The scandal around mis-sold payment protection insurance (PPI) has threatened to overshadow "substantial progress" at taxpayer-backed Lloyds Banking Group.
The lender, which is 39.7% state-owned, took an additional £375 million hit to cover the growing volume of PPI claims, bringing the total set aside to nearly £3.6 billion.
While this triggered a 9% slide in bottom-line pre-tax profits to £288 million in the three months to March 31, the underlying picture appeared to be much brighter.
Shares in the bank rose nearly 5% as officials revealed a significant cut to its bad debts, lower eurozone exposure and higher underlying profits in its core businesses.
The group also repaid a hefty chunk off the liquidity support from the Government and Bank of England - leaving £12.9 billion of Treasury-guaranteed loans left to repay, down 45% from the end of last year and down 77% compared to 12 months ago.
Richard Hunter, head of equities at Hargreaves Lansdown Stockbrokers, said: "There are some signs of improvement within the update and the overall figure has beaten analyst expectations."
Lloyds, which includes the Halifax, was pushed to a £3.5 billion loss in 2011 by the PPI mis-selling scandal, leaving taxpayers wondering when they will get their money back.
Chief executive Antonio Horta-Osorio has previously warned the bank faces a tough 2012, with income-related targets set to be delayed as a result of the weaker-than expected economic outlook. The Portuguese banker announced thousands of job losses as part of his strategic review as well as plans to sell off large parts of its international operations.
But Mr Horta-Osorio said "substantial progress" had been made with the review, including the reduction of non-core assets as it disposed of several businesses in the period, such as its onshore Dubai business to HSBC.
The bank said it advanced £3.25 billion of gross new lending to small businesses in the first quarter and is on track to fulfil its commitment of £12 billion of gross new lending to small and medium enterprises (SMEs) in 2012. Net lending to small businesses grew 4% year on year, compared with a 4% decline in the wider market, Lloyds said.