UPDATE 4-Lloyds mis-selling hit cools prospects for UK share sale

* Lloyds' PPI mis-selling bill rises to 6.8 bln stg

* CEO 'very confident' taxpayers will get money bank

* 2012 pretax profit 2.6 bln stg vs 2.4 bln forecast

* UK Treasury says 'still work to be done' at bank

* Shares fall as much as 8.6 pct

By Matt Scuffham and Steve Slater

LONDON, March 1 (Reuters) - Britain's biggest retail bankLloyds set aside another 1.5 billion pounds ($2.3billion) to compensate customers mis-sold loan insurance,halting a strong rise in its shares and cooling prospects for asale of the government's stake.

Lawmakers want to sell the state's 39 percent shareholding,acquired when it bailed out Lloyds during the 2008 financialcrisis, as soon as possible and certainly by the next electionin 2015.

Returning to taxpayers some or all of the 20 billion poundsspent on rescuing Lloyds would give the Conservativeled-coalition a boost against the opposition Labour party whichis ahead in opinion polls.

Senior executives at rival Royal Bank of Scotland,which was also bailed out with taxpayers' money, said onThursday they were hopeful that the government would startselling its 82 percent stake next year.

Shares in Lloyds have had a strong run, up 44 percent in thelast 12 months, as Chief Executive Antonio Horta-Osorioimpressed investors by cutting the bank's loan book and costsmore quickly than expected and reining in bad debts.

They closed on Thursday, the day before Lloyds announced thelatest compensation figures, at 54 pence.

The strong performance had fuelled market expectations thatthe shares would soon hit 61 pence - the level the governmentregards as its break-even price, which could trigger a partialsale.

But on Friday they fell as much as 8.6 percent to just under50 pence at one point after the higher compensation billovershadowed full-year results that beat forecasts. The sharesrecovered partially and closed 2.2 percent lower.

Horta-Osorio said he was "very confident" taxpayers wouldget their money back.

His annual bonus of 1.5 million pounds will be paid onlywhen the shares are trading above the 73.6 pence the governmentbought in at or the government sells at least a third of itsholding for more than the break-even 61 pence. The break-evenprice takes account of fees the government has already receivedfrom the bank.

The CEO's bonus will be paid in shares and deferred until2018.

Britain's Finance Ministry said on Friday there was "stillwork to be done" as the bank continued to deal with pastproblems. It did not comment on the likely timing of any sharesale.

Lloyds expects to pay out a total of 6.8 billion pounds tocustomers wrongly sold payment protection insurance (PPI), morethan any other bank. The next highest is Barclays on2.6 billion pounds.

The policies were meant to protect customers in the event ofsickness or redundancy, but were often sold to borrowers who didnot want or need them.

More than 14 billion pounds has now been set aside by UKbanks to deal with the issue and industry sources have said thefinal bill could hit 25 billion pounds.

Lloyds made an underlying pretax profit of 2.6 billionpounds in 2012, up from 638 million a year earlier and ahead ofthe consensus forecast of 2.4 billion pounds, according toThomson Reuters I/B/E/S data.

The bank is also one of more than a dozen still beinginvestigated by regulators for their role in a globalrate-rigging scandal, but Finance Director George Culmer said itwas not one of the lenders at the centre of the probe.

"This isn't something we're just passive about," he said."We do make proactive enquiries. It's not something that we geta lot of heat on."

Lloyds also set aside 400 million pounds to compensate smallbusinesses mis-sold complicated interest-rate hedging products.The provisions dragged the bank to a pretax loss of 570 millionpounds for the year, compared with a 3.5 billion loss in 2011.

Horta-Osorio said Lloyds' plan to sell 632 branches to theCo-Op remained "on plan" despite reports that it was on theverge of collapse.

However, the bank is also preparing for a stock marketlisting of the branches as a fall-back option.