UPDATE 2-Bank of China profit up; overseas holdings weigh

(Adds details and quote in paragraphs 3-6 and 8-10)

By Kennix Chim and Simon Rabinovitch

HONG KONG/BEIJING Aug 28 (Reuters) - Bank of China (3988.HK), the country's flagship foreign exchange lender, posted a forecast-beating 15 percent rise in second-quarter profit as rising fee income helped offset its exposure to overseas holdings including subprime U.S. mortgage assets.

Bank of China's first-half profit growth was the weakest among its peers due to its heavy overseas presence as U.S. rate cuts compressed its foreign currency lending spreads. Other Chinese banks have feasted on growing interest margins, although domestic margins are expected to narrow in the second half.

More than 30 percent of Bank of China's assets are in foreign currency, compared with an industry average of 8 percent, the bank said in a statement. Yuan currency appreciation and interest rate cuts in Hong Kong and the United States made it hard to prevent its foreign currency assets from losing value, it said.

The lender said it expects loan growth in the second half to slow from the first half, when lending increased by 13.8 percent, as Beijing curbs credit expansion to control inflation.

Bank of China President Li Lihui also said the bank will continue to underperform its peers in the second half.

"Our unique capital structure and business structure are not the same as others domestically so we confront more serious challenges than our peers," Li told reporters in Beijing, but said the bank's global reach and diversified business structure position it well for the long term.

Bank of China (601988.SS), the hardest-hit among big Chinese banks by its exposure to the U.S. subprime mortgage meltdown, said it held $5.47 billion worth of U.S. subprime-related securities at the end of June, and booked an impairment allowance of $2.4 billion for those securities for the first half.

It also held $17.3 billion of securities related to troubled U.S. mortgage firms Freddie Mac FRE.N and Fannie Mae FNM.N but reduced those holdings to $12.67 billion as of Aug 25. Bank of China's exposure to the two agencies was lower than brokerage CLSA's $20 billion estimate made in July.

The bank also said it held $5 billion in non-agency U.S. mortgage-backed securities, and has set aside impairment allowance of $599 million as of the end of June.

BEATING FORECASTS

The Beijing-based lender, in which Royal Bank of Scotland (RBS.L) has a nearly 4.5 percent stake, earned an April-June net profit of 20.5 billion yuan, compared with 17.8 billion yuan a year ago, beating five analysts' average forecast for 19.1 billion yuan based on Reuters calculations.

In the first half of this year, Bank of China reported 42.2 billion yuan net profit, up 43 percent from 29.5 billion yuan a year earlier and ahead of the 40.8 billion yuan forecast by analysts.

"Chinese banks' first-half results are outperforming other Chinese companies. Even though the lenders' second-half results cannot match the high growth of the first half, the fundamentals are still strong compared with other sectors," said Lawrence Lo, vice president at Lombard Odieer Darier Hentsch (Asia) Ltd.

Separately, its Hong Kong-based overseas flagship, Bank of China (Hong Kong) Ltd (2388.HK), posted a 5.1 percent fall in first-half profit to HK$7.1 billion ($910 million) and booked a net charge of HK$2.1 billion in impairment allowances for its U.S. asset-backed securities.

For a factbox on foreign bank investments in Chinese lenders, click [ID:nHKG15200]

Bank of China's net interest income derived from lending operations jumped 14.8 percent to 81.5 billion yuan in the first half of 2008. Net fee and commission income rose 45 percent to 22.4 billion yuan.

Net interest margins widened to 2.72 percent in the first half compared with 2.66 percent a year earlier.

Bank of China's Hong Kong-listed shares have lost 12 percent so far this year, compared with a 25 percent slide in the benchmark Hang Seng Index .HSI. Its Chinese domestic A-shares were down 45 percent during the same period of time.

(US$1=HK$7.8=6.828 yuan)

(Additional reporting by Eadie Chen in Beijing; editing by Tony Munroe and Sue Thomas)