Britain's biggest lender reported a 17% decline in the third quarter as bad debt provisions surged compared with 2021.
The FTSE 100 (^FTSE) bank revealed a £668m ($775.6m) impairment charge in the three months to 30 September, a big swing from the £199m it held onto in credit last year.
Pre-tax profits were £1.5bn in the third quarter, a considerable drop compared to the £2bn reported last year and below the market consensus of £1.8bn.
Read more: FTSE 100: Barclays post £2bn profit
Lloyds said the loss reflects the worsening economy and higher interest rate environment, but assured investors that there has been only "very modest" evidence of customers struggling with repayments to-date.
The bank is exposed to Britain's cooling housing market amid falling house prices while surging mortgage rates has seen repayments climb for millions of borrowers.
Lloyds forecasts the UK economy to shrink 1% next year, with house prices declining 7.9%. Its worst-case scenario assumes a crash of almost 18% in house values.
“Lloyds’ exposure to traditional lending, especially mortgages, puts it in the firing line when conditions sour,” Sophie Lund-Yates, equity analyst at Hargreaves Lansdown, said.
Shares in the lender were down as much as 1.6% in early trade on Thursday in London.
Charlie Nunn, group chief executive at Lloyds, said: "Our income growth, balance sheet momentum and resilient customer franchise have enabled the group to deliver a robust financial performance and strong capital generation, alongside updated guidance for 2022.
"The current environment is concerning for many people and we are committed to maintaining support for our customers.
"The group’s resilient business model and prudent approach to risk position the group well to face the current macroeconomic uncertainties while generating enhanced returns for our shareholders."
Despite this, revenues at the group jumped on the back of higher interest rates.
Lloyds’ underlying net interest income rose to £3.4bn in the quarter, driven by a stronger net interest margin of 2.98% from 2.55%. This is the difference between what a bank earns in interest and pays on deposits.
It comes as the Bank of England has consistently hiked the key rate over recent months to its current level of 2.25%, sending average mortgage rates higher and making it more expensive to borrow.
Chief financial officer William Chalmers told journalists in a media call that Lloyds will be passing about 50% of rising rates through to savings customers, in line with its competitors. He added that, so far, customers have been resilient as the cost of living soars, with unarranged overdraft use and minimum payments on credit cards all stable.
It also updated its full-year outlook and upped its net interest margin expectations to at least 2.9%.
Barclays said it achieved income growth in all three of its businesses, adding its diversified income streams position the group well for the current economic and market environment including rising interest rates.