WRAPUP 1-Israeli bank profits fall less than feared

* Hapoalim Q1 net profit 659 mln shekels vs 540 mln forecast

* Leumi profit 431 mln shekels, above forecast of 375 mln

* Discount profit 278 mln shekels vs 194 mln consensus

* Bad loan charges better than expected at all three banks

By Tova Cohen

TEL AVIV, May 31 (Reuters) - Israel's top three banks posted smaller-than-expected falls in quarterly net profit on Thursday, raising hopes they can keep a lid on bad loans even as the country's economic boom slows.

Analysts said the results underscored the advantages of top bank Hapoalim over its rivals, as it benefited from a lower exposure to foreign banks and non-banking investments, as well as tight cost control and solid fee income.

Israel's economy grew at an annualised rate of 3 percent in the first quarter, its slowest pace in nearly three years, raising fears of a big increase in bad loans from the country's many highly-leveraged conglomerates.

Hapoalim, Israel's largest bank in terms of market value and outstanding credit, reported a 26 percent fall in first-quarter profit to 659 million shekels ($180 million), beating expectations of 540 million in a Reuters poll.

Psagot brokerage analyst Terence Klingman said the results justified his preference for Hapoalim over top rival Leumi .

"On an operational level the bank has a clear advantage over Leumi and it seems the overall risk in its balance sheet - credit portfolio together with exposure to bonds in foreign banks and investments in shares of (non-banking) companies - is lower than that of Leumi," Klingman said.

Deutsche Bank analyst Dan Harverd said there were several positive surprises in Hapoalim's report including a 3 percent increase in core net interest income and strong fee income, including a pick-up in securities and foreign trade activity.

"The bank reported a quarterly return on equity (ROE) of 11.3 percent whereas the consensus expectation was for single digit ROE in 2012, suggesting potential for earnings upgrades following (the) results," Harverd said.

"The overall impression is of a typical mid-cycle quarter with profitability levels representative of the long term," said Harverd, who rates Hapoalim "buy".

Hapoalim's shares were up 1.8 percent to 12.59 shekels in afternoon trade.

EARNINGS VOLATILITY

One of the main areas of focus for Israeli banks in 2012 and 2013 will be regulation. Israel's banking regulator issued guidelines that banks have to raise their core capital ratio to 9 percent by the end of 2014 as part of Basel III standards.

Hapoalim, which has a core Tier 1 ratio of 8.2 percent, is "well on course to get to the 9.0 percent target ahead of the year-end 2014 deadline," Citi analyst Michael Klahr said.

Leumi, which had a core Tier I ratio of 8.28 percent, saw its net profit fall 22 percent to 431 million shekels compared with 375 million forecast. Expenses relating to credit losses amounted to 225 million shekels, below expectations.

Harverd called Leumi's results "solid" but said that once again the profitability gap versus Hapoalim was underscored with ROE weak at 7.5 percent.

"Leumi's holdings in non-banking corporations had a negative impact on results calling into question again the wisdom of the strategy, in our view," he said.

There was a 59 million shekel charge for its investment in mobile phone operator Partner Communications and a 48 million shekel loss from its stake in Israel Corp.

"It is not so much the losses that bother us ... more the volatility to earnings that arises from non-banking earnings," Harverd said.

The quality of Leumi's credit portfolio remains high while the level of diversification has increased, he said.

Leumi shares were up 1.5 percent to 9.86 shekels.ž

Israel Discount Bank, the country's third-largest bank, beat forecasts with an 11 percent fall in quarterly profit to 278 million shekels, above a Reuters poll consensus of 194 million. Its shares gained 1.9 percent to 4.28 shekels.

($1 = 3.88 shekels) (Additional reporting by Steven Scheer; Editing by Mark Potter)