* Gains regulatory approval for insurance IPO
* Group will revisit state aid repayments timing after insurance IPO
* Reducing exposure to Ukraine, Russia (Recasts leads, adds executive quotes, analyst comment)
By Laura Noonan
LONDON, May 7 (Reuters) - Dutch financial group ING cut loan losses faster than expected in the first quarter and gained regulatory approval for the sale of its insurance business, taking the sting out of weaker-than-expected underlying earnings.
ING on Wednesday said it made a profit of 988 million euros ($1.38 billion), less than the 1.103 billion predicted by a Reuters poll of ten analysts, as its insurance arm slightly undershot expectations.
The group has already radically reshaped itself to comply with the terms of a 10 billion euro state rescue, shedding investment banking operations and cutting thousands of jobs. The sale of its insurance division is the last milestone in that process and will leave ING as a pure bank.
Chief Executive Ralph Hamers said on a conference call that once the insurance sale was completed, ING would consider whether it could accelerate its repayment of state aid, something that would allow the bank to resume dividend repayments faster.
The final payment of the bailout, totalling 1.025 billion euros, is due to be made in May 2015. ING has said it will pay out at least 40 percent of its earnings to shareholders after that.
"We've always said that if there is a possibility to accelerate, we will certainly take a look at it," Hamers said.
ING said it would inject 850 million euros into the insurance unit ahead of its planned initial public offering (IPO). The IPO will not be used to raise new capital, after ING attracted private investment of 1.275 billion euros into the business last month, the company said.
ING shares were down 0.7 percent in morning trade, broadly in line with European banks
ING's banking business reported an underlying net interest margin - a measure of the gap between what the bank pays for funding and what it earns from lending - rose to 150 basis points, hitting ING's target of 150 and 155 basis points by 2017. In the first quarter of 2013, the figure was 138 basis points.
Loan losses fell to 468 million euros from 561 million euros a year earlier, in line with the bank's guidance that 2013 was the peak.
"They're still at a relatively elevated level," ING's chief risk officer Wilfred Nagel said. "We do see these signs of recovery, but there's always a lag between that and our risk costs (loan losses)." That lag is usually two or three quarters, he added.
Jefferies' analyst Omar Fall said the drop in loan losses was good news given the state of the Dutch property market, where house prices have fallen 21.5 percent from their 2008 peak and one third of all homes are worth less than their mortgages.
"The underlying profit looks a bit soft versus consensus, but that's all driven by non-operating stuff at the insurer," Fall said. "The quality items look good...loan losses are much better than expected."
ING is one of the 128 banks whose loan books are being reviewed by the European Central Bank ahead of an EU-wide exercise to examine whether banks need more capital to withstand another financial crash.
Executives declined to comment in detail, but said in general the doomsday scenarios being used in the tests were likely to inspire more confidence amongst investors than health checks in 2010 and 2011 that were discredited for being too soft.
The bank's net lending grew by 5.1 billion euros, more than the 2.5 billion euros of new lending in the first quarter of 2013, but was outstripped by the 8.3 billion euros increase in deposits.
Hamers said the balance between the two was moving in the right direction but not quite where the bank would like it.
Analysts see loan growth, which is particularly challenging in the weak Dutch market, as key to ING's future earnings. Earlier this week, the European Commission raised its economic growth forecasts for the Netherlands, which is still expected to lag European Union-area growth for 2014 and 2015.
The bank's return on equity was 10.2 percent for the quarter, against a target of 10 to 13 percent, which is broadly in line with ambitions of European peers.. Its core tier one capital, a key measure of financial strength, came in at 10.1 percent, well ahead of expectations, partly because of changes to its internal models.
ING is a lender in politically troubled neighbours Ukraine and Russia, though that makes up less than 2 percent of its overall book. "We have reduced exposure somewhat, it is our intention to continue to support our clients for as long as is reasonably possible," Hamers said. ($1 = 0.7177 euros) (Editing by Erica Billingham)