being bought by Santander, of Spain, the owner of Abbey, gave a gloomy forecast on future trading.

It said: “The outlook for the UK economy has worsened as 2008 has progressed and the degree of uncertainty about the economic outlook has increased. There is a risk that the current economic and market turbulence could continue for a significant period of time, and a risk of further uncertainty and contagion impacting the valuation of Alliance & Leicester.”

The group’s mortgage business has slowed dramatically as it seeks to tighten lending criteria in the face of market troubles. Its share of gross lending — all new business and advances — more than halved to 1.6 per cent from 3.4 per cent in the first half of last year. The bank said that it was focused on improving cost-efficiency, reducing core operating costs by £21 million in the first half of 2008 compared with the same period in 2007. It insisted that it was in “good shape” and said that it was well capitalised and that its retail and commercial banking businesses were performing better than expected. A&L said that it had focused its franchise growth on current accounts and retail customer deposits. It said that 154,000 new personal current accounts and 17,200 new business banking current accounts had been opened. Retail customer deposit balances were up £800 million to £24.1 billion at June 30, while mortgage balances had been reduced by £2.1 billion to £40.6 billion.

David Bennett, chief executive, told analysts yesterday why the group had agreed to the £1.26 billion takeover by Santander. “The proposal . . . provided greater stability and greater certainty in uncertain times,” he said.

Mr Bennett pointed out that market turbulence could continue for a significant period and he emphasised the value of being part of a larger group in uncertain times.

This week HBOS — which owns Halifax and Bank of Scotland — and Lloyds TSB both reported sharp falls in profits for the first six months of the year as rising levels of toxic debt hit their balance sheets.

Alex Potter, an analyst at Collins Stewart, said in a note: “As with Abbey in the early part of this century, small banks lacking the skills set in capital markets are the ones being hurt most by credit events. First-half earnings [at Alliance & Leicester] were almost completely wiped out by Treasury losses as well as the expensive funding facility. We fear this will mean a repeat performance at Bradford & Bingley, reporting on August 29.”

Jennifer Kapila, an analyst at Dresdner Kleinwort, added: “The potential read-across to Bradford & Bingley, particularly with respect to margins, does not look good.”

The shares, supported by hopes that a rival might yet appear to top Santander’s 317p-per-share offer, rose a modest ¼p to 340¾p.

Telling figures

99%: The collapse in A&L's half-year profits

£66m: The fall in value of its Treasury investments

£1.26bn: The amount Santander is paying for A&L

£21bn: The fall in mortgage balances to June 30

£800m: The rise in retail customer deposit balances

Source: company statement

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive